497 1 d492712d497.htm FINAL PROSPECTUS SUPPLEMENT Final Prospectus Supplement
Table of Contents

Filed pursuant to Rule 497
File No. 333-220385

 

PROSPECTUS SUPPLEMENT

(to Prospectus dated November 1, 2017)

 

 

 

 

 

 

LOGO

$50,000,000

5.95% Notes due 2022

 

 

We are an internally managed, closed-end, non-diversified management investment company that has elected to be treated as a business development company under the Investment Company Act of 1940, as amended. Our principal investment objective is to produce attractive risk-adjusted returns by generating current income from our debt investments and capital appreciation from our equity and equity related investments.

We are offering $50 million in aggregate principal amount of 5.95% notes due 2022, which we refer to as the Notes. The Notes will mature on December 15, 2022. We will pay interest on the Notes on March 15, June 15, September 15 and December 15 of each year, beginning March 15, 2018. We may redeem the Notes in whole or in part at any time or from time to time on or after December 15, 2019, at the redemption price of 100% plus accrued and unpaid interest, as discussed under the section titled “Description of the Notes — Optional Redemption” in this prospectus supplement. The Notes will be issued in minimum denominations of $25 and integral multiples of $25 in excess thereof.

Under the terms of this variable price reoffer, the underwriters have agreed to purchase the Notes from us at 97% of the aggregate principal amount of the Notes (resulting in $48.5 million in aggregate proceeds to us, before deducting expenses payable by us). The underwriters propose to offer the Notes for sale, from time to time, in one or more negotiated transactions, at prices that may be different than par. These sales may occur at market prices prevailing at the time of sale, at prices related to such prevailing market prices or at negotiated prices.

The underwriters may also purchase up to an additional $7.5 million aggregate principal amount of Notes offered hereby, within 30 days of the date of this prospectus supplement. If the underwriters exercise this option to purchase additional Notes in full, the total aggregate proceeds to us, before deducting expenses payable by us, will be $55.8 million.

The Notes will be our direct unsecured obligations and rank pari passu, which means equal in right of payment, with all outstanding and future unsecured unsubordinated indebtedness issued by us. Because the Notes will not be secured by any of our assets, they will be effectively subordinated to all of our existing and future secured indebtedness (or any indebtedness that is initially unsecured as to which we subsequently grant security), to the extent of the value of the assets securing such indebtedness, including, without limitation, borrowings under our senior secured revolving credit facility, as amended, or the Credit Facility, of which we had $86.0 million outstanding as of December 12, 2017. The Notes will be structurally subordinated to all existing and future indebtedness and other obligations of any of our subsidiaries since the Notes are obligations exclusively of Capital Southwest Corporation and not of any of our subsidiaries. None of our subsidiaries is a guarantor of the Notes and the Notes will not be required to be guaranteed by any subsidiary we may acquire or create in the future. In any liquidation, dissolution, bankruptcy or other similar proceeding, the holders of any of our existing or future secured indebtedness may assert rights against the assets pledged to secure that indebtedness in order to receive full payment of their indebtedness before the assets may be used to pay other creditors, including the holders of the Notes, and any assets of our subsidiaries will not be directly available to satisfy the claims of our creditors, including holders of the Notes. For further discussion, see the section titled “Description of the Notes” in this prospectus supplement.

The Notes will rank pari passu with, or equal to, our general liabilities. In total, these general liabilities were $20.2 million as of September 30, 2017. We currently do not have outstanding debt that is subordinated to the Notes and do not currently intend to issue indebtedness that expressly provides that it is subordinated to the Notes. Therefore, the Notes will not be senior to any of our indebtedness or obligations.

We intend to list the Notes on The Nasdaq Global Select Market and we expect trading to commence thereon within 30 days of the original issue date under the trading symbol “CSWCL.” The Notes are expected to trade “flat.” This means that purchasers will not pay, and sellers will not receive, any accrued and unpaid interest on the Notes that is not included in the trading price. Currently, there is no public market for the Notes and there can be no assurance that one will develop.

This prospectus supplement and the accompanying prospectus contain important information about us that a prospective investor should know before investing in the Notes. Please read this prospectus supplement and the accompanying prospectus before investing and keep them for future reference. We file annual, quarterly and current reports, proxy statements and other information with the Securities and Exchange Commission, or the SEC. This information is available free of charge by contacting us at 5400 Lyndon B. Johnson Freeway, Suite 1300, Dallas, Texas 75240 or by telephone at (214) 238-5700 or on our website at www.capitalsouthwest.com. Information contained on our website is not incorporated by reference into this prospectus supplement or the accompanying prospectus, and you should not consider that information to be part of this prospectus supplement or the accompanying prospectus. The SEC also maintains a website at www.sec.gov that contains such information.

 

 

Investing in the Notes involves a high degree of risk, and should be considered highly speculative. See “Supplementary Risk Factors ” beginning on page S-15 of this prospectus supplement and “Risk Factors” beginning on page 12 of the accompanying prospectus to read about factors you should consider, including the risk of leverage, before investing in the Notes.

 

 

Neither the Securities and Exchange Commission nor any state securities commission, nor any other regulatory body, has approved or disapproved of these securities or determined if this prospectus supplement or the accompanying prospectus is truthful or complete. Any representation to the contrary is a criminal offense.

THE NOTES ARE NOT DEPOSITS OR OTHER OBLIGATIONS OF A BANK AND ARE NOT INSURED BY THE FEDERAL DEPOSIT INSURANCE CORPORATION OR ANY OTHER GOVERNMENT AGENCY.

 

 

Delivery of the Notes in book-entry form only through The Depository Trust Company, or DTC, will be made on or about December 15, 2017.

Book-Running Manager

Keefe, Bruyette & Woods,

                          A Stifel Company

Lead Managers

 

Janney Montgomery Scott   Ladenburg Thalmann

Co-Managers

 

BB&T Capital Markets    B. Riley FBR

The date of this prospectus supplement is December 12, 2017


Table of Contents

TABLE OF CONTENTS

Prospectus Supplement

 

     Page  

ABOUT THIS PROSPECTUS SUPPLEMENT

     S-ii  

PROSPECTUS SUPPLEMENT SUMMARY

     S-1  

TERMS OF THE NOTES OFFERING

     S-8  

SUPPLEMENTARY RISK FACTORS

     S-15  

SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS

     S-20  

USE OF PROCEEDS

     S-21  

CAPITALIZATION

     S-22  

SELECTED FINANCIAL DATA

     S-23  

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

     S-25  

RATIO OF EARNINGS TO FIXED CHARGES

     S-38  

DESCRIPTION OF THE NOTES

     S-39  

MATERIAL U.S. FEDERAL INCOME TAX CONSEQUENCES

     S-51  

UNDERWRITING

     S-56  

LEGAL MATTERS

     S-60  

INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

     S-60  

CHANGE IN INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

     S-60  

AVAILABLE INFORMATION

     S-61  

INDEX TO FINANCIAL STATEMENTS

     SF-1  

Prospectus

 

PROSPECTUS SUMMARY

     1  

FEES AND EXPENSES

     10  

RISK FACTORS

     12  

CAUTIONARY STATEMENT CONCERNING FORWARD-LOOKING STATEMENTS

     28  

USE OF PROCEEDS

     30  

PRICE RANGE OF COMMON STOCK AND DISTRIBUTIONS

     31  

RATIOS OF EARNINGS TO FIXED CHARGES

     34  

SELECTED FINANCIAL DATA

     35  

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

     38  

SENIOR SECURITIES

     52  

BUSINESS

     53  

PORTFOLIO COMPANIES

     61  

MANAGEMENT

     66  

CERTAIN RELATIONSHIPS AND RELATED PARTY TRANSACTIONS

     87  

CONTROL PERSONS AND PRINCIPAL STOCKHOLDERS

     88  

SALES OF COMMON STOCK BELOW NET ASSET VALUE

     90  

DIVIDEND REINVESTMENT PLAN

     95  

DESCRIPTION OF COMMON STOCK

     96  

DESCRIPTION OF OUR DEBT SECURITIES

     99  

MATERIAL U.S. FEDERAL INCOME TAX CONSIDERATIONS

     111  

REGULATION

     120  

PLAN OF DISTRIBUTION

     124  

CUSTODIAN, TRANSFER AND DISTRIBUTION PAYING AGENT AND REGISTRAR

     126  

BROKERAGE ALLOCATION AND OTHER PRACTICES

     126  

LEGAL MATTERS

     126  

INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

     126  

CHANGE IN INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

     126  

AVAILABLE INFORMATION

     127  

INDEX TO FINANCIAL STATEMENTS

     F-1  

 

S-i


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ABOUT THIS PROSPECTUS SUPPLEMENT

This document is in two parts. The first part is this prospectus supplement, which describes the specific details regarding this offering of Notes and also adds to and updates information contained in the accompanying prospectus. The second part is the accompanying prospectus, which provides general information about us and the securities we may offer from time to time, some of which may not apply to this offering. To the extent the information contained in this prospectus supplement differs from the information contained in the accompanying prospectus, the information in this prospectus supplement shall control.

You should rely only on the information contained in this prospectus supplement and the accompanying prospectus. Neither we nor the underwriters have authorized any other person to provide you with different information from that contained in this prospectus supplement or the accompanying prospectus. If anyone provides you with different or inconsistent information, you should not rely on it. This prospectus supplement and the accompanying prospectus do not constitute an offer to sell, or a solicitation of an offer to buy, any of the Notes by any person in any jurisdiction where it is unlawful for that person to make such an offer or solicitation or to any person in any jurisdiction to whom it is unlawful to make such an offer or solicitation. The information contained in this prospectus supplement and the accompanying prospectus is complete and accurate only as of their respective dates, regardless of the time of their delivery or sale of the Notes. This prospectus supplement supersedes the accompanying prospectus to the extent it contains information different from or additional to the information in the accompanying prospectus.

 

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PROSPECTUS SUPPLEMENT SUMMARY

This summary highlights some of the information in this prospectus supplement and the accompanying prospectus. It is not complete and may not contain all of the information that you may want to consider. To understand the terms of the Notes offered hereby, you should read the entire prospectus supplement and the accompanying prospectus carefully, including “Supplementary Risk Factors,” “Risk Factors,” “Use of Proceeds,” “Selected Financial Data,” “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” and the financial statements contained elsewhere in this prospectus supplement and/or the accompanying prospectus. Together, these documents describe the specific terms of the Notes we are offering. In this prospectus supplement and the accompanying prospectus, unless the context otherwise requires, the “Company,” “Capital Southwest Corporation,” “we,” “us” and “our” refer to Capital Southwest Corporation and our subsidiaries. You should also read and review the documents identified in the section titled “Available Information” in this prospectus supplement.

Organization

Capital Southwest Corporation, which we refer to as CSWC or the Company, is an internally managed investment company that specializes in providing customized financing to middle market companies in a broad range of industry segments located primarily in the United States. Our common stock currently trades on The Nasdaq Global Select Market under the ticker symbol “CSWC.”

CSWC was organized as a Texas corporation on April 19, 1961. Prior to March 30, 1988, CSWC was registered as a closed-end, non-diversified investment company under the Investment Company Act of 1940 Act, as amended, or the 1940 Act. On that date, we elected to be treated as a business development company, or BDC, under the 1940 Act.

We are also a regulated investment company, or RIC, under Subchapter M of the U.S. Internal Revenue Code of 1986, or the Code. As such, we are not required to pay corporate-level income tax on our investment income. We intend to maintain our RIC tax treatment, which requires that we qualify annually as a RIC by meeting certain specified requirements.

On September 30, 2015, we completed the spin-off, which we refer to as the Share Distribution, of CSW Industrials, Inc., or CSWI. CSWI is now an independent publicly traded company. The Share Distribution was effected through a tax-free, pro-rata distribution of 100.0% of CSWI’s common stock to shareholders of the Company. Each Company shareholder received one share of CSWI common stock for every one share of Company common stock on the record date, September 18, 2015. Cash was paid in lieu of any fractional shares of CSWI common stock.

Following the Share Distribution, we have maintained operations as an internally-managed BDC and pursued a credit-focused investing strategy akin to similarly structured organizations. We intend to continue to provide capital to middle-market companies. We intend to invest primarily in debt securities, including senior debt, second lien and subordinated debt, and may also invest in preferred stock and common stock alongside our debt investments or through warrants.

 



 

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The following diagram depicts CSWC’s current summary organizational structure:

 

 

LOGO

Capital Southwest Management Corporation, or CSMC, a wholly-owned subsidiary of CSWC, is the management company for CSWC. CSMC generally incurs all normal operating and administrative expenses, including, but not limited to, salaries and related benefits, rent, equipment and other administrative costs required for day-to-day operations.

CSWC also has a direct wholly-owned subsidiary that has been elected to be a taxable entity, or the Taxable Subsidiary. The primary purpose of the Taxable Subsidiary is to permit CSWC to hold certain interests in portfolio companies that are organized as limited liability companies (or other forms of pass-through entities) and still allow us to satisfy the RIC tax requirement that at least 90.0% of our gross income for U.S. federal income tax purposes must consist of qualifying investment income. The Taxable Subsidiary is taxed at normal corporate tax rates based on its taxable income.

Overview

CSWC is an internally managed investment company that specializes in providing customized debt and equity financing to lower middle market, or LMM, companies and debt capital to upper middle market, or UMM, companies in a broad range of investment segments located primarily in the United States. Our principal investment objective is to produce attractive risk-adjusted returns by generating current income from our debt investments and capital appreciation from our equity and equity related investments. Our investment strategy is to partner with business owners, management teams and financial sponsors to provide flexible financing solutions to fund growth, changes of control, or other corporate events. We invest primarily in senior debt securities, secured by security interests in portfolio company assets and in secured and unsecured subordinated debt securities. We also invest in equity interests in our portfolio companies alongside our debt securities.

We focus on investing in companies with histories of generating revenues and positive cash flow, established market positions and proven management teams with strong operating discipline. We target senior debt, subordinated debt, and equity investments in LMM companies, as well as first and second lien syndicated loans in UMM companies. Our target LMM companies typically have annual earnings before interest, taxes, depreciation and amortization, or EBITDA, between $3.0 million and $15.0 million, and our LMM investments generally range from $5.0 million to $20.0 million. Our UMM investments generally include syndicated first and second lien loans in companies with EBITDA generally greater than $50.0 million, and our UMM investments typically range from $5.0 million to $10.0 million.

 



 

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We seek to fill the financing gap for LMM businesses, which, historically, have had more limited access to financing from commercial banks and other traditional sources. The underserved nature of the LMM creates the opportunity for us to meet the financing needs of LMM companies while also negotiating favorable transaction terms and equity participations. Our ability to invest across a company’s capital structure, from secured loans to equity securities, allows us to offer portfolio companies a comprehensive suite of financing options. Providing customized financing solutions is important to LMM companies. We generally seek to partner directly with financial sponsors, entrepreneurs, management teams and business owners in making our investments. Our LMM debt investments typically include first lien senior debt, secured by a first lien on the assets of the portfolio company, as well as subordinated debt. Our LMM investments typically have a term of between five and seven years from the original investment date. We also often seek to invest in the equity securities in our LMM portfolio companies.

Our investments in UMM companies primarily consist of direct investments in or secondary purchases of interest bearing debt securities in privately held companies that are generally larger in size than the LMM companies included in our portfolio. Our UMM debt investments are generally secured by either a first or second priority lien on the assets of the portfolio company and typically have an expected duration of between three and seven years from the original investment date.

Our principal executive offices are located at 5400 Lyndon B. Johnson Freeway, Suite 1300, Dallas, Texas 75240. We maintain a website at http://www.capitalsouthwest.com. Information contained on our website is not incorporated by reference into this prospectus supplement or the accompanying prospectus, and you should not consider that information to be part of this prospectus supplement or the accompanying prospectus.

Business Strategies

Our principal investment objective is to produce attractive risk-adjusted returns by generating current income from our debt investments and realizing capital appreciation from our equity and equity-related investments. We have adopted the following business strategies to achieve our investment objective:

 

    Leveraging the Experience of our Management Team. Our senior management team has extensive experience advising, investing in and lending to middle market companies across changing market cycles. The members of our management team have diverse investment backgrounds, with prior experience at investment banks, commercial banks, and BDCs in the capacity of senior officers. We believe this diverse experience provides us with an in-depth understanding of the strategic, financial and operational challenges and opportunities of the middle market companies in which we invest. We believe this understanding allows us to select and structure better investments and to efficiently monitor and provide managerial assistance to our portfolio companies.

 

    Applying Rigorous Underwriting Policies and Active Portfolio Management. Our senior management team has implemented rigorous underwriting policies that are followed in each transaction. These policies include a thorough analysis of each potential portfolio company’s competitive position, financial performance, management team operating discipline, growth potential and industry attractiveness, which we believe allows us to better assess the company’s prospects. After investing in a company, we monitor the investment closely, typically receiving monthly, quarterly and annual financial statements. Senior management, together with the deal team and accounting and finance departments, meets at least monthly to analyze and discuss in detail the company’s financial performance and industry trends. We believe that our initial and ongoing portfolio review process allows us to monitor effectively the performance and prospects of our portfolio companies.

 

   

Investing Across Multiple Companies, Industries, Regions and End Markets. We seek to maintain a portfolio of investments that is appropriately diverse among various companies, industries, geographic

 



 

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regions and end markets. This portfolio balance is intended to mitigate the potential effects of negative economic events for particular companies, regions, industries and end markets. However, we may from time to time hold securities of individual portfolio companies that comprise more than 5.0% of our total assets and/or more than 10.0% of the outstanding voting securities of the portfolio company. For that reason, we are classified as a non-diversified management investment company under the 1940 Act.

 

    Utilizing Long-Standing Relationships to Source Deals. Our senior management team and investment professionals maintain extensive relationships with entrepreneurs, financial sponsors, attorneys, accountants, investment bankers, commercial bankers and other non-bank providers of capital who refer prospective portfolio companies to us. These relationships historically have generated significant investment opportunities. We believe that our network of relationships will continue to produce attractive investment opportunities.

 

    Focusing on Underserved Markets. The middle market has traditionally been underserved. We believe that operating margin and growth pressures, as well as regulatory concerns, have caused many financial institutions to de-emphasize services to middle market companies in favor of larger corporate clients and more liquid capital market transactions. We also invest in securities that would be rated below investment grade if they were rated. We believe these dynamics have resulted in the financing market for middle market companies being underserved, providing us with greater investment opportunities.

 

    Focus on Established Companies. We generally invest in companies with established market positions, experienced management teams and recurring cash flow streams. We believe that those companies generally possess better risk adjusted return profiles than earlier stage companies that are building their management teams and establishing their revenue base. We also believe that established companies in our target range generally provide opportunities for capital appreciation.

 

    Capital Structures Appropriate for Potential Industry and Business Volatility. Our investment team spends significant time understanding the performance of both the target portfolio company and its specific industry throughout a full economic cycle. The history of each specific industry and target portfolio company will demonstrate a different level of potential volatility in financial performance. We seek to understand this dynamic thoroughly and invest our capital at leverage levels in the capital structure that will remain in enterprise value and in securities that will receive interest payments if such downside volatility were to occur.

 

    Providing Customized Financing Solutions. We offer a variety of financing structures and have the flexibility to structure our investments to meet the needs of our portfolio companies. Often we invest in senior and subordinated debt securities, coupled with equity interests. We believe our ability to customize financing structures makes us an attractive partner to middle market companies.

Risk Factors

Investing in our securities involves a high degree of risk. You should consider carefully the information found in the sections titled “Supplementary Risk Factors” beginning on page S-15 of this prospectus supplement and “Risk Factors” beginning on page 12 of the accompanying prospectus, including, but not limited to, the following risks:

 

    Our financial condition and results of operations will depend on our ability to effectively allocate and manage capital.

 

    Our investments in portfolio companies involve a number of significant risks:

 

    They may have unpredictable operating results, could become parties to litigation, may be engaged in rapidly changing businesses with products subject to a substantial risk of obsolescence and may require substantial additional capital to support their operations, finance expansion or maintain their competitive position.

 



 

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    Most of our portfolio companies are private companies. Private companies may not have readily publicly available information about their businesses, operations and financial condition. Consequently, we rely on the ability of our management team and investment professionals to obtain adequate information to evaluate the potential returns from making investments in these portfolio companies. If we are unable to uncover all material information about the target portfolio company, we may not make a fully informed investment decision and may lose all or part of our investment.

 

    The lack of liquidity in our investments may adversely affect our business.

 

    Any unrealized losses or defaults we experience may be an indication of future realized losses, which could reduce our income available to make distributions.

 

    Our investments in equity securities involve a substantial degree of risk. We may not realize gains from our equity investments.

 

    Prepayments of our debt investments by our portfolio companies could adversely impact our results of operations and reduce our return on equity.

 

    Our business model depends to a significant extent upon strong referral relationships. Our inability to maintain or develop these relationships, as well as the failure of these relationships to generate investment opportunities, could adversely affect our business.

 

    In addition to regulatory limitations on our ability to raise capital, our Credit Facility contains various covenants, which, if not complied with, could accelerate our repayment obligations under the Credit Facility, thereby materially and adversely affecting our liquidity, financial condition, results of operations and ability to pay distributions. All of our assets are subject to security interests under our secured Credit Facility and if we default on our obligations under the Credit Facility, we may suffer adverse consequences, including foreclosure on our assets.

 

    Because we borrow money to make investments, the potential for gain or loss on amounts invested in us is magnified and may increase the risk of investing in us.

 

    Changes in interest rates may affect our cost of capital, the value of investments and net investment income.

 

    If we do not invest a sufficient portion of our assets in qualifying assets, we could fail to qualify as a BDC or be precluded from investing according to our current business strategy. A failure on our part to maintain our status as a BDC would significantly reduce our operating flexibility.

 

    We will be subject to corporate-level income tax if we are unable to qualify as a RIC under Subchapter M of the Code. Even if we qualify as a RIC, we may face tax liabilities that reduce our cash flow.

 

    Our historical financial statements are not necessarily representative of the results we would have achieved as a stand-alone publicly-traded company and therefore may not be indicative of our future performance.

 

    Our investment portfolio is and will continue to be recorded at fair value. Our board of directors, or the Board, has final responsibility for overseeing, reviewing and approving, in good faith, our fair value determination. As a result of recording our investments at fair value, there is and will continue to be subjectivity as to the value of our portfolio investments.

 

    The capital markets may experience periods of disruption and instability. Such market conditions may materially and adversely affect debt and equity capital markets in the United States, which may have a negative impact on our business and operations.

 

    Changes in the laws or regulations governing our business, or changes in the interpretations thereof, and any failure by us to comply with these laws or regulations, could negatively affect the profitability of our operations.

 

    The market price of our common stock may fluctuate significantly.

 



 

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Investment Criteria

Our investment team has identified the following investment criteria that we believe are important in evaluating prospective investment opportunities. However, not all of these criteria have been or will be met in connection with each of our investments:

 

    Companies with Positive and Sustainable Cash Flow: We generally seek to invest in established companies with sound historical financial performance.

 

    Excellent Management: Management teams with a proven record of achievement, exceptional ability, unyielding determination and integrity. We believe management teams with these attributes are more likely to manage the companies in a manner that protects and enhances value.

 

    Industry: We primarily focus on companies having competitive advantages in their respective markets and/or operating in industries with barriers to entry, which may help protect their market position.

 

    Strong Private Equity Sponsors: We focus on developing relationships with leading private equity firms in order to partner with these firms and provide them capital to support the acquisition and growth of their portfolio companies.

 

    Appropriate Risk-Adjusted Returns: We focus on and price opportunities to generate returns that are attractive on a risk-adjusted basis, taking into consideration factors, in addition to the ones depicted above, including credit structure, leverage levels and the general volatility and potential volatility of cash flows.

 

    Location: We primarily focus on companies located in the United States. Each new investment is evaluated for its appropriateness within our existing portfolio. Prospective portfolio company candidates for our existing portfolio companies may be located worldwide.

Recent Developments

On August 22, 2017, we received an exemptive order that allows us to withhold shares of our common stock to satisfy tax withholding obligations related to the vesting of restricted stock granted pursuant to the Company’s 2010 Restricted Stock Award Plan, as amended, or the 2010 Plan, and to pay the exercise price of options to purchase shares of our common stock granted pursuant to the Company’s 2009 Stock Incentive Plan, as amended, or the 2009 Plan. In connection with the exemptive order, our Board approved an amendment to the 2010 Plan, or the Restricted Stock Plan Amendment. The Restricted Stock Plan Amendment allows the Company to withhold shares of our common stock from a participant’s restricted stock award in order to satisfy tax withholding obligations related to the vesting of such restricted stock. Shares withheld by us pursuant to the Restricted Stock Plan Amendment will not be available for issuance or reissuance under the 2010 Plan. Our Board approved the Restricted Stock Plan Amendment pursuant to the powers granted under Section 14 of the 2010 Plan. In addition, our Board approved an amendment to the 2009 Plan, or the Stock Incentive Plan Amendment. The Stock Incentive Plan Amendment allows a participant of such plan to pay the exercise price of an option with cash or pursuant to a net exercise feature that allows the Company to withhold the number of shares of our common stock from such participant’s option equal to the aggregate exercise price of the option being exercised divided by the fair market value of a share of our common stock. Shares withheld by us pursuant to the Stock Incentive Plan Amendment will not be available for issuance or reissuance under the 2009 Plan. Our Board approved the Stock Incentive Plan Amendment pursuant to the powers granted under Section 18 of the 2009 Plan.

On August 30, 2017, our Board declared a quarterly cash dividend of $0.24 per share of common stock. The dividend was paid on October 2, 2017 to shareholders of record on September 15, 2017.

 



 

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On November 6, 2017, our Board approved the entry into a form of indemnification agreement, or the Indemnification Agreement, with each of its directors and named executive officers, each an Indemnitee. The Indemnification Agreement provides for the indemnification, and advancement of expenses, to the full extent permitted by law, against judgments, arbitration awards, mediation amounts, penalties, settlements, fines, excise or similar taxes, and reasonable expenses incurred by the Indemnitee in connection with any threatened, pending or completed action, suit or proceeding on account of Indemnitee’s service as a director, officer, employee or agent of the Company.

On November 16, 2017, the Company entered into Amendment No. 1, or the Amendment, to its Credit Facility dated as of August 30, 2016, among the Company, as borrower, the lenders party thereto, ING Capital LLC, as administrative agent, and Texas Capital Bank, N.A., as documentation agent. The Amendment (1) increased the total borrowing capacity under the Credit Facility to $180 million, supported by a diversified group of eight lenders, (2) increased the Credit Facility’s accordion feature that allows for an increase in total commitments of up to $250 million under the Credit Facility from new and existing lenders on the same terms and conditions as the existing commitments, (3) reduced the interest rate on borrowings from the London Interbank Offered Rate, or LIBOR, plus 3.25% to LIBOR plus 3.00%, with a step-down to LIBOR plus 2.75% at the time the Company’s net worth exceeds $325 million, (4) reduced unused commitment fees based on utilization, and (5) extended the Credit Facility’s revolving period that ended on August 30, 2019 through November 16, 2020. Additionally, the final maturity of the Credit Facility was extended from August 30, 2020 to November 16, 2021. There are no changes to the covenants or the events of default in the Credit Facility as a result of the Amendment.

On November 30, 2017, our Board declared a quarterly cash dividend of $0.26 per share of common stock. The dividend is payable on January 2, 2018 to shareholders of record on December 15, 2017.

 



 

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TERMS OF THE NOTES OFFERING

This summary sets forth certain terms of the Notes that we are offering pursuant to this prospectus supplement and the accompanying prospectus. This section and the “Description of the Notes” section in this prospectus supplement outline the specific legal and financial terms of the Notes. You should read this section of the prospectus supplement together with the section titled “Description of the Notes” beginning on page S-39 of this prospectus supplement and the more general description of the Notes in the section titled “Description of Our Debt Securities” beginning on page 99 of the accompanying prospectus before investing in the Notes. Capitalized terms used in this prospectus supplement and not otherwise defined shall have the meanings ascribed to them in the accompanying prospectus or in the indenture governing the Notes.

 

Issuer

   Capital Southwest Corporation

Title of the securities

   5.95% Notes due 2022

Initial aggregate principal amount being offered

   $50,000,000

Option to purchase additional Notes

   The underwriters may also purchase from us up to an additional $7.5 million aggregate principal amount of Notes offered hereby within 30 days of the date of this prospectus supplement.

Issue price

   Variable Price Re-offer. The underwriters propose to offer the Notes for sale, from time to time, in one or more negotiated transactions, at prices that may be different than par. These sales may occur at market prices prevailing at the time of sale, at prices related to such prevailing market prices or at negotiated prices.

Principal payable at maturity

   100% of the aggregate principal amount; the principal amount of each Note will be payable on its stated maturity date at the office of the trustee for the Notes or at such other office as we may designate.

Type of note

   Fixed rate note

Listing

   We intend to list the Notes on The Nasdaq Global Select Market within 30 days of the original issue date under the trading symbol “CSWCL.”

Interest rate

   5.95% per year

Day count basis

   360-day year of twelve 30-day months

Original issue date

   December 15, 2017

Stated maturity date

   December 15, 2022

Date interest starts accruing

   December 15, 2017

Interest payment dates

   Every March 15, June 15, September 15 and December 15, commencing March 15, 2018. If an interest payment date falls on a non-business day, the applicable interest payment will be made on the next business day and no additional interest will accrue as a result of such delayed payment.

 



 

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Interest periods

   The initial interest period will be the period from and including December 15, 2017, to, but excluding, the initial interest payment date, and the subsequent interest periods will be the periods from and including an interest payment date to, but excluding, the next interest payment date or the stated maturity date, as the case may be.

Regular record dates for interest

   Every March 1, June 1, September 1 and December 1, commencing March 1, 2018.

Specified currency

   U.S. Dollars

Place of payment

   New York City and/or such other places that may be specified in the indenture or a notice to holders.

Ranking of notes

  

The Notes will be our direct unsecured obligations and will rank:

 

•  pari passu with our other outstanding and future unsecured unsubordinated indebtedness;

 

•  senior to any of our future indebtedness that expressly provides it is subordinated to the Notes;

 

•  effectively subordinated to all of our existing and future secured indebtedness (including indebtedness that is initially unsecured in respect of which we subsequently grant security), to the extent of the value of the assets securing such indebtedness, including, without limitation, borrowings under our Credit Facility, of which $86.0 million was outstanding as of December 12, 2017; and

 

•  structurally subordinated to all future indebtedness and other obligations of any of our subsidiaries.

Denominations

   We will issue the Notes in denominations of $25 and integral multiples of $25 in excess thereof.

Business day

   Each Monday, Tuesday, Wednesday, Thursday and Friday that is not a day on which banking institutions in New York City or another place of payment are authorized or obligated by law or executive order to close.

Optional redemption

   The Notes may be redeemed in whole or in part at any time or from time to time at our option on or after December 15, 2019 upon not less than 30 days nor more than 60 days written notice by mail prior to the date fixed for redemption thereof, at a redemption price of 100% of the outstanding principal amount of the Notes plus accrued and

 



 

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   unpaid interest payments otherwise payable for the then-current quarterly interest period accrued to the date fixed for redemption.
   You may be prevented from exchanging or transferring the Notes when they are subject to redemption. In case any Notes are to be redeemed in part only, the redemption notice will provide that, upon surrender of such Note, you will receive, without a charge, a new Note or Notes of authorized denominations representing the principal amount of your remaining unredeemed Notes.
   Before redeeming any Notes, we would have to comply with certain requirements under our Credit Facility, to the extent such requirements remain in effect at such time, or otherwise obtain consent from the lenders.
   Any exercise of our option to redeem the Notes will be done in compliance with the 1940 Act.
   If we redeem only some of the Notes, the trustee or DTC, as applicable, will determine the method for selection of the particular Notes to be redeemed, in accordance with the indenture governing the Notes and in accordance with the rules of any national securities exchange or quotation system on which the Notes are listed. Unless we default in payment of the redemption price, on and after the date of redemption, interest will cease to accrue on the Notes called for redemption.

Sinking fund

   The Notes will not be subject to any sinking fund.

Repayment at option of holders

   Holders will not have the option to have the Notes repaid prior to the stated maturity date.

Satisfaction and discharge

   We may satisfy and discharge our obligations under the indenture and the Notes by delivering to the trustee for cancellation all outstanding Notes or, in certain circumstances, by depositing with the trustee after the Notes have become due and payable, will become due and payable at their stated maturity within one year, or are to be called for redemption moneys sufficient to pay all of the outstanding Notes, and paying all other sums payable under the indenture by us. See “Description of the Notes — Satisfaction and Discharge” in this prospectus supplement.

Defeasance

   The Notes are subject to defeasance by us. “Defeasance” means that, by depositing with a trustee an amount of cash and/or government

 



 

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   securities sufficient to pay all principal and interest, if any, on the Notes when due and satisfying any additional conditions required under the indenture relating to the Notes, we will be deemed to have been discharged from our obligations under the Notes. See “Description of the Notes —Defeasance” in this prospectus supplement.

Covenant defeasance

   The Notes are subject to covenant defeasance by us. In the event of a “covenant defeasance,” upon depositing such funds and satisfying conditions similar to those for defeasance we would be released from certain covenants under the indenture relating to the Notes. The consequences to the holders of the Notes would be that, while they would no longer benefit from certain covenants under the indenture, and while the Notes could not be accelerated for any reason, the holders of the Notes nonetheless could look to the Company for repayment of the Notes if there were a shortfall in the funds deposited with the trustee or the trustee is prevented from making a payment. See “Description of the Notes — Defeasance” in this prospectus supplement.

Form of notes

   The Notes will be represented by global securities that will be deposited and registered in the name of DTC or its nominee. This means that, except in limited circumstances, you will not receive certificates for the Notes. Beneficial interests in the Notes will be represented through book-entry accounts of financial institutions acting on behalf of beneficial owners as direct and indirect participants in DTC. Investors may elect to hold interests in the Notes through either DTC, if they are a participant, or indirectly through organizations that are participants in DTC.

Trustee, paying agent, and security registrar

   U.S. Bank National Association

Other covenants

   In addition to any covenants described elsewhere in this prospectus supplement or the accompanying prospectus, the following covenants shall apply to the Notes:
  

•  We agree that for the period of time during which the Notes are outstanding, we will not violate Section 18(a)(1)(A) as modified by Section 61(a)(1) of the 1940 Act or any successor provisions, whether or not we continue to be subject to such provisions of the 1940 Act, but giving effect, in either case,

 



 

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to any exemptive relief granted to us by the SEC. Currently, these provisions generally prohibit us from incurring additional borrowings, including through the issuance of additional debt securities, unless our asset coverage, as defined in the 1940 Act, equals at least 200% after such borrowings. See “Supplementary Risk Factors — Risks Related to the Notes — Pending legislation may allow us to incur additional leverage” in this prospectus supplement.

 

•  We agree that, for the period of time during which the Notes are outstanding, we will not violate Section 18(a)(1)(B) as modified by (i) Section 61(a)(1) of the 1940 Act or any successor provisions and after giving effect to any exemptive relief granted to us by the SEC and (ii) the two other exceptions set forth below. These statutory provisions of the 1940 Act are not currently applicable to us and will not be applicable to us as a result of this offering. However, if Section 18(a)(1)(B) as modified by Section 61(a)(1) of the 1940 Act were currently applicable to us in connection with this offering, these provisions would generally prohibit us from declaring any cash dividend or distribution upon any class of our capital stock, or purchasing any such capital stock if our asset coverage, as defined in the 1940 Act, were below 200% at the time of the declaration of the dividend or distribution or the purchase and after deducting the amount of such dividend, distribution, or purchase. Under the covenant, we will be permitted to declare a cash dividend or distribution notwithstanding the prohibition contained in Section 18(a)(1)(B) as modified by Section 61(a)(1) of the 1940 Act or any successor provisions, but only up to such amount as is necessary for us to maintain our status as a RIC under Subchapter M of the Code. Furthermore, the covenant will not be triggered unless and until such time as our asset coverage has not been in compliance with the minimum asset coverage required by Section 18(a)(1)(B) as modified by Section 61(a)(1) of the 1940 Act or any successor provisions (after giving effect to any exemptive relief granted to us by the

 



 

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SEC) for more than six consecutive months. See “Supplementary Risk Factors — Risks Related to the Notes — Pending legislation may allow us to incur additional leverage” in this prospectus supplement.

 

•  If, at any time, we are not subject to the reporting requirements of Sections 13 or 15(d) of the Securities Exchange Act of 1934, or the Exchange Act, to file any periodic reports with the SEC, we agree to furnish to holders of the Notes and the trustee, for the period of time during which the Notes are outstanding, our audited annual consolidated financial statements, within 90 days of our fiscal year end, and unaudited interim consolidated financial statements, within 45 days of our fiscal quarter end (other than our fourth fiscal quarter). All such financial statements will be prepared, in all material respects, in accordance with applicable Generally Accepted Accounting Principles in the United States of America, or U.S. GAAP.

Events of default

   You will have rights if an Event of Default occurs with respect to the Notes and is not cured.
   The term “Event of Default” in respect of the Notes means any of the following:
  

•  We do not pay the principal of, or any premium on, any Note when due and payable at maturity;

 

•  We do not pay interest on any Note when due and payable, and such default is not cured within 30 days of its due date;

 

•  We remain in breach of any other covenant in respect of the Notes for 60 days after we receive a written notice of default stating we are in breach (the notice must be sent by either the trustee or holders of at least 25% of the principal amount of the outstanding Notes);

 

•  We file for bankruptcy or certain other events of bankruptcy, insolvency or reorganization occur and remain undischarged or unstayed for a period of 60 days; or

 

•  On the last business day of each of twenty-four consecutive calendar months, the Notes have an asset coverage of less than 100%, giving effect to any exemptive relief granted to us by the SEC.

 



 

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Further issuances

   We have the ability to issue additional debt securities under the indenture with terms different from the Notes and, without the consent of the holders of the Notes, to reopen the Notes and issue additional Notes. If we issue additional debt securities, these additional debt securities could have a lien or other security interest greater than that accorded to the holders of the Notes, which are unsecured.

Use of proceeds

   We estimate that the net proceeds we will receive from the sale of the Notes will be approximately $47.9 million ($55.2 million if the underwriters exercise their option to purchase additional Notes in full) after deducting estimated offering expenses.
   We intend to use the net proceeds from this offering to repay outstanding indebtedness under our Credit Facility. However, through re-borrowings under our Credit Facility, we intend to make investments in LMM and UMM portfolio companies in accordance with our investment objective and strategies, to make investments in marketable securities and other temporary investments, and for other general corporate purposes, including payment of operating expenses. As of December 12, 2017, we had $86.0 million of indebtedness outstanding under our Credit Facility. Our Credit Facility matures on November 16, 2021, and borrowings under the Credit Facility currently bear interest on a per annum basis equal to LIBOR plus 3.00%. See “Use of Proceeds” in this prospectus supplement.

Governing law

   The Notes and the indenture will be governed by and construed in accordance with the laws of the State of New York.

Global clearance and settlement procedures

   Interests in the Notes will trade in DTC’s Same Day Funds Settlement System, and any permitted secondary market trading activity in such Notes will, therefore, be required by DTC to be settled in immediately available funds. None of the Company, the trustee or the paying agent will have any responsibility for the performance by DTC or its participants or indirect participants of their respective obligations under the rules and procedures governing their operations.

 



 

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SUPPLEMENTARY RISK FACTORS

Investing in the Notes involves a high degree of risk. Before you invest in the Notes, you should be aware of various significant risks, including those described below. You should carefully consider these risks, together with all of the other information included in this prospectus supplement and the accompanying prospectus, before you decide whether to make an investment in the Notes. The risks set forth below are not the only risks we face. If any of the following risks occur, our business, financial condition and results of our operations could be materially adversely affected. In such case, you could lose all or part of your investment.

Risks Related to the Notes

The Notes will be unsecured and therefore will be effectively subordinated to any secured indebtedness we have currently incurred or may incur in the future and will rank pari passu with, or equal to, all outstanding and future unsecured unsubordinated indebtedness issued by us and our general liabilities.

The Notes will not be secured by any of our assets or any of the assets of any of our subsidiaries. As a result, the Notes will effectively be subordinated to any secured indebtedness we or our subsidiaries have outstanding as of the date of this prospectus supplement (including our Credit Facility) or that we or our subsidiaries may incur in the future (or any indebtedness that is initially unsecured as to which we subsequently grant security) to the extent of the value of the assets securing such indebtedness. In any liquidation, dissolution, bankruptcy or other similar proceeding, the holders of any of our secured indebtedness or secured indebtedness of our subsidiaries may assert rights against the assets pledged to secure that indebtedness in order to receive full payment of their indebtedness before the assets may be used to pay other creditors, including the holders of the Notes. As of December 12, 2017, we had $86.0 million in outstanding indebtedness under our Credit Facility, which is secured by (1) substantially all of the present and future property and assets of the Company and the guarantors and (2) 100.0% of the equity interests in the Company’s wholly-owned subsidiaries.

The Notes will be structurally subordinated to the indebtedness and other liabilities of our subsidiaries.

The Notes will be obligations exclusively of Capital Southwest Corporation, and not of any of our subsidiaries. None of our subsidiaries will be a guarantor of the Notes and the Notes will not be required to be guaranteed by any subsidiary we may acquire or create in the future. Any assets of our subsidiaries will not be directly available to satisfy the claims of our creditors, including holders of the Notes. Except to the extent we are a creditor with recognized claims against our subsidiaries, all claims of creditors of our subsidiaries will have priority over our equity interests in such entities (and therefore the claims of our creditors, including holders of the Notes) with respect to the assets of such entities. Even if we are recognized as a creditor of one or more of these entities, our claims would still be effectively subordinated to any security interests in the assets of any such entity and to any indebtedness or other liabilities of any such entity senior to our claims. Consequently, the Notes will be structurally subordinated to all indebtedness and other liabilities, including trade payables, of any of our existing or future subsidiaries. These entities may incur substantial indebtedness in the future, all of which would be structurally senior to the Notes.

The indenture under which the Notes will be issued contains limited protection for holders of the Notes.

The indenture under which the Notes will be issued offers limited protection to holders of the Notes. The terms of the indenture and the Notes do not restrict our or any of our subsidiaries’ ability to engage in, or otherwise be a party to, a variety of corporate transactions, circumstances or events that could have a material adverse impact on your investment in the Notes. In particular, the terms of the indenture and the Notes will not place any restrictions on our or our subsidiaries’ ability to:

 

   

issue securities or otherwise incur additional indebtedness or other obligations, including (1) any indebtedness or other obligations that would be equal in right of payment to the Notes, (2) any indebtedness

 

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or other obligations that would be secured and therefore rank effectively senior in right of payment to the Notes to the extent of the values of the assets securing such debt, (3) indebtedness of ours that is guaranteed by one or more of our subsidiaries and which therefore is structurally senior to the Notes and (4) securities, indebtedness or obligations issued or incurred by our subsidiaries that would be senior to our equity interests in those entities and therefore rank structurally senior to the Notes with respect to the assets of our subsidiaries, in each case other than an incurrence of indebtedness or other obligation that would cause a violation of Section 18(a)(1)(A) as modified by Section 61(a)(1) of the 1940 Act or any successor provisions, whether or not we continue to be subject to such provisions of the 1940 Act, but giving effect, in each case, to any exemptive relief granted to us by the SEC. Currently, these provisions generally prohibit us from making additional borrowings, including through the issuance of additional debt or the sale of additional debt securities, unless our asset coverage, as defined in the 1940 Act, equals at least 200% after such borrowings. See “— Pending legislation may allow us to incur additional leverage” below;

 

    pay dividends on, or purchase or redeem or make any payments in respect of, capital stock or other securities ranking junior in right of payment to the Notes, including subordinated indebtedness, except that we have agreed that, for the period of time during which the Notes are outstanding, we will not violate Section 18(a)(1)(B) as modified by (i) Section 61(a)(1) of the 1940 Act or any successor provisions and after giving effect to any exemptive relief granted to us by the SEC and (ii) the following two exceptions: (A) we will be permitted to declare a cash dividend or distribution notwithstanding the prohibition contained in Section 18(a)(1)(B) as modified by Section 61(a)(1) of the 1940 Act or any successor provisions, but only up to such amount as is necessary for us to maintain our status as a RIC under Subchapter M of the Code; and (B) this restriction will not be triggered unless and until such time as our asset coverage has not been in compliance with the minimum asset coverage required by Section 18(a)(1)(B) as modified by Section 61(a)(1) of the 1940 Act or any successor provisions (after giving effect to any exemptive relief granted to us by the SEC) for more than six consecutive months. If Section 18(a)(1)(B) as modified by Section 61(a)(1) of the 1940 Act were currently applicable to us in connection with this offering, these provisions would generally prohibit us from declaring any cash dividend or distribution upon any class of our capital stock, or purchasing any such capital stock if our asset coverage, as defined in the 1940 Act, were below 200% at the time of the declaration of the dividend or distribution or the purchase and after deducting the amount of such dividend, distribution or purchase; see “— Pending legislation may allow us to incur additional leverage” below;

 

    sell assets (other than certain limited restrictions on our ability to consolidate, merge or sell all or substantially all of our assets);

 

    enter into transactions with affiliates;

 

    create liens (including liens on the shares of our subsidiaries) or enter into sale and leaseback transactions;

 

    make investments; or

 

    create restrictions on the payment of dividends or other amounts to us from our subsidiaries.

In addition, the indenture (as defined in “Description of the Notes”) will not require us to make an offer to purchase the Notes in connection with a change of control or any other event.

Furthermore, the terms of the indenture and the Notes do not protect holders of the Notes in the event that we experience changes (including significant adverse changes) in our financial condition, results of operations or credit ratings, if any, as they do not require that we or our subsidiaries adhere to any financial tests or ratios or specified levels of net worth, revenues, income, cash flow, or liquidity other than as described under “Description of the Notes — Events of Default” elsewhere herein.

Our ability to recapitalize, incur additional debt (including additional debt that matures sooner than the Notes), and take a number of other actions that are not limited by the terms of the Notes may have important

 

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consequences for you as a holder of the Notes, including making it more difficult for us to satisfy our obligations with respect to the Notes or negatively affecting the trading value of the Notes.

Other debt we issue or incur in the future could contain more protections for its holders than the indenture and the Notes, including additional covenants and events of default. The issuance or incurrence of any such debt with incremental protections could affect the market for, trading levels, and prices of the Notes.

The price you pay for the Notes may be higher than the prices paid by other investors.

The underwriters propose to offer the Notes for sale to investors, from time to time, in one or more negotiated transactions, at prices that may be different than par. These sales may occur at market prices prevailing at the time of sale, at prices related to such prevailing market prices or at negotiated prices. Accordingly, there is a risk that the price you pay for your Notes will be higher than the prices paid by other investors.

There is no existing trading market for the Notes and, even if The Nasdaq Global Select Market approves the listing of the Notes, an active trading market for the Notes may not develop, which could limit your ability to sell the Notes and/or the market price of the Notes.

The Notes will be a new issue of debt securities for which there initially will not be a trading market. We intend to list the Notes on The Nasdaq Global Select Market within 30 days of the original issue date under the symbol “CSWCL.” However, there is no assurance that the Notes will be approved for listing on The Nasdaq Global Select Market.

Moreover, even if the listing of the Notes is approved, we cannot provide any assurances that an active trading market will develop or be maintained for the Notes or that you will be able to sell your Notes. If the Notes are traded after their initial issuance, they may trade at a discount from their initial offering price depending on prevailing interest rates, the market for similar securities, our credit ratings, if any, general economic conditions, our financial condition, performance and prospects and other factors. The underwriters have advised us that they intend to make a market in the Notes, but they are not obligated to do so. The underwriters may discontinue any market-making in the Notes at any time at their sole discretion.

Accordingly, we cannot assure you that the Notes will be approved for listing on The Nasdaq Global Select Market, that a liquid trading market will develop or be maintained for the Notes, that you will be able to sell your Notes at a particular time or that the price you receive when you sell will be favorable. To the extent an active trading market does not develop, the liquidity and trading price for the Notes may be harmed. Accordingly, you may be required to bear the financial risk of an investment in the Notes for an indefinite period of time.

Our amount of debt outstanding will increase as a result of this offering, and if we default on our obligations to pay our other indebtedness, we may not be able to make payments on the Notes.

Any default under the agreements governing our indebtedness, including a default under our Credit Facility or other indebtedness to which we may be a party that is not waived by the required lenders, and the remedies sought by lenders or the holders of such indebtedness could make us unable to pay principal, premium, if any, and interest on the Notes and substantially decrease the market value of the Notes. If we are unable to generate sufficient cash flow and are otherwise unable to obtain funds necessary to meet required payments of principal, premium, if any, and interest on our indebtedness, or if we otherwise fail to comply with the various covenants, including financial and operating covenants, in the instruments governing our indebtedness (including the Credit Facility), we could be in default under the terms of the agreements governing such indebtedness, including the Notes. In the event of such default, the holders of such indebtedness could elect to declare all the funds borrowed thereunder to be due and payable, together with accrued and unpaid interest, the lenders under the Credit Facility or other debt we may incur in the future could elect to terminate their commitment, cease making further loans and institute foreclosure proceedings against our assets, and we could be forced into bankruptcy or liquidation.

 

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Our ability to generate sufficient cash flow in the future is, to some extent, subject to general economic, financial, competitive, legislative and regulatory factors as well as other factors that are beyond our control. We cannot assure you that our business will generate cash flow from operations, or that future borrowings will be available to us under the Credit Facility or otherwise, in an amount sufficient to enable us to meet our payment obligations under the Notes, our other debt, and to fund other liquidity needs.

If our operating performance declines and we are not able to generate sufficient cash flow to service our debt obligations, we may in the future need to refinance or restructure our debt, including any Notes sold, sell assets, reduce or delay capital investments, seek to raise additional capital or seek to obtain waivers from the lenders under the Credit Facility or other debt that we may incur in the future to avoid being in default. If we are unable to implement one or more of these alternatives, we may not be able to meet our payment obligations under the Notes and our other debt. If we breach our covenants under the Credit Facility or any of our other debt and seek a waiver, we may not be able to obtain a waiver from the required lenders or holders thereof. If this occurs, we would be in default under the Credit Facility or other debt, the lenders or holders could exercise rights as described above, and we could be forced into bankruptcy or liquidation. If we are unable to repay debt, lenders having secured obligations could proceed against the collateral securing the debt. Because the Credit Facility has, and any future credit facilities will likely have, customary cross-default provisions, if the indebtedness under the Notes, the Credit Facility or under any future credit facility is accelerated, we may be unable to repay or finance the amounts due.

Proposed tax reform could have a negative effect on holders of the Notes or us.

On November 16, 2017, the U.S. House of Representatives passed the Tax Cuts and Jobs Act (H.R. 1), and on December 2, 2017, the U.S. Senate passed an alternative version of the Tax Cuts and Jobs Act (together with any amended versions, the “Tax Reform Bills”). Either of the Tax Reform Bills would make significant changes to the United States income tax rules applicable to both individuals and entities, including corporations. There is uncertainty as to the likelihood of either of the Tax Reform Bills or any other tax reform legislation being enacted and the impact of any such tax reform legislation on us or an investment in the Notes. You are urged to consult with your tax advisor with respect to the status of any such tax reform legislation and any other regulatory or administrative developments and proposals and their potential effect on your investment in the Notes.

A downgrade, suspension or withdrawal of the credit rating assigned by a rating agency to us or the Notes, if any, or change in the debt markets could cause the liquidity or market value of the Notes to decline significantly.

Our credit ratings are an assessment by rating agencies of our ability to pay our debts when due. Consequently, real or anticipated changes in our credit ratings will generally affect the market value of the Notes. These credit ratings may not reflect the potential impact of risks relating to the structure or marketing of the Notes. Credit ratings are not a recommendation to buy, sell or hold any security, and may be revised or withdrawn at any time by the issuing organization in its sole discretion. Neither we nor any underwriter undertakes any obligation to maintain our credit ratings or to advise holders of Notes of any changes in our credit ratings. There can be no assurance that our credit ratings will remain for any given period of time or that such credit ratings will not be lowered or withdrawn entirely by the rating agencies if in their judgment future circumstances relating to the basis of the credit ratings, such as adverse changes in our company, so warrant. The conditions of the financial markets and prevailing interest rates have fluctuated in the past and are likely to fluctuate in the future, which could have an adverse effect on the market prices of the Notes.

 

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We may choose to redeem the Notes when prevailing interest rates are relatively low.

On or after December 15, 2019, we may choose to redeem the Notes from time to time, especially if prevailing interest rates are lower than the rate borne by the Notes. Before redeeming any Notes, we would have to comply with certain requirements under our Credit Facility, to the extent such requirements remain in effect at such time, or otherwise obtain consent from the lenders. If prevailing rates are lower at the time of redemption, and we redeem the Notes, you likely would not be able to reinvest the redemption proceeds in a comparable security at an effective interest rate as high as the interest rate on the Notes being redeemed. Our redemption right also may adversely impact your ability to sell the Notes as the optional redemption date or period approaches.

Changes relating to LIBOR may adversely affect the value of the LIBOR-indexed, floating-rate debt securities in our portfolio.

In July 2017, the head of the United Kingdom Financial Conduct Authority announced the desire to phase out the use of LIBOR by the end of 2021. As of September 30, 2017, approximately 89.9% of our debt investment portfolio (at fair value) bore interest rates indexed upon LIBOR. The use of a new index could reduce our interest income and therefore have an adverse effect on our results of operations. Management continues to monitor the status and discussions regarding LIBOR.

Pending legislation may allow us to incur additional leverage.

As a BDC, under the 1940 Act we generally are not permitted to incur indebtedness unless immediately after any borrowing we have an asset coverage for total borrowings of at least 200.0% (i.e., the amount of debt may not exceed 50.0% of the value of our assets). Legislation recently passed by the U.S. House of Representatives Financial Services Committee, if it becomes law, would modify this section of the 1940 Act and increase the amount of debt that BDCs may incur by modifying the asset coverage percentage from 200.0% to 150.0%. As a result, we may be able to incur additional indebtedness in the future and therefore your risk of an investment in us may increase.

 

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SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS

This prospectus supplement and the accompanying prospectus include “forward-looking statements” within the meaning of Section 27A of the Securities Act of 1933, Section 21E of the Exchange Act and the Private Securities Litigation Reform Act of 1995. Information contained in this prospectus supplement and the accompanying prospectus contain forward-looking statements, which can be identified by the use of forward-looking terminology such as “may,” “predict,” “will,” “continue,” “likely,” “would,” “could,” “should,” “expect,” “anticipate,” “potential,” “estimate,” “indicate,” “seek,” “believe,” “target,” “intend” or “project” or the negative of these words or other variations on these words or comparable terminology. The matters described in the section titled “Supplementary Risk Factors” in this prospectus supplement and the section titled “Risk Factors” in the accompanying prospectus and certain other factors noted throughout this prospectus supplement and the accompanying prospectus constitute cautionary statements identifying important factors with respect to any such forward-looking statements, including certain risks and uncertainties that could cause actual results to differ materially from those in such forward-looking statements. We undertake no obligation to revise or update any forward-looking statements but advise you to consult any additional disclosures that we may make directly to you or through reports that we may file in the future with the SEC, including annual reports on Form 10-K, quarterly reports on Form 10-Q and current reports on Form 8-K. Accordingly, there are or will be important factors that could cause our actual results to differ materially from those expressed or implied by the forward-looking statements. We believe these factors include, but are not limited to, the following:

 

    our future operating results;

 

    market conditions and our ability to access debt and equity capital and our ability to manage our capital resources effectively;

 

    the timing of cash flows, if any, from the operations of our portfolio companies;

 

    our business prospects and the prospects of our existing and prospective portfolio companies;

 

    the financial condition and ability of our existing and prospective portfolio companies to achieve their objectives;

 

    the adequacy of our cash resources and working capital;

 

    our ability to recover unrealized losses;

 

    our expected financings and investments;

 

    our contractual arrangements and other relationships with third parties;

 

    the impact of fluctuations in interest rates on our business;

 

    the impact of a protracted decline in the liquidity of credit markets on our business;

 

    our ability to operate as a BDC and a RIC, including the impact of changes in laws or regulations governing our operations or the operations of our portfolio companies;

 

    the dependence of our future success on the general economy and its impact on the industries in which we invest;

 

    our ability to successfully invest any capital raised in an offering;

 

    the return or impact of current and future investments;

 

    our transition to a debt focused investment strategy;

 

    the valuation of our investments in portfolio companies, particularly those having no liquid trading market;

 

    our regulatory structure and tax treatment; and

 

    the timing, form and amount of any dividend distributions.

 

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USE OF PROCEEDS

We estimate the net proceeds we will receive from the sale of the $50 million aggregate principal amount of the Notes in this offering will be $47.9 million (or $55.2 million if the underwriters exercise their option to purchase additional Notes in full), based on the purchase price paid by the underwriters of 97% of the aggregate principal amount of the Notes, after deducting estimated offering expenses of approximately $600,000 payable by us.

We intend to use the net proceeds from this offering to repay outstanding indebtedness under our Credit Facility. However, through re-borrowings under our Credit Facility, we intend to make investments in LMM and UMM portfolio companies in accordance with our investment objective and strategies, to make investments in marketable securities and other temporary investments, and for other general corporate purposes, including payment of operating expenses. As of December 12, 2017, we had $86.0 million of indebtedness outstanding under our Credit Facility. Our Credit Facility matures on November 16, 2021, and borrowings under the Credit Facility currently bear interest on a per annum basis equal to LIBOR plus 3.00%.

 

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CAPITALIZATION

The following table sets forth our cash and cash equivalents and capitalization:

(a) on an actual basis as of September 30, 2017; and

(b) on an as adjusted basis for the sale of $50 million aggregate principal amount of the Notes offered hereby (assuming no exercise of the option to purchase additional Notes) based on the purchase price paid by the underwriters of 97% of the aggregate principal amount of the Notes, after deducting estimated offering expenses of approximately $600,000 payable by us, and to reflect the use of proceeds from this offering.

This table should be read together with “Use of Proceeds” and “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” each included in this prospectus supplement, and our most recent consolidated financial statements and notes thereto included in this prospectus supplement and the accompanying prospectus.

 

     As of September 30, 2017  
     Actual     As Adjusted for
this Offering
 
     (Unaudited)
(in thousands, except share
and per share numbers)
 

Cash and cash equivalents

   $ 33,329     $ 33,329  

Borrowings:

    

Credit Facility(1)

     56,000       8,100  

Notes offered hereby (net of deferred issuance costs)

     —         47,900  
  

 

 

   

 

 

 

Total borrowings

   $ 56,000     $ 56,000  
  

 

 

   

 

 

 

Net Assets:

    

Common stock, par value $0.25 per share, 25,000,000 common shares authorized, and 18,358,808 common shares issued and outstanding

   $ 4,590     $ 4,590  

Additional paid-in capital

     262,019       262,019  

Net investment income in excess of (less than) distributions

     (1,277     (1,277

Accumulated undistributed net realized gain

     9,223       9,223  

Unrealized appreciation of investments, net of income taxes

     41,896       41,896  

Treasury stock — at cost, 2,339,512 shares

     (23,937     (23,937

Total net assets

   $ 292,514     $ 292,514  

Total liabilities and net assets

   $ 368,670     $ 368,670  
  

 

 

   

 

 

 

 

(1)  The above table reflects the carrying value of indebtedness outstanding as of September 30, 2017. As of December 12, 2017, outstanding indebtedness under our Credit Facility was $86.0 million. The net proceeds from the sale of the Notes in this offering are expected to be used to pay down outstanding indebtedness under our Credit Facility. On an as adjusted for this offering basis and reflecting the use of proceeds from this offering, the line item “Credit Facility” would be $38.1 million as of December 12, 2017. See “Use of Proceeds” in this prospectus supplement.

 

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SELECTED FINANCIAL DATA

The selected financial and other data below reflects the historical financial condition and the results of operations of Capital Southwest Corporation as of and for the six months ended September 30, 2017 and 2016 and as of and for the years ended March 31, 2017, 2016, 2015, 2014 and 2013. The selected financial data as of and for the six months ended September 30, 2017 and 2016 have been derived from our unaudited financial statements, and the selected financial data as of and for the years ended March 31, 2017, 2016, 2015, 2014 and 2013 has been derived from consolidated financial statements that have been audited by Grant Thornton LLP, an independent registered public accounting firm. You should read this selected financial and other data in conjunction with our “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” “Senior Securities” and the financial statements and related notes in this prospectus supplement and the accompanying prospectus.

Selected Consolidated Financial Data

(In thousands except per share data)

 

    Six Months
Ended
September 30,
    Year ended March 31,  
    2017     2016     2017     2016     2015     2014     2013  

Income statement data:

             

Investment income:

             

Interest and dividends:

  $ 15,882     $ 8,560     $ 22,324     $ 8,033     $ 9,231     $ 11,915     $ 10,100  

Interest income from cash and cash equivalents

    12       126       166       386       122       67       71  

Fees and other income

    339       197       984       741       595       625       664  
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total investment income

    16,233       8,883       23,474       9,160       9,948       12,607       10,835  
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Operating expenses:

             

Compensation-related expenses

    4,341       3,728       8,217       9,515       6,440       5,489       5,628  

Interest expense

    1,649       103       989                          

General, administrative and other

    2,592       2,357       4,601       11,610       5,683       2,963       2,710  
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total operating expenses

    8,582       6,188       13,807       21,125       12,123       8,452       8,338  
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Income (loss) before income taxes

    7,651       2,695       9,667       (11,965     (2,175     4,155       2,497  

Income tax expense (benefit)

    278       958       1,779       (1,278     270       (739     590  
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net investment income (loss)

    7,373       1,737       7,888       (10,687     (2,445     4,894       1,907  
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net realized gains (losses):

             

Non-control/Non-affiliate investments

    834       (260     3,992       (9,575     8,226       14,084       2,660  

Affiliate investments

          3,986       3,876       (1,458     157,213             66,037  

Control investments

                28       231       (1,175           20,861  
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net realized gains (losses) on investments before income tax

    834       3,726       7,896       (10,802     164,264       14,084       89,558  

Net unrealized appreciation (depreciation) on investments

    5,880       4,153       7,690       16,089       (108,377     93,032       16,367  
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net realized and unrealized gains on investments

    6,714       7,879       15,586       5,287       55,887       107,116       105,925  
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net increase (decrease) in net assets resulting from operations

  $ 14,087     $ 9,616     $ 23,474     $ (5,400   $ 53,442     $ 112,010     $ 107,832  
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

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    Six Months
Ended
September 30,
    Year ended March 31,  
    2017     2016     2017     2016     2015     2014     2013  

Net investment income gain (loss) per share — basic and diluted

  $ 0.46     $ 0.11     $ 0.50     $ (0.68   $ (0.16   $ 0.32     $ 0.13  

Net realized earnings per share — basic and diluted(1)

  $ 0.51     $ 0.35     $ 1.00     $ (1.37   $ 10.45     $ 1.24     $ 6.03  

Net increase (decrease) in net assets from operations — basic and diluted

  $ 0.88     $ 0.61     $ 1.48     $ (0.35   $ 3.44     $ 7.32     $ 7.09  

Net asset value per common share

  $ 18.26     $ 17.74     $ 17.80     $ 17.34     $ 49.30     $ 49.98     $ 43.30  

Total dividends/distributions declared per common share

  $ 0.45     $ 0.17     $ 0.79     $ 0.14     $ 0.20     $ 0.20     $ 5.29  

Weighted average number of shares outstanding — basic

    16,010       15,728       15,825       15,636       15,492       15,278       15,177  

Weighted average number of shares outstanding — diluted

    16,075       15,802       15,877       15,724       15,531       15,298       15,207  

 

(1)  “Net realized earnings per share — basic and diluted” is calculated as the sum of “Net investment income (loss)” and “Net realized gain (loss) on investments” divided by weighted average shares outstanding — basic and diluted.

 

    Six Months
Ended
September 30,
    Year ended March 31,  
    2017     2016     2017     2016     2015     2014     2013  

Balance sheet data:

             

Assets:

             

Investments at fair value

  $ 321,860     $ 238,319     $ 286,880     $ 178,436     $ 535,536     $ 677,920     $ 574,187  

Cash and cash equivalents

    33,329       57,840       22,386       95,969       225,797       88,163       81,767  

Interest, escrow and other receivables

    4,715       4,296       4,308       6,405       4,418       1,371       2,756  

Net pension assets

    —         —         —         —         10,294       10,962       8,762  

Deferred tax asset

    1,846       1,940       2,017       2,342       —         —         —    

Debt issuance costs

    1,972       2,443       2,137       —         —         —         —    

Other assets

    4,948       2,437       8,024       1,341       827       278       200  
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total assets

  $ 368,670     $ 307,275     $ 325,752     $ 284,493     $ 776,872     $ 778,694     $ 667,672  
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Liabilities:

             

Credit facility

  $ 56,000     $ —       $ 25,000     $ —       $ —       $ —       $ —    

Other liabilities

    14,077       6,087       5,996       9,028       4,923       3,263       3,102  

Payable for unsettled transactions

    —         19,361       —         3,940       —         —         —    

Income tax payable

    —         211       —         —         —         —         —    

Dividends payable

    3,838       —         7,191       625       —         —         —    

Accrued restoration plan liability

    2,122       2,165       2,170       2,205       3,119       3,103       2,650  

Deferred income taxes

    119       522       323       —         1,412       1,940       2,143  
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total liabilities

    76,156       28,346       40,680       11,858       9,454       8,306       7,895  

Net assets

    292,514       278,929       285,072       272,635       767,418       770,388       659,777  
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total liabilities and net assets

  $ 368,670     $ 307,275     $ 325,752     $ 284,493     $ 776,872     $ 778,694     $ 667,672  
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Other data:

             

Number of portfolio companies

    27       27       28       23       22       27       28  

Expense ratios (as percentage of average net assets):

             

Total expenses, excluding interest expense

    2.40     2.26     4.59     4.48     1.59     1.18     1.36

 

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MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND

RESULTS OF OPERATIONS

The information contained in this section should be read in conjunction with our consolidated financial statements and notes thereto appearing elsewhere in this prospectus supplement and the accompanying prospectus.

The information contained herein may contain “forward-looking statements” based on our current expectations, assumptions and estimates about us and our industry. These forward-looking statements involve risks and uncertainties. Words such as “believe,” “seek,” “estimate,” “expect,” “intend,” “target,” “will,” “would,” “may,” “could,” “continue” and other similar expressions identify forward-looking statements. In addition, any statements that refer to expectations, projections or other characterizations of future events or circumstances are forward-looking statements that are subject to risks, uncertainties and assumptions. Our actual results could differ materially from those we express in the forward-looking statements as a result of several factors more fully described in the section titled “Supplementary Risk Factors” in this prospectus supplement, the section titled “Risk Factors” in the accompanying prospectus, the section titled “Special Note Regarding Forward-Looking Statements” in this prospectus supplement and the section titled “Cautionary Statement Concerning Forward-Looking Statements” in the accompanying prospectus.

OVERVIEW

We are an internally managed investment company that specializes in providing customized debt and equity financing to lower middle market, or LMM, companies and debt capital to upper middle market, or UMM, companies in a broad range of investment segments located primarily in the United States. Our principal investment objective is to produce attractive risk-adjusted returns by generating current income from our debt investments and capital appreciation from our equity and equity related investments. Our investment strategy is to partner with business owners, management teams and financial sponsors to provide flexible financing solutions to fund growth, changes of control, or other corporate events. We invest primarily in senior debt securities, secured by security interests in portfolio company assets, and in secured and unsecured subordinated debt securities. We also invest in equity interests in our portfolio companies alongside our debt securities.

We focus on investing in companies with histories of generating revenues and positive cash flow, established market positions and proven management teams with strong operating discipline. We target senior debt, subordinated debt, and equity investments in LMM companies, as well as first and second lien syndicated loans in UMM companies. Our target LMM companies typically have annual earnings before interest, taxes, depreciation and amortization, or EBITDA between $3.0 million and $15.0 million, and our LMM investments generally range from $5.0 million to $20.0 million. Our UMM investments generally include syndicated first and second lien loans in companies with EBITDA generally greater than $50.0 million, and our UMM investments typically range from $5.0 million to $10.0 million.

We seek to fill the financing gap for LMM businesses, which, historically, have had more limited access to financing from commercial banks and other traditional sources. The underserved nature of the LMM creates the opportunity for us to meet the financing needs of LMM companies while also negotiating favorable transaction terms and equity participations. Our ability to invest across a company’s capital structure, from secured loans to equity securities, allows us to offer portfolio companies a comprehensive suite of financing options. Providing customized financing solutions is important to LMM companies. We generally seek to partner directly with financial sponsors, entrepreneurs, management teams and business owners in making our investments. Our LMM debt investments typically include first lien senior debt, secured by a first lien on the assets of the portfolio company, as well as subordinated debt. Our LMM investments typically have a term of between five and seven years from the original investment date. We also often seek to invest in equity securities in our LMM portfolio companies.

Our investments in UMM companies primarily consist of direct investments in or secondary purchases of interest bearing debt securities in privately held companies that are generally larger in size than the LMM

 

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companies included in our portfolio. Our UMM debt investments are generally secured by either a first or second priority lien on the assets of the portfolio company and typically have an expected duration of between three and seven years from the original investment date.

CRITICAL ACCOUNTING POLICIES AND USE OF ESTIMATES

The preparation of our consolidated financial statements in accordance with U.S. GAAP requires management to make certain estimates and assumptions that affect the reported amounts of assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenues and expenses for the periods covered by the consolidated financial statements. We have identified investment valuation and revenue recognition as our most critical accounting estimates. On an on-going basis, we evaluate our estimates, including those related to the matters below. These estimates are based on the information that is currently available to us and on various other assumptions that we believe to be reasonable under the circumstances. Actual results could differ materially from those estimates under different assumptions or conditions. A discussion of our critical accounting policies follows.

Valuation of Investments

The most significant determination inherent in the preparation of our consolidated financial statements is the valuation of our investment portfolio and the related amounts of unrealized appreciation and depreciation. As of September 30, 2017 and March 31, 2017, our investment portfolio at fair value represented approximately 87.3% and 88.1%, respectively, of our total assets. We are required to report our investments at fair value. We follow the provisions of Accounting Standards Codification, or ASC, 820, Fair Value Measurements and Disclosures (“ASC 820”). ASC 820 defines fair value, establishes a framework for measuring fair value, establishes a fair value hierarchy based on the quality of inputs used to measure fair value, and enhances disclosure requirements for fair value measurements. ASC 820 requires us to assume that the portfolio investment is to be sold in the principal market to independent market participants, which may be a hypothetical market. See Note 4 — “Fair Value Measurements” in the notes to consolidated financial statements for a detailed discussion of our investment portfolio valuation process and procedures.

Due to the inherent uncertainty in the valuation process, our determination of fair value for our investment portfolio may differ materially from the values that would have been determined had a ready market for the securities actually existed. In addition, changes in the market environment, portfolio company performance, and other events may occur over the lives of the investments that may cause the gains or losses ultimately realized on these investments to be materially different than the valuations currently assigned. We determine fair value of each individual investment and record changes in fair value as unrealized appreciation or depreciation.

Our Board has the final responsibility for reviewing and approving, in good faith, our determination of the fair value for our investment portfolio and our valuation procedures, consistent with the Investment Company Act of 1940 requirements. We believe our investment portfolio as of September 30, 2017 and March 31, 2017 approximates fair value as of those dates based on the markets in which we operate and other conditions in existence on those reporting dates.

Revenue Recognition

Interest and Dividend Income

Interest and dividend income is recorded on an accrual basis to the extent amounts are expected to be collected. Dividend income is recognized on the date dividends are declared. Discounts/premiums received to par on loans purchased are capitalized and accreted or amortized into income over the life of the loan. In accordance with our valuation policy, accrued interest and dividend income is evaluated periodically for collectability. When we do not expect the debtor to be able to service all of its debt or other obligations, we will generally establish a

 

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reserve against interest income receivable, thereby placing the loan or debt security on non-accrual status, and cease to recognize interest income on that loan or debt security until the borrower has demonstrated the ability and intent to pay contractual amounts due. If a loan or debt security’s status significantly improves regarding ability to service debt or other obligations, it will be restored to accrual basis. As of September 30, 2017, we did not have any investments on non-accrual status.

Recently Issued Accounting Standards

In February 2016, the FASB issued ASU 2016-02, Leases, which requires lessees to recognize on the balance sheet a right-of-use asset, representing its right to use the underlying asset for the lease term, and a lease liability for all leases with terms greater than 12 months. The guidance also requires qualitative and quantitative disclosures designed to assess the amount, timing, and uncertainty of cash flows arising from leases. The standard requires the use of a modified retrospective transition approach, which includes a number of optional practical expedients that entities may elect to apply. The new guidance is effective for annual periods beginning after December 15, 2018, and interim periods therein. Early application is permitted. CSWC is currently evaluating the impact the adoption of this new accounting standard will have on its consolidated financial statements, but the impact of the adoption is not expected to be material.

In May 2014, the FASB issued ASU 2014-09, Revenue from Contracts with Customers (Topic 606). ASU 2014-09 supersedes the revenue recognition requirements under SAC Topic 605, Revenue Recognition, and most industry-specific guidance throughout the Industry Topics of the ASC. The core principle of the guidance is that an entity should recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which an entity expects to be entitled in exchange for those goods or services. Under the new guidance, an entity is required to perform the following five steps: (1) identify the contract(s) with a customer; (2) identify the performance obligations in the contract; (3) determine the transaction price; (4) allocate the transaction price to the performance obligations in the contract, and (5) recognize revenue when (or as) the entity satisfies a performance obligation. The new guidance will significantly enhance comparability of revenue recognition practices across entities, industries, jurisdictions and capital markets. Additionally, the guidance requires improved disclosures as to the nature, amount, timing and uncertainty of revenue that is recognized.

In May 2016, the FASB issued ASU No. 2016-12, Revenue from Contracts with Customers (Topic 606) —Narrow-Scope Improvements and Practical Expedients. This ASU clarified guidance on assessing collectability, presenting sales tax, measuring noncash consideration, and certain transition matters. The FASB tentatively decided to defer the effective date of the new revenue standard for public entities under U.S. GAAP for one year. The new guidance will be effective for the annual reporting period beginning after December 15, 2017, including interim periods within that reporting period. Early adoption would be permitted for annual reporting periods beginning after December 15, 2016. CSWC completed its initial assessment in evaluating the potential impact on its consolidated financial statements and based on its initial assessment determined that its financial contracts are excluded from the scope of ASU 2014-09. As a result of the scope exception for financial contracts, the Company’s management has determined that there will be no material changes to the recognition timing and classification of revenues and expenses; additionally, the Company’s management does not expect the adoption of ASU 2014-09 to have a significant impact to pretax income or on its consolidated financial statement disclosures upon adoption. The Company will continue to evaluate the impacts of ASU 2014-09 through the date of adoption to ensure that its initial assessment continues to remain accurate.

In August 2016, the FASB issued ASU 2016-15, Statement of Cash Flows (Topic 230), which is intended to reduce the existing diversity in practice in how certain cash receipts and cash payments are presented and classified in the statement of cash flows. The guidance is effective for annual periods beginning after December 15, 2017, and interim periods therein. Early application is permitted. The impact of the adoption of this new accounting standard on the Company’s consolidated financial statements is not expected to be material.

 

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INVESTMENT PORTFOLIO COMPOSITION

Our LMM investments consist of secured debt, subordinated debt, equity warrants and direct equity investments in privately held LMM companies based in the United States. Our LMM portfolio companies generally have annual EBITDA between $3.0 million and $15.0 million, and our LMM investments typically range from $5.0 million to $20.0 million. The LMM debt investments are typically secured by either a first or second priority lien on the assets of the portfolio company, generally bear interest at floating rates, and generally have a term of between five and seven years from the original investment date.

Our UMM investments consist of direct investments in or secondary purchases of interest-bearing debt securities in privately held companies based in the United States that are generally larger in size than the LMM companies included in our portfolio with EBITDA generally greater than $50.0 million. Our UMM investments typically range from $5.0 million to $10.0 million. Our UMM debt investments are generally secured by ether a first or second priority lien on the assets of the portfolio company and typically have a term of between three and seven years from the original investment date.

The total value of our investment portfolio was $321.9 million as of September 30, 2017, as compared to $286.9 million as of March 31, 2017. As of September 30, 2017, we had investments in 27 portfolio companies with an aggregate cost of $279.8 million. As of March 31, 2017, we had investments in 28 portfolio companies with an aggregate cost of $250.5 million.

As of September 30, 2017 and March 31, 2017, approximately $168.5 million, or 89.9%, and $155.0 million, or 92.6%, respectively, of our debt investment portfolio (at fair value) bore interest at floating rates, all of which were subject to contractual minimum interest rates. As of September 30, 2017 and March 31, 2017, approximately $18.8 million, or 10.1%, and $12.4 million, or 7.4%, respectively, of our debt investment portfolio (at fair value) bore interest at fixed rates.

The following tables provide a summary of our investments in LMM and UMM companies as of September 30, 2017 and March 31, 2017 (excluding our investment in I-45 SLF LLC, or I-45 SLF):

 

     As of September 30, 2017  
           LMM(a)                 UMM        
     (dollars in thousands)  

Number of portfolio companies

     13       13  

Fair value

   $ 170,139     $ 84,320  

Cost

   $ 131,762     $ 83,283  

% of portfolio at cost — debt

     77.8     100.0

% of portfolio at cost — equity

     22.2      

% of debt investments at cost secured by first lien

     63.5     61.6

Weighted average annual effective yield(b)(c)

     11.4     9.9

Weighted average EBITDA(c)

   $ 9.1     $ 93.8  

Weighted average leverage through CSWC security(c)(d)

     3.5x       3.7x  

 

(a) At September 30, 2017, we had equity ownership in approximately 84.6% of our LMM investments.
(b)  The weighted-average annual effective yields were computed using the effective interest rates for all debt investments at cost as of September 30, 2017, including accretion of original issue discount but excluding fees payable upon repayment of the debt instruments and any debt investments on non-accrual status. As of September 30, 2017, there were no investments on non-accrual status. Weighted-average annual effective yield is higher than what an investor in shares in our common stock will realize on its investment because it does not reflect our expenses or any sales load paid by an investor.
(c)  Weighted average metrics are calculated using investment cost basis weighting.
(d) 

Includes CSWC debt investments only. Calculated as the amount of each portfolio company’s debt (including CSWC’s position and debt senior or pari passu to CSWC’s position, but excluding debt

 

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  subordinated to CSWC’s position) in the capital structure divided by each portfolio company’s adjusted EBITDA. Management uses this metric as a guide to evaluate relative risk of its position in each portfolio debt investment.

 

     As of March 31, 2017  
     LMM(a)     UMM  
     (dollars in thousands)  

Number of portfolio companies

     10       17  

Fair value

   $ 126,305     $ 97,180  

Cost

   $ 93,822     $ 95,918  

% of portfolio at cost — debt

     74.8     100.0

% of portfolio at cost — equity

     25.2      

% of debt investments at cost secured by first lien

     61.5     51.2

Weighted average annual effective yield(b)(c)

     11.4     9.6

Weighted average EBITDA(c)

   $ 7.4     $ 101.3  

Weighted average leverage through CSWC security(c)(d)

     3.1x       4.0x  

 

  (a)  At March 31, 2017, we had equity ownership in approximately 70.0% of our LMM investments.
  (b)  The weighted-average annual effective yields were computed using the effective interest rates for all debt investments at cost as of March 31, 2017, including accretion of original issue discount but excluding fees payable upon repayment of the debt instruments and any debt investments on non-accrual status. As of March 31, 2017, there were no investments on non-accrual status. Weighted-average annual effective yield is higher than what an investor in shares in our common stock will realize on its investment because it does not reflect our expenses or any sales load paid by an investor.
  (c)  Weighted average metrics are calculated using investment cost basis weighting.
  (d)  Includes CSWC debt investments only. Calculated as the amount of each portfolio company’s debt (including CSWC’s position and debt senior or pari passu to CSWC’s position, but excluding debt subordinated to CSWC’s position) in the capital structure divided by each portfolio company’s adjusted EBITDA. Management uses this metric as a guide to evaluate relative risk of its position in each portfolio debt investment.

 

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As of September 30, 2017 and March 31, 2017, our investment portfolio consisted of the following investments:

 

     Fair Value      Percentage of
Total Portfolio
    Cost      Percentage of
Total Portfolio
 
     (dollars in millions)  

September 30, 2017:

          

First lien loans(a)

   $ 136.1        42.3   $ 135.0        48.2

Second lien loans

     32.4        10.1       32.0        11.4  

Subordinated debt

     18.9        5.9       18.8        6.7  

Preferred equity

     22.3        6.9       15.3        5.5  

Common equity & warrants

     44.8        13.9       13.9        5.0  

I-45 SLF LLC(b)

     67.4        20.9       64.8        23.2  
  

 

 

    

 

 

   

 

 

    

 

 

 
   $ 321.9        100.0   $ 279.8        100.0
  

 

 

    

 

 

   

 

 

    

 

 

 

March 31, 2017(c):

          

First lien loans

   $ 107.8        37.6   $ 106.8        42.6

Second lien loans

     47.2        16.5       46.9        18.7  

Subordinated debt

     12.5        4.3       12.4        4.9  

Preferred equity

     18.3        6.4       14.8        5.9  

Common equity & warrants

     37.7        13.1       8.8        3.6  

I-45 SLF LLC(b)

     63.4        22.1       60.8        24.3  
  

 

 

    

 

 

   

 

 

    

 

 

 
   $ 286.9        100.0   $ 250.5        100.0
  

 

 

    

 

 

   

 

 

    

 

 

 

 

(a) Included in first lien loans are loans structured as first lien last out loans. These loans may in certain cases be subordinated in payment priority to other senior secured lenders. As of September 30, 2017 and March 31, 2017, the fair value of the first lien last out loans are $22.0 million and $21.8 million, respectively.
(b) I-45 SLF, LLC is a joint venture between CSWC and Main Street Capital. This entity primarily invests in syndicated senior secured loans in the UMM. The portfolio companies held by I-45 SLF represent a diverse set of industry classifications, which are similar to those in which CSWC invests directly. We own 80.0% of I-45 SLF and have a profits interest of 75.6%, while Main Street Capital owns 20.0% and has a profits interest of 24.4%. I-45 SLF’s Board of Managers makes all investment and operational decisions for the fund, and consists of equal representation from our Company and Main Street. The Company does not guarantee or otherwise obligate itself to make payments on debts owed by I-45 SLF.
(c) Presentation of the March 31, 2017 disclosure is updated to conform to the current period presentation.

Portfolio Asset Quality

We utilize an internally developed investment rating system to rate the performance and monitor the expected level of returns for each debt investment in our portfolio. The investment rating system takes into account both quantitative and qualitative factors of the portfolio company and the investments held therein, including each investment’s expected level of returns and the collectability of our debt investments, comparisons to competitors and other industry participants and the portfolio company’s future outlook. The ratings are not intended to reflect the performance or expected level of returns of our equity investments.

 

    Investment Rating 1 represents the least amount of risk in our portfolio. The investment is performing materially above underwriting expectations and the trends and risk factors are generally favorable.

 

    Investment Rating 2 indicates the investment is performing as expected at the time of underwriting and the trends and risk factors are generally favorable to neutral.

 

   

Investment Rating 3 involves an investment performing below underwriting expectations and the trends and risk factors are generally neutral to negative. The portfolio company or investment may be out of

 

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compliance with financial covenants and interest payments may be impaired, however principal payments are generally not past due.

 

    Investment Rating 4 indicates that the investment is performing materially below underwriting expectations, the trends and risk factors are generally negative and the risk of the investment has increased substantially. Interest and principal payments on our investment are likely to be impaired.

The following table shows the distribution of our debt portfolio investments on the 1 to 4 investment rating scale at fair value as of September 30, 2017 and March 31, 2017:

 

     As of September 30, 2017  

Investment Rating

   Debt
Investments at
Fair Value
     Percentage of
Debt Portfolio
 
     (dollars in thousands)  

1

   $ 8,250        4.4

2

     168,957        90.2  

3

     10,109        5.4  

4

             
  

 

 

    

 

 

 

Total

   $ 187,316        100.0
  

 

 

    

 

 

 

 

     As of March 31, 2017  

Investment Rating

   Debt
Investments at
Fair Value
     Percentage of
Debt Portfolio
 
     (dollars in thousands)  

1

   $ 12,173        7.3

2

     155,276        92.7  

3

             

4

             
  

 

 

    

 

 

 

Total

   $ 167,449        100.0
  

 

 

    

 

 

 

Interest and dividend income is recorded on an accrual basis to the extent amounts are expected to be collected. When we do not expect the debtor to be able to service all of its debt or other obligations, we will generally establish a reserve against interest income receivable, thereby placing the loan or debt security on non-accrual status, and cease to recognize interest income on that loan or debt security until the borrower has demonstrated the ability and intent to pay contractual amounts due.

As of September 30, 2017 and March 31, 2017, we did not have any investments on non-accrual status.

Investment Activity

During the six months ended September 30, 2017, we made debt investments in six new portfolio companies totaling $55.2 million, follow-on debt investments in one portfolio company totaling $4.6 million, and equity investments in one existing and three new portfolio companies totaling $5.4 million. We also funded $4.0 million on our existing equity commitment to I-45 SLF. We received contractual principal repayments totaling approximately $5.6 million and full prepayments of approximately $35.6 million from seven portfolio companies.

During the six months ended September 30, 2016, we made debt investments in seven new portfolio companies totaling $48.9 million, follow-on debt investments in three portfolio companies totaling $6.4 million, and an equity investment in one existing portfolio company totaling $12.0 million. We received contractual principal repayments totaling approximately $1.2 million and full prepayments of approximately $11.0 million

 

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from two portfolio companies. We received proceeds related to the sales of certain equity securities totaling $4.4 million and recognized realized gains on such sales totaling $4.0 million.

Total portfolio investment activity for the six months ended September 30, 2017 and 2016 was as follows (dollars in thousands):

 

Six months ended September 30, 2017    First Lien
Loans
    Second Lien
Loans
    Subordinated
Debt
    Preferred &
Common
Equity
    I-45 SLF,
LLC
     Total  

Fair value, beginning of period

   $ 107,817     $ 47,176     $ 12,453     $ 56,039     $ 63,395      $ 286,880  

New investments

     45,323             14,406       5,441       4,000        69,170  

Proceeds from sales of investments

                       (15            (15

Principal repayments received

     (17,930     (15,179     (8,100                  (41,209

PIK interest earned

                       142              142  

Accretion of loan discounts

     304       54       25                    383  

Realized gain

     465       241       114       14          834  

Unrealized gain (loss)

     146       53       (52     5,522       6        5,675  
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

    

 

 

 

Fair value, end of period

   $ 136,125     $ 32,345     $ 18,846     $ 67,143     $ 67,401      $ 321,860  
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

    

 

 

 

Weighted average yield on debt investments at end of period

                10.71
             

 

 

 

Weighted average yield on total investments at end of period

                10.65
             

 

 

 

 

Six months ended September 30, 2016    First Lien
Loans
    Second Lien
Loans
    Subordinated
Debt
    Preferred &
Common
Equity
    I-45 SLF,
LLC
     Total  

Fair value, beginning of period

   $ 39,491     $ 38,227     $ 15,114     $ 49,267     $ 36,337      $ 178,436  

New investments

     52,580       2,940                   12,000        67,520  

Proceeds from sales of investments

                       (4,442            (4,442

Principal repayments received

     (7,098     (5,088     (79                  (12,265

Accretion of loan discounts

     114       45       17                    176  

Realized gain

     28       193             3,998              4,219  

Unrealized gain (loss)

     1,160       146       (203     1,388       2,184        4,675  
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

    

 

 

 

Fair value, end of period

   $ 86,275     $ 36,463     $ 14,849     $ 50,211     $ 50,521      $ 238,319  
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

    

 

 

 

Weighted average yield on debt investments at end of period

                10.00
             

 

 

 

Weighted average yield on total investments at end of period

                9.13
             

 

 

 

RESULTS OF OPERATIONS

The composite measure of our financial performance presented herein is captioned “Net increase in net assets from operations” and consists of three elements. The first is “Net investment income,” which is the difference between income from interest, dividends and fees and our combined operating and interest expenses, net of applicable income taxes. The second element is “Net realized gain on investments before income tax,” which is the difference between the proceeds received from the disposition of portfolio securities and their stated cost, net of applicable income tax expense based on our tax year. The third element is the “Net change in unrealized appreciation of investments, net of tax,” which is the net change in the market or fair value of our investment portfolio, compared with stated cost. It should be noted that the “Net realized gain on investments before income

 

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tax” and “Net change in unrealized appreciation of investments, net of tax” are directly related in that when an appreciated portfolio security is sold to realize a gain, a corresponding decrease in net unrealized appreciation occurs by transferring the gain associated with the transaction from being “unrealized” to being “realized.” Conversely, when a loss is realized on a depreciated portfolio security, an increase in net unrealized appreciation occurs.

Comparison of three months ended September 30, 2017 and September 30, 2016

 

     Three Months Ended
September 30,
    Net Change  
     2017     2016     Amount     %  
     (in thousands)  

Total investment income

   $ 8,509     $ 4,726     $ 3,783       80.0

Total operating expenses

     (4,438     (2,949     (1,490     50.5
  

 

 

   

 

 

   

 

 

   

Income before taxes

     4,071       1,777       2,293       129.0

Income tax expense

     134       412       (279     (67.7 )% 
  

 

 

   

 

 

   

 

 

   

Net investment income

     3,937       1,365       2,572       188.4

Net realized gain on investments before income tax

     210       3,527       (3,317     (94.0 )% 

Net change in unrealized appreciation on investments, net of tax

     4,496       2,026       2,469       121.9
  

 

 

   

 

 

   

 

 

   

Net increase in net assets from operations

   $ 8,643     $ 6,918     $ 1,724       24.9
  

 

 

   

 

 

   

 

 

   

Investment Income

Total investment income consisted of interest income, management fees, dividend income and other income for each applicable period. For the three months ended September 30, 2017, we reported investment income of $8.5 million, a $3.8 million, or 80.0%, increase as compared to the three months ended September 30, 2016. The increase was primarily due to a $2.7 million, or 105.1%, increase in interest income generated from our debt investments due to a 35.6% increase in the cost basis of debt investments held from $137.0 million to $185.8 million year over year in addition to an increase in the weighted average yield on debt investments from 10.00% to 10.71% year over year. Additionally, there was an increase of approximately $1.1 million in dividend income due to an increase in dividends received from I-45 SLF and Media Recovery, Inc.

Operating Expenses

Due to the nature of our business, the majority of our operating expenses are related to employees’ and directors’ compensation, office expenses, and legal, professional and accounting fees.

For the three months ended September 30, 2017, our total operating expenses were $4.4 million, an increase of $1.5 million, or 50.5%, as compared to the total operating expenses of $2.9 million for the three months ended September 30, 2016. The increase was primarily attributable to a $0.8 million increase in interest expense incurred on our Credit Facility due to an increase in borrowings during the three months ended September 30, 2017. The remaining increase was due to individually immaterial items within compensation, professional fees and general and administrative fees.

Net Investment Income

For the three months ended September 30, 2017, income before taxes increased by $2.3 million, or 129.0%. As a result of the $3.8 million increase in total investment income, offset by a $1.5 million increase in operating expenses, net investment income increased from the prior year period by $2.6 million to $3.9 million.

 

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Increase in Net Assets from Operations

During the three months ended September 30, 2017, we recognized realized gains totaling $0.2 million, which consisted of net gains on the full repayments of three non-control/non-affiliate investments.

In addition, during the three months ended September 30, 2017, we recorded a net change in unrealized appreciation of investments totaling $4.5 million, consisting of net unrealized appreciation on our current portfolio of $4.5 million, the reversal of $0.1 million of net unrealized appreciation recognized in prior periods due to realized gains noted above, and net unrealized appreciation related to deferred tax associated with the Taxable Subsidiary of $0.1 million. Net unrealized appreciation on our current portfolio included unrealized gains on Media Recovery, Inc. of $4.1 million and TitanLiner, Inc. of $2.4 million, partially offset by unrealized losses on Deepwater Corrosion Services of $1.2 million. These unrealized gains and losses were due to changes in fair value based on the overall EBITDA performance and cash flows of each investment.

During the three months ended September 30, 2016, we recognized realized gains totaling $3.5 million, which consisted of net gains on the partial repayments of seven non-control/non-affiliate investments, prepayment of one non-control/non-affiliate investment, the sale of certain equity securities, and the write down of two escrow receivables. In addition, during the three months ended September 30, 2016, we recorded a net change in unrealized appreciation of investments totaling $2.0 million, consisting of net unrealized appreciation on our current portfolio of $5.8 million and the reversal of $3.8 million of net unrealized appreciation recognized in prior periods due to realized gains noted above. Net unrealized appreciation on our current portfolio included unrealized gains on Deepwater Corrosion Services of $3.4 million and Media Recovery, Inc. of $2.5 million.

Comparison of six months ended September 30, 2017 and September 30, 2016

 

     Six Months Ended
September 30,
    Net Change  
     2017     2016     Amount     %  
     (in thousands)  

Total investment income

   $ 16,233     $ 8,883     $ 7,350       82.7

Total operating expenses

     (8,582     (6,188     (2,394     38.7
  

 

 

   

 

 

   

 

 

   

Income before taxes

     7,651       2,695       4,956       183.9

Income tax expense

     278       958       (680     (71.0 )% 
  

 

 

   

 

 

   

 

 

   

Net investment income

     7,373       1,737       5,636       324.5

Net realized gain on investments before income tax

     834       3,726       (2,892     (77.6 )% 

Net change in unrealized appreciation on investments, net of tax

     5,880       4,153       1,727       41.6
  

 

 

   

 

 

   

 

 

   

Net increase in net assets from operations

   $ 14,087     $ 9,616     $ 4,471       46.5
  

 

 

   

 

 

   

 

 

   

Investment Income

Total investment income consisted of interest income, management fees, dividend income and other income for each applicable period. For the six months ended September 30, 2017, Capital Southwest reported investment income of $16.2 million, a $7.4 million, or 82.7%, increase as compared to the six months ended September 30, 2016. The increase was primarily due to a $5.0 million, or 102.7%, increase in interest income generated from our debt investments due to a 35.6% increase in the cost basis of debt investments held from $137.0 million to $185.8 million year over year in addition to an increase in the weighted average yield on debt investments from 10.00% to 10.71% year over year. Additionally, there was an increase of $2.4 million in dividend income due to dividends received from I-45 SLF and Media Recovery, Inc.

Operating Expenses

Due to the nature of our business, the majority of our operating expenses are related to employees’ and directors’ compensation, office expenses, and legal, professional and accounting fees.

 

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For the six months ended September 30, 2017, our total operating expenses were $8.6 million, an increase of $2.4 million, or 38.7%, as compared to the total operating expenses of $6.2 million for the six months ended September 30, 2016. The increase was primarily attributable to a $1.5 million increase in interest expense incurred on the Credit Facility and a $0.6 million increase in compensation (including both cash and share-based compensation) during the six months ended September 30, 2017.

Net Investment Income

For the six months ended September 30, 2017, income before taxes increased by $5.0 million, or 183.9%. As a result of the $7.4 million increase in total investment income, offset by a $2.4 million increase in operating expenses, net investment income increased from the prior year period by $5.6 million to $7.4 million.

Increase in Net Assets from Operations

During the six months ended September 30, 2017, we recognized realized gains totaling $0.8 million, which consisted of net gains on the partial repayments of two non-control/non-affiliate investments, full repayment on seven non-control/non-affiliate investments, and the sale of one non-control/non-affiliate equity investment.

In addition, during the six months ended September 30, 2017, we recorded a net change in unrealized appreciation of investments totaling $5.9 million, consisting of net unrealized appreciation on our current portfolio of $6.0 million, the reversal of $0.3 million of net unrealized appreciation recognized in prior periods due to realized gains noted above, and net unrealized appreciation related to deferred tax associated with the Taxable Subsidiary of $0.2 million. Net unrealized appreciation on our current portfolio included unrealized gains on TitanLiner, Inc. of $8.5 million, Media Recovery, Inc. of $2.0 million and Vistar Media of $1.4 million, partially offset by unrealized losses on Deepwater Corrosion Services of $5.3 million. These unrealized gains and losses were due to changes in fair value based on the overall EBITDA performance and cash flows of each investment.

During the six months ended September 30, 2016, we recognized realized gains totaling $3.7 million, which consisted of net gains on the partial repayments of seven non-control/non-affiliate investments, prepayment of one non-control/non-affiliate investment, the sale of certain equity securities, and the write down of two escrow receivables. In addition, during the six months ended September 30, 2016, we recorded a net change in unrealized appreciation of investments totaling $4.2 million, consisting of net unrealized appreciation on our current portfolio of $7.9 million, the reversal of $3.2 million of net unrealized appreciation recognized in prior periods due to realized gains noted above, and net unrealized depreciation related to deferred tax associated with the Taxable Subsidiary of $0.5 million. Net unrealized appreciation on our current portfolio included unrealized gains on Deepwater Corrosion Services of $4.3 million and Media Recovery, Inc. of $3.4 million.

FINANCIAL LIQUIDITY AND CAPITAL RESOURCES

Management believes that the Company’s cash and cash equivalents, cash available from investments, and commitments under the Credit Facility are adequate to meet its needs for the next twelve months.

Cash

At September 30, 2017, the Company had cash and cash equivalents of approximately $33.3 million.

Financing Transactions

In August 2016, we entered into the Credit Facility, which provides additional liquidity to support our investment and operational activities, which included total commitments of $100.0 million. The Credit Facility also contains an accordion feature which allows us to increase the total commitments under the facility up to

 

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$150.0 million from new and existing lenders on the same terms and conditions as the existing commitments. In August 2017, we increased our total commitments by $15 million through adding an additional lender using the accordion feature. As of September 30, 2017, the Credit Facility includes total commitments of $115.0 million from a diversified group of six lenders and is scheduled to mature August 30, 2020.

Borrowings under the Credit Facility bear interest on a per annum basis at a rate equal to the applicable LIBOR rate plus 3.25% with no LIBOR floor. We pay unused commitment fees of 0.50% to 1.50% per annum, based on utilization, on the unused lender commitments under the Credit Facility.

The Credit Facility contains certain affirmative and negative covenants, including but not limited to: (1) certain reporting requirements, (2) maintaining RIC and BDC status, (3) maintaining a minimum shareholders’ equity, (4) maintaining a minimum consolidated net worth, (5) maintaining a regulatory asset coverage of not less than 200.0%, (6) maintaining a consolidated interest coverage ratio of at least 2.5 to 1.0, and (7) at any time the outstanding advances exceed 90.0% of the borrowing base, maintaining a minimum liquidity of not less than 10.0% of the covered debt amount.

The Credit Facility also contains customary events of default, including, without limitation, nonpayment, misrepresentation of representations and warranties in a material respect, breach of covenant, bankruptcy, and change of control, with customary cure and notice provisions. If the Company defaults on its obligations under the Credit Facility, the lenders may have the right to foreclose upon and sell, or otherwise transfer, the collateral subject to their security interests.

The Credit Facility is secured by (1) substantially all of the present and future property and assets of the Company and the guarantors and (2) 100.0% of the equity interests in the Company’s wholly-owned subsidiaries. As of September 30, 2017, substantially all of the Company’s assets were pledged as collateral for the Credit Facility.

At September 30, 2017, CSWC had $56.0 million in borrowings outstanding under the Credit Facility. CSWC recognized interest expense related to the Credit Facility, including unused commitment fees and amortization of deferred loan costs of $0.9 million and $1.6 million, respectively, for the three and six months ended September 30, 2017. The weighted average interest rate on the Credit Facility was 4.76% as of September 30, 2017. As of September 30, 2017, CSWC was in compliance with all financial covenants under the Credit Facility.

Our primary use of funds will be investments in portfolio companies and operating expenses.

CONTRACTUAL OBLIGATIONS

There have been no material changes to our contractual obligations from what was previously disclosed in our annual report filed on Form 10-K with the SEC on June 1, 2017.

OFF-BALANCE SHEET ARRANGEMENTS

We may be a party to financial instruments with off-balance sheet risk in the normal course of business to meet the financial needs of our portfolio companies. These instruments may include commitments to extend credit and fund equity capital and involve, to varying degrees, elements of liquidity and credit risk in excess of the amount recognized in the balance sheet. At September 30, 2017, we had a total of approximately $7.7 million in currently unfunded commitments, consisting of $3.2 million in equity capital commitments to I-45 SLF that had not been fully called and a $2.0 million revolver and $2.5 million delayed draw term loan to Zenfolio Inc. The Company believes its assets will provide adequate cover to satisfy these commitments. As of September 30, 2017, the Company had cash and cash equivalents of $33.3 million and $59.0 million in available borrowings under the Credit Facility. At March 31, 2017, we had a total of approximately $7.2 million in outstanding commitments related to equity capital commitments to I-45 SLF that had not been fully called. At March 31, 2017, the commitment to I-45 SLF was our sole unfunded obligation.

 

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RECENT DEVELOPMENTS

On August 22, 2017, we received an exemptive order that allows us to withhold shares of our common stock to satisfy tax withholding obligations related to the vesting of restricted stock granted pursuant to the 2010 Plan and to pay the exercise price of options to purchase shares of our common stock granted pursuant to the 2009 Plan. In connection with the exemptive order, our Board approved the Restricted Stock Plan Amendment. The Restricted Stock Plan Amendment allows the Company to withhold shares of our common stock from a participant’s restricted stock award in order to satisfy tax withholding obligations related to the vesting of such restricted stock. Shares withheld by us pursuant to the Restricted Stock Plan Amendment will not be available for issuance or reissuance under the 2010 Plan. Our Board approved the Restricted Stock Plan Amendment pursuant to the powers granted under Section 14 of the 2010 Plan. In addition, our Board approved the Stock Incentive Plan Amendment. The Stock Incentive Plan Amendment allows a participant of such plan to pay the exercise price of an option with cash or pursuant to a net exercise feature that allows the Company to withhold the number of shares of our common stock from such participant’s option equal to the aggregate exercise price of the option being exercised divided by the fair market value of a share of our common stock. Shares withheld by us pursuant to the Stock Incentive Plan Amendment will not be available for issuance or reissuance under the 2009 Plan. Our Board approved the Stock Incentive Plan Amendment pursuant to the powers granted under Section 18 of the 2009 Plan.

On August 30, 2017, our Board declared a quarterly cash dividend of $0.24 per share of common stock. The dividend was paid on October 2, 2017 to shareholders of record on September 15, 2017.

On November 6, 2017, our Board approved the entry into the Indemnification Agreement, with each of the Indemnitees. The Indemnification Agreement provides for the indemnification, and advancement of expenses, to the full extent permitted by law, against judgments, arbitration awards, mediation amounts, penalties, settlements, fines, excise or similar taxes, and reasonable expenses incurred by the Indemnitee in connection with any threatened, pending or completed action, suit or proceeding on account of Indemnitee’s service as a director, officer, employee or agent of the Company.

On November 16, 2017, the Company entered into the Amendment to its Credit Facility dated as of August 30, 2016, among the Company, as borrower, the lenders party thereto, ING Capital LLC, as administrative agent, and Texas Capital Bank, N.A., as documentation agent. The Amendment (1) increased the total borrowing capacity under the Credit Facility to $180 million, supported by a diversified group of eight lenders, (2) increased the Credit Facility’s accordion feature that allows for an increase in total commitments of up to $250 million under the Credit Facility from new and existing lenders on the same terms and conditions as the existing commitments, (3) reduced the interest rate on borrowings from LIBOR plus 3.25% to LIBOR plus 3.00%, with a step-down to LIBOR plus 2.75% at the time the Company’s net worth exceeds $325 million, (4) reduced unused commitment fees based on utilization, and (5) extended the Credit Facility’s revolving period that ended on August 30, 2019 through November 16, 2020. Additionally, the final maturity of the Credit Facility was extended from August 30, 2020 to November 16, 2021. There are no changes to the covenants or the events of default in the Credit Facility as a result of the Amendment.

On November 30, 2017, our Board declared a quarterly cash dividend of $0.26 per share of common stock. The dividend is payable on January 2, 2018 to shareholders of record on December 15, 2017.

 

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RATIO OF EARNINGS TO FIXED CHARGES

The following table contains our ratio of earnings to fixed charges for the periods indicated, computed as set forth below. You should read these ratios of earnings to fixed charges in connection with our financial statements, including the notes to those statements, included in this prospectus supplement and the accompanying prospectus.

 

     For the
Six
Months
Ended
September 30,
2017
     For the
Year
Ended
March 31,
2017
     For the
Year
Ended
March 31,
2016
    For the
Year
Ended
March 31,
2015
    For the
Year
Ended
March 31,
2014
    For the
Year
Ended
March 31,
2013
 

Earnings to Fixed Charges(1)

     9.71        26.53             (2)           (2)           (2)           (2) 

 

(1)  Earnings include net realized and unrealized gains or losses. Net realized and unrealized gains or losses can vary substantially from period to period.

 

    Excluding net realized and unrealized gains and losses, the earnings to fixed charges ratio would be 5.64 for the six months ended September 30, 2017, 10.77 for the year ended March 31, 2017, and unchanged for the years ended March 31, 2016, 2015, 2014 and 2013.

 

(2)  There were no fixed charges for the years ended March 31, 2016, 2015, 2014 and 2013.

For purposes of computing the ratios of earnings to fixed charges, earnings represent net increase in net assets resulting from operations plus (or minus) income tax expense (benefit) including excise tax expense plus fixed charges. Fixed charges include interest and credit facility fees expense and amortization of debt issuance costs.

 

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DESCRIPTION OF THE NOTES

The Notes will be issued under a base indenture, dated October 23, 2017, and a first supplemental indenture thereto, to be entered into between us and U.S. Bank National Association, as trustee. We refer to the indenture and the first supplemental indenture collectively as the “indenture” and to U.S. Bank National Association as the “trustee.” The Notes are governed by the indenture, as required by federal law for all bonds and notes of companies that are publicly offered. An indenture is a contract between us and the financial institution acting as trustee on your behalf, and is subject to and governed by the Trust Indenture Act of 1939, as amended. The trustee has two main roles. First, the trustee can enforce your rights against us if we default. There are some limitations on the extent to which the trustee acts on your behalf, described in the second paragraph under “— Events of Default — Remedies if an Event of Default Occurs” below. Second, the trustee performs certain administrative duties for us with respect to the Notes.

This section includes a summary description of the material terms of the Notes and the indenture. Because this section is a summary, however, it does not describe every aspect of the Notes and the indenture. We urge you to read the indenture because it, and not this description, defines your rights as a holder of the Notes. The base indenture has been attached as an exhibit to the registration statement of which this prospectus supplement is a part and the first supplemental indenture will be attached as an exhibit to a post-effective amendment to the registration statement of which this prospectus supplement is a part, in each case, as filed with the SEC. See “Available Information” in this prospectus supplement for information on how to obtain a copy of the indenture.

General

The Notes will mature on December 15, 2022. The principal payable at maturity will be 100% of the aggregate principal amount. The interest rate of the Notes is 5.95% per year and will be paid every March 15, June 15, September 15 and December 15, beginning on March 15, 2018, and the regular record dates for interest payments will be every March 1, June 1, September 1 and December 1, commencing March 1, 2018. If an interest payment date falls on a non-business day, the applicable interest payment will be made on the next business day and no additional interest will accrue as a result of such delayed payment. The initial interest period will be the period from and including December 15, 2017, to, but excluding, the initial interest payment date, and the subsequent interest periods will be the periods from and including an interest payment date to, but excluding, the next interest payment date or the stated maturity date, as the case may be.

We will issue the Notes in denominations of $25 and integral multiples of $25 in excess thereof. The Notes will not be subject to any sinking fund and holders of the Notes will not have the option to have the Notes repaid prior to the stated maturity date.

The indenture does not limit the amount of debt (including secured debt) that may be issued by us or our subsidiaries under the indenture or otherwise, but does contain a covenant regarding our asset coverage that would have to be satisfied at the time of our incurrence of additional indebtedness. See “— Other Covenants” and “— Events of Default.” Other than the foregoing and as described under “— Other Covenants” and “— Events of Default” below, the indenture does not contain any financial covenants and does not restrict us from paying dividends or issuing or repurchasing our other securities. Other than restrictions described under “— Merger or Consolidation” below, the indenture does not contain any covenants or other provisions designed to afford holders of the Notes protection in the event of a highly leveraged transaction involving us or if our credit rating declines as the result of a takeover, recapitalization, highly leveraged transaction or similar restructuring involving us that could adversely affect your investment in the Notes.

We have the ability to issue indenture securities with terms different from the Notes and, without the consent of the holders of the Notes, to reopen the Notes and issue additional Notes.

 

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Optional Redemption

The Notes may be redeemed in whole or in part at any time or from time to time at our option on or after December 15, 2019, upon not less than 30 days nor more than 60 days written notice by mail prior to the date fixed for redemption thereof, at a redemption price of 100% of the outstanding principal amount of the Notes to be redeemed plus accrued and unpaid interest payments otherwise payable thereon for the then-current quarterly interest period accrued to the date fixed for redemption.

You may be prevented from exchanging or transferring the Notes when they are subject to redemption. In case any Notes are to be redeemed in part only, the redemption notice will provide that, upon surrender of such Note, you will receive, without a charge, a new Note or Notes of authorized denominations representing the principal amount of your remaining unredeemed Notes. Any exercise of our option to redeem the Notes will be done in compliance with the 1940 Act, to the extent applicable.

If we redeem only some of the Notes, the trustee or, with respect to global securities, DTC will determine the method for selection of the particular Notes to be redeemed, in accordance with the indenture and the 1940 Act, to the extent applicable, and in accordance with the rules of any national securities exchange or quotation system on which the Notes are listed. Unless we default in payment of the redemption price, on and after the date of redemption, interest will cease to accrue on the Notes called for redemption.

Before redeeming any Notes, we would have to comply with certain requirements under our Credit Facility, to the extent such requirements remain in effect at such time, or otherwise obtain consent from the lenders.

Global Securities

Each Note will be issued in book-entry form and represented by a global security that we deposit with and register in the name of The Depository Trust Company, New York, New York, known as DTC, or its nominee. A global security may not be transferred to or registered in the name of anyone other than the depositary or its nominee, unless special termination situations arise. As a result of these arrangements, the depositary, or its nominee, will be the sole registered owner and holder of all the Notes represented by a global security, and investors will be permitted to own only beneficial interests in a global security. For more information about these arrangements, see “— Book-Entry Procedures” below.

Termination of a Global Security

If a global security is terminated for any reason, interests in it will be exchanged for certificates in non-book-entry form (certificated securities). After that exchange, the choice of whether to hold the certificated Notes directly or in street name will be up to the investor. Investors must consult their own banks or brokers to find out how to have their interests in a global security transferred on termination to their own names, so that they will be holders.

Payment and Paying Agents

We will pay interest to the person listed in the trustee’s records as the owner of the Notes at the close of business on a particular day in advance of each due date for interest, even if that person no longer owns the Note on the interest due date. That day, usually about two weeks in advance of the interest due date, is called the “record date.” Because we will pay all the interest for an interest period to the holders on the record date, holders buying and selling the Notes must work out between themselves the appropriate purchase price. The most common manner is to adjust the sales price of the Notes to prorate interest fairly between buyer and seller based on their respective ownership periods within the particular interest period. This prorated interest amount is called “accrued interest.”

 

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Payments on Global Securities

We will make payments on the Notes so long as they are represented by a global security in accordance with the applicable policies of the depositary as in effect from time to time. Under those policies, we will make payments directly to the depositary, or its nominee, and not to any indirect holders who own beneficial interests in the global security. An indirect holder’s right to those payments will be governed by the rules and practices of the depositary and its participants, as described under “— Book-Entry Procedures” below.

Payments on Certificated Securities

In the event the Notes become represented by certificated securities, we will make payments on the Notes as follows. We will pay interest that is due on an interest payment date to the holder of the Notes as shown on the trustee’s records as of the close of business on the regular record date. We will make all payments of principal and premium, if any, by check at the office of the applicable trustee in New York, New York and/or at other offices that may be specified in the indenture or a notice to holders against surrender of the Note.

Alternatively, at our option, we may pay any cash interest that becomes due on the Notes by mailing a check to the holder at his, her or its address shown on the trustee’s records as of the close of business on the regular record date or by transfer to an account at a bank in the United States, in either case, on the due date.

Payment When Offices Are Closed

If any payment is due on the Notes on a day that is not a business day, we will make the payment on the next day that is a business day. Payments made on the next business day in this situation will be treated under the indenture as if they were made on the original due date. Such payment will not result in a default under the Notes or the indenture, and no interest will accrue on the payment amount from the original due date to the next day that is a business day.

Book-entry and other indirect holders should consult their banks or brokers for information on how they will receive payments on the Notes.

Events of Default

You will have rights if an Event of Default occurs in respect of the Notes and the Event of Default is not cured, as described later in this subsection.

The term “Event of Default” in respect of the Notes means any of the following:

 

    We do not pay the principal of, or any premium on, any Note when due and payable at maturity;

 

    We do not pay interest on any Note when due and payable, and such default is not cured within 30 days of its due date;

 

    We remain in breach of any other covenant in respect of the Notes for 60 days after we receive a written notice of default stating we are in breach (the notice must be sent by either the trustee or holders of at least 25% of the principal amount of the outstanding Notes);

 

    We file for bankruptcy or certain other events of bankruptcy, insolvency or reorganization occur and remain undischarged or unstayed for a period of 60 days; or

 

    On the last business day of each of twenty-four consecutive calendar months, the Notes have an asset coverage of less than 100%, giving effect to any exemptive relief granted to us by the SEC.

An Event of Default for the Notes may, but does not necessarily, constitute an Event of Default for any other series of debt securities issued under the same or any other indenture. The trustee may withhold notice to the holders of the Notes of any default, except in the payment of principal or interest, if it in good faith considers the withholding of notice to be in the best interests of the holders.

 

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Remedies if an Event of Default Occurs

If an Event of Default has occurred and is continuing, the trustee or the holders of not less than 25% in principal amount of the Notes may declare the entire principal amount of all the Notes to be due and immediately payable, but this does not entitle any holder of Notes to any redemption payout or redemption premium. If an Event of Default referred to in the second to last bullet point above with respect to us has occurred, the entire principal amount of all of the Notes will automatically become due and immediately payable. This is called a declaration of acceleration of maturity. In certain circumstances, a declaration of acceleration of maturity may be canceled by the holders of a majority in principal amount of the Notes if (1) we have deposited with the trustee all amounts due and owing with respect to the Notes (other than principal or any payment that has become due solely by reason of such acceleration) and certain other amounts, and (2) any other Events of Default have been cured or waived.

Except in cases of default, where the trustee has some special duties, the trustee is not required to take any action under the indenture at the request of any holders unless the holders offer the trustee reasonable protection from expenses and liability (called an “indemnity”). If reasonable indemnity is provided, the holders of a majority in principal amount of the Notes may direct the time, method and place of conducting any lawsuit or other formal legal action seeking any remedy available to the trustee. The trustee may refuse to follow those directions in certain circumstances. No delay or omission in exercising any right or remedy will be treated as a waiver of that right, remedy or Event of Default.

Before you are allowed to bypass the trustee and bring your own lawsuit or other formal legal action or take other steps to enforce your rights or protect your interests relating to the Notes, the following must occur:

 

    You must give the trustee written notice that an Event of Default has occurred and remains uncured;

 

    The holders of at least 25% in principal amount of all the Notes must make a written request that the trustee take action because of the default and must offer reasonable indemnity to the trustee against the cost and other liabilities of taking that action;

 

    The trustee must not have taken action for 60 days after receipt of the above notice and offer of indemnity; and

 

    The holders of a majority in principal amount of the Notes must not have given the trustee a direction inconsistent with the above notice during that 60-day period.

However, you are entitled at any time to bring a lawsuit for the payment of money due on your Notes on or after the due date.

Book-entry and other indirect holders should consult their banks or brokers for information on how to give notice or direction to or make a request of the trustee and how to declare or cancel an acceleration of maturity.

Each year, we will furnish to the trustee a written statement of certain of our officers certifying that to their knowledge we are in compliance with the indenture and the Notes, or else specifying any default.

Waiver of Default

The holders of a majority in principal amount of the Notes may waive any past defaults other than a default:

 

    in the payment of principal (or premium, if any) or interest; or

 

    in respect of a covenant that cannot be modified or amended without the consent of each holder of the Notes.

 

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Merger or Consolidation

Under the terms of the indenture, we are generally permitted to consolidate or merge with another entity. We are also permitted to sell all or substantially all of our assets to another entity. However, we may not take any of these actions unless all the following conditions are met where:

 

    we merge out of existence or convey or transfer all or substantially all of our assets, the resulting entity must agree to be legally responsible for our obligations under the Notes;

 

    the merger or sale of assets must not cause a default on the Notes and we must not already be in default (unless the merger or sale would cure the default). For purposes of this no-default test, a default would include an Event of Default that has occurred and has not been cured, as described under “Events of Default” above. A default for this purpose would also include any event that would be an Event of Default if the requirements for giving us a notice of default or our default having to exist for a specific period of time were disregarded; and

 

    we must deliver certain certificates and documents to the trustee.

Notwithstanding any of the foregoing and subject to the 1940 Act, any subsidiary of ours may consolidate with, merge into or transfer all or part of its property and assets to other subsidiaries of ours or to us. Additionally, this covenant shall not apply to: (1) our merger or the merger of one of our subsidiaries with an affiliate solely for the purpose of reincorporating in another jurisdiction; (2) any conversion by us or a subsidiary from an entity formed under the laws of one state to any entity formed under the laws of another state; or (3) any combination of (1) and (2) above.

Modification or Waiver

There are three types of changes we can make to the indenture and the Notes issued thereunder.

Changes Requiring Your Approval

First, there are changes that we cannot make to your Notes without your specific approval. The following is a list of those types of changes:

 

    change the stated maturity of the principal of (or premium, if any, on) or any installment of principal of or interest on the Notes;

 

    reduce any amounts due on the Notes or reduce the rate of interest on the Notes;

 

    reduce the amount of principal payable upon acceleration of the maturity of a Note following a default;

 

    change the place or currency of payment on a Note;

 

    impair your right to sue for payment;

 

    reduce the percentage of holders of Notes whose consent is needed to modify or amend the indenture; and

 

    reduce the percentage of holders of Notes whose consent is needed to waive compliance with certain provisions of the indenture or to waive certain defaults or reduce the percentage of holders of Notes required to satisfy quorum or voting requirements at a meeting of holders of the Notes.

Changes Not Requiring Approval

The second type of change does not require any vote by the holders of the Notes. This type is limited to clarifications and certain other changes that would not adversely affect holders of the Notes in any material respect.

 

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Changes Requiring Majority Approval

Any other change to the indenture and the Notes would require the following approval:

 

    if the change affects only the Notes, it must be approved by the holders of a majority in principal amount of the Notes; and

 

    if the change affects more than one series of debt securities issued under the same indenture, it must be approved by the holders of a majority in principal amount of all of the series affected by the change, with all affected series voting together as one class for this purpose.

In each case, the required approval must be given by written consent.

The holders of a majority in principal amount of all of the series of debt securities issued under an indenture, voting together as one class for this purpose, may waive our compliance with some of our covenants in that indenture. However, we cannot obtain a waiver of a payment default or of any of the matters covered by the bullet points included above under “— Changes Requiring Your Approval.”

Further Details Concerning Voting

When taking a vote, we will use the following rules to decide how much principal to attribute to the Notes:

The Notes will not be considered outstanding, and therefore not eligible to vote, if we have deposited or set aside in trust money for their payment or redemption or if we or any affiliate of ours own any Notes. The Notes will also not be eligible to vote if they have been fully defeased as described later under “— Defeasance — Full Defeasance” below.

We will generally be entitled to set any day as a record date for the purpose of determining the holders of the Notes that are entitled to vote or take other action under the indenture. However, the record date may not be earlier than 30 days before the date of the first solicitation of holders to vote on or take such action and not later than the date such solicitation is completed. If we set a record date for a vote or other action to be taken by holders of the Notes, that vote or action may be taken only by persons who are holders of the Notes on the record date and must be taken within eleven months following the record date.

Book-entry and other indirect holders should consult their banks or brokers for information on how approval may be granted or denied if we seek to change the indenture or the Notes or request a waiver.

Satisfaction and Discharge

The indenture will be discharged and will cease to be of further effect with respect to the Notes when:

 

    Either

 

    all the Notes that have been authenticated have been delivered to the trustee for cancellation; or

 

    all the Notes that have not been delivered to the trustee for cancellation:

 

    have become due and payable, or

 

    will become due and payable at their stated maturity within one year, or

 

    are to be called for redemption,

and we, in the case of the first, second and third sub-bullets above, have irrevocably deposited or caused to be deposited with the trustee as trust funds in trust solely for the benefit of the holders of the Notes, in amounts in the currency payable for the Notes as will be sufficient, to pay and discharge the entire

 

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indebtedness (including all principal, premium, if any, and interest) on such Notes delivered to the trustee for cancellation (in the case of Notes that have become due and payable on or prior to the date of such deposit) or to the stated maturity or redemption date, as the case may be;

 

    we have paid or caused to be paid all other sums payable by us under the indenture with respect to the Notes; and

 

    we have delivered to the trustee an officers’ certificate and legal opinion, each stating that all conditions precedent provided for in the indenture relating to the satisfaction and discharge of the indenture and the Notes have been complied with.

Defeasance

The following provisions will be applicable to the Notes. “Defeasance” means that, by depositing with a trustee an amount of cash and/or government securities sufficient to pay all principal and interest, if any, on the Notes when due and satisfying any additional conditions noted below, we will be deemed to have been discharged from our obligations under the Notes. In the event of a “covenant defeasance,” upon depositing such funds and satisfying similar conditions discussed below we would be released from certain covenants under the indenture relating to the Notes.

Covenant Defeasance

Under current U.S. federal income tax law and the indenture, we can make the deposit described below and be released from some of the restrictive covenants in the indenture under which the Notes were issued. This is called “covenant defeasance.” In that event, you would lose the protection of those restrictive covenants but would gain the protection of having money and government securities set aside in trust to repay your Notes. In order to achieve covenant defeasance, the following must occur:

 

    Since the Notes are denominated in U.S. dollars, we must deposit in trust for the benefit of all holders of the Notes a combination of cash and U.S. government or U.S. government agency notes or bonds that will generate enough cash to make interest, principal and any other payments on the Notes on their various due dates;

 

    We must deliver to the trustee a legal opinion of our counsel confirming that, under current U.S. federal income tax law, we may make the above deposit without causing you to be taxed on the Notes any differently than if we did not make the deposit;

 

    We must deliver to the trustee a legal opinion of our counsel stating that the above deposit does not require registration by us under the 1940 Act, and a legal opinion and officers’ certificate stating that all conditions precedent to covenant defeasance have been complied with;

 

    Defeasance must not result in a breach or violation of, or result in a default under, the indenture or any of our other material agreements or instruments; and

 

    No default or event of default with respect to the Notes shall have occurred and be continuing and no defaults or events of default related to bankruptcy, insolvency or reorganization shall occur during the next 90 days.

If we accomplish covenant defeasance, you can still look to us for repayment of the Notes if there were a shortfall in the trust deposit or the trustee is prevented from making payment. In fact, if one of the remaining Events of Default occurred (such as our bankruptcy) and the Notes became immediately due and payable, there might be a shortfall. Depending on the event causing the default, you may not be able to obtain payment of the shortfall.

 

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Full Defeasance

If there is a change in U.S. federal income tax law, as described below, we can legally release ourselves from all payment and other obligations on the Notes (called “full defeasance”) if we put in place the following other arrangements for you to be repaid:

 

    Since the Notes are denominated in U.S. dollars, we must deposit in trust for the benefit of all holders of the Notes a combination of money and U.S. government or U.S. government agency notes or bonds that will generate enough cash to make interest, principal and any other payments on the Notes on their various due dates;

 

    We must deliver to the trustee a legal opinion confirming that there has been a change in current U.S. federal tax law or an Internal Revenue Service (“IRS”) ruling that allows us to make the above deposit without causing you to be taxed on the Notes any differently than if we did not make the deposit;

 

    We must deliver to the trustee a legal opinion of our counsel stating that the above deposit does not require registration by us under the 1940 Act, and a legal opinion and officers’ certificate stating that all conditions precedent to defeasance have been complied with;

 

    Defeasance must not result in a breach or violation of, or constitute a default under, the indenture or any of our other material agreements or instruments; and

 

    No default or event of default with respect to the Notes shall have occurred and be continuing and no defaults or events of default related to bankruptcy, insolvency or reorganization shall occur during the next 90 days.

If we ever did accomplish full defeasance, as described above, you would have to rely solely on the trust deposit for repayment of the Notes. You could not look to us for repayment in the unlikely event of any shortfall. Conversely, the trust deposit would most likely be protected from claims of our lenders and other creditors if we ever became bankrupt or insolvent.

Other Covenants

In addition to any other covenants described in this prospectus supplement and the accompanying prospectus, as well as standard covenants relating to payment of principal and interest, maintaining an office where payments may be made or securities can be surrendered for payment, payment of taxes by the Company and related matters, the following covenants will apply to the Notes:

 

    We agree that for the period of time during which the Notes are outstanding, we will not violate Section 18(a)(1)(A) as modified by Section 61(a)(1) of the 1940 Act or any successor provisions, whether or not we continue to be subject to such provisions of the 1940 Act, but giving effect, in either case, to any exemptive relief granted to us by the SEC. Currently, these provisions generally prohibit us from incurring additional borrowings, including through the issuance of additional debt securities, unless our asset coverage, as defined in the 1940 Act, equals at least 200% after such borrowings. See “Supplementary Risk Factors —Risks Related to the Notes — Pending legislation may allow us to incur additional leverage” in this prospectus supplement.

 

   

We agree that, for the period of time during which the Notes are outstanding, we will not violate Section 18(a)(1)(B) as modified by (i) Section 61(a)(1) of the 1940 Act or any successor provisions and after giving effect to any exemptive relief granted to us by the SEC and (ii) the two other exceptions set forth below. These statutory provisions of the 1940 Act are not currently applicable to us and will not be applicable to us as a result of this offering. However, if Section 18(a)(1)(B) as modified by Section 61(a)(1) of the 1940 Act were currently applicable to us in connection with this offering, these provisions would generally prohibit us from declaring any cash dividend or distribution upon any class of our capital stock, or purchasing any such capital stock if our asset coverage, as defined in the 1940 Act, were below 200% at the time of the declaration of the dividend or distribution or the purchase and after deducting the amount of such

 

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dividend, distribution, or purchase. Under the covenant, we will be permitted to declare a cash dividend or distribution notwithstanding the prohibition contained in Section 18(a)(1)(B) as modified by Section 61(a)(1) of the 1940 Act or any successor provisions, but only up to such amount as is necessary for us to maintain our status as a RIC under Subchapter M of the Code. Furthermore, the covenant will not be triggered unless and until such time as our asset coverage has not been in compliance with the minimum asset coverage required by Section 18(a)(1)(B) as modified by Section 61(a)(1) of the 1940 Act or any successor provisions (after giving effect to any exemptive relief granted to us by the SEC) for more than six consecutive months. See “Supplementary Risk Factors — Risks Related to the Notes — Pending legislation may allow us to incur additional leverage” in this prospectus supplement.

 

    If, at any time, we are not subject to the reporting requirements of Sections 13 or 15(d) of the Exchange Act to file any periodic reports with the SEC, we agree to furnish to holders of the Notes and the trustee, for the period of time during which the Notes are outstanding, our audited annual consolidated financial statements, within 90 days of our fiscal year end, and unaudited interim consolidated financial statements, within 45 days of our fiscal quarter end (other than our fourth fiscal quarter). All such financial statements will be prepared, in all material respects, in accordance with applicable U.S. GAAP.

Form, Exchange and Transfer of Certificated Registered Securities

If registered Notes cease to be issued in book-entry form, they will be issued:

 

    only in fully registered certificated form;

 

    without interest coupons; and

 

    unless we indicate otherwise, in denominations of $25 and amounts that are multiples of $25.

Holders may exchange their certificated securities for Notes of smaller denominations or combined into fewer Notes of larger denominations, as long as the total principal amount is not changed and as long as the denomination is equal to or greater than $25.

Holders may exchange or transfer their certificated securities at the office of the trustee. We have appointed the trustee to act as our agent for registering Notes in the names of holders transferring Notes. We may appoint another entity to perform these functions or perform them ourselves.

Holders will not be required to pay a service charge to transfer or exchange their certificated securities, but they may be required to pay any tax or other governmental charge associated with the transfer or exchange. The transfer or exchange will be made only if our transfer agent is satisfied with the holder’s proof of legal ownership.

We may appoint additional transfer agents or cancel the appointment of any particular transfer agent. We may also approve a change in the office through which any transfer agent acts.

If any certificated securities of a particular series are redeemable and we redeem less than all the Notes, we may block the transfer or exchange of those Notes selected for redemption during the period beginning 15 days before the day we mail the notice of redemption and ending on the day of that mailing, in order to freeze the list of holders to prepare the mailing. We may also refuse to register transfers or exchanges of any certificated Notes selected for redemption, except that we will continue to permit transfers and exchanges of the unredeemed portion of any Note that will be partially redeemed.

If registered Notes are issued in book-entry form, only the depositary will be entitled to transfer and exchange the Notes as described in this subsection, since it will be the sole holder of the Notes.

 

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Resignation of Trustee

The trustee may resign or be removed with respect to the Notes provided that a successor trustee is appointed to act with respect to the Notes. In the event that two or more persons are acting as trustee with respect to different series of indenture securities under the indenture, each of the trustees will be a trustee of a trust separate and apart from the trust administered by any other trustee.

Indenture Provisions — Ranking

The Notes will be our direct unsecured obligations and will rank:

 

    pari passu with our existing and future unsubordinated unsecured indebtedness;

 

    senior to any of our future indebtedness that expressly provides it is subordinated to the Notes; and

 

    effectively subordinated to all of our existing and future secured indebtedness (including indebtedness that is initially unsecured to which we subsequently grant security), to the extent of the value of the assets securing such indebtedness, including, without limitation, borrowings under our Credit Facility; and

 

    structurally subordinated to all future indebtedness and other obligations of any of our subsidiaries.

Book-Entry Procedures

The Notes will be represented by global securities that will be deposited and registered in the name of DTC or its nominee. This means that, except in limited circumstances, you will not receive certificates for the Notes. Beneficial interests in the Notes will be represented through book-entry accounts of financial institutions acting on behalf of beneficial owners as direct and indirect participants in DTC. Investors may elect to hold interests in the Notes through either DTC, if they are a participant, or indirectly through organizations that are participants in DTC.

The Notes will be issued as fully registered securities registered in the name of Cede & Co. (DTC’s partnership nominee) or such other name as may be requested by an authorized representative of DTC. One fully registered certificate will be issued for each issuance of the Notes, in the aggregate principal amount thereof, and will be deposited with DTC. Interests in the Notes will trade in DTC’s Same Day Funds Settlement System, and any permitted secondary market trading activity in such Notes will, therefore, be required by DTC to be settled in immediately available funds. None of the Company, the trustee or the Paying Agent will have any responsibility for the performance by DTC or its participants or indirect participants of their respective obligations under the rules and procedures governing their operations.

DTC is a limited-purpose trust company organized under the New York Banking Law, a “banking organization” within the meaning of the New York Banking Law, a member of the Federal Reserve System, a “clearing corporation” within the meaning of the New York Uniform Commercial Code, and a “clearing agency” registered pursuant to the provisions of Section 17A of the Exchange Act. DTC holds and provides asset servicing for over 3.5 million issues of U.S. and non-U.S. equity, corporate and municipal debt issues, and money market instruments from over 100 countries that DTC’s participants (“Direct Participants”) deposit with DTC. DTC also facilitates the post-trade settlement among Direct Participants of sales and other securities transactions in deposited securities through electronic computerized book-entry transfers and pledges between Direct Participants’ accounts. This eliminates the need for physical movement of securities certificates. Direct Participants include both U.S. and non-U.S. securities brokers and dealers, banks, trust companies, clearing corporations, and certain other organizations. DTC is a wholly owned subsidiary of The Depository Trust & Clearing Corporation (“DTCC”).

DTCC is the holding company for DTC, National Securities Clearing Corporation and Fixed Income Clearing Corporation, all of which are registered clearing agencies. DTCC is owned by the users of its regulated

 

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subsidiaries. Access to the DTC system is also available to others such as both U.S. and non-U.S. securities brokers and dealers, banks, trust companies and clearing corporations that clear through or maintain a custodial relationship with a Direct Participant, either directly or indirectly (“Indirect Participants”). DTC has Standard & Poor’s Ratings Services’ highest rating: AAA. The DTC Rules applicable to its participants are on file with the SEC. More information about DTC can be found at www.dtcc.com and www.dtc.org.

Purchases of the Notes under the DTC system must be made by or through Direct Participants, which will receive a credit for the Notes on DTC’s records. The ownership interest of each actual purchaser of each security, or the “Beneficial Owner,” is in turn to be recorded on the Direct and Indirect Participants’ records. Beneficial Owners will not receive written confirmation from DTC of their purchase. Beneficial Owners are, however, expected to receive written confirmations providing details of the transaction, as well as periodic statements of their holdings, from the Direct or Indirect Participant through which the Beneficial Owner entered into the transaction. Transfers of ownership interests in the Notes are to be accomplished by entries made on the books of Direct and Indirect Participants acting on behalf of Beneficial Owners. Beneficial Owners will not receive certificates representing their ownership interests in the Notes, except in the event that use of the book-entry system for the Notes is discontinued.

To facilitate subsequent transfers, all Notes deposited by Direct Participants with DTC are registered in the name of DTC’s partnership nominee, Cede & Co. or such other name as may be requested by an authorized representative of DTC. The deposit of the Notes with DTC and their registration in the name of Cede & Co. or such other DTC nominee do not effect any change in beneficial ownership. DTC has no knowledge of the actual Beneficial Owners of the Notes; DTC’s records reflect only the identity of the Direct Participants to whose accounts the Notes are credited, which may or may not be the Beneficial Owners. The Direct and Indirect Participants will remain responsible for keeping account of their holdings on behalf of their customers.

Conveyance of notices and other communications by DTC to Direct Participants, by Direct Participants to Indirect Participants, and by Direct Participants and Indirect Participants to Beneficial Owners will be governed by arrangements among them, subject to any statutory or regulatory requirements as may be in effect from time to time.

Redemption notices shall be sent to DTC. If less than all of the Notes within an issue are being redeemed, DTC’s practice is to determine by lot the amount of the interest of each Direct Participant in such issue to be redeemed.

Redemption proceeds, distributions, and interest payments on the Notes will be made to Cede & Co., or such other nominee as may be requested by an authorized representative of DTC. DTC’s practice is to credit Direct Participants’ accounts upon DTC’s receipt of funds and corresponding detail information from us or the trustee on the payment date in accordance with their respective holdings shown on DTC’s records. Payments by Participants to Beneficial Owners will be governed by standing instructions and customary practices, as is the case with securities held for the accounts of customers in bearer form or registered in “street name,” and will be the responsibility of such Participant and not of DTC nor its nominee, the trustee, or us, subject to any statutory or regulatory requirements as may be in effect from time to time. Payment of redemption proceeds, distributions, and interest payments to Cede & Co. (or such other nominee as may be requested by an authorized representative of DTC) is the responsibility of us or the trustee, but disbursement of such payments to Direct Participants will be the responsibility of DTC, and disbursement of such payments to the Beneficial Owners will be the responsibility of Direct and Indirect Participants.

DTC may discontinue providing its services as securities depository with respect to the Notes at any time by giving reasonable notice to us or to the trustee. Under such circumstances, in the event that a successor securities depository is not obtained, certificates are required to be printed and delivered. We may decide to discontinue use

 

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of the system of book-entry-only transfers through DTC (or a successor securities depository). In that event, certificates will be printed and delivered to DTC.

The information in this section concerning DTC and DTC’s book-entry system has been obtained from sources that we believe to be reliable, but we take no responsibility for the accuracy thereof.

 

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MATERIAL U.S. FEDERAL INCOME TAX CONSEQUENCES

The following summary describes certain U.S. federal income tax consequences applicable to an investment in the Notes. This summary does not purport to be a complete description of the income tax considerations applicable to such an investment. The summary is based upon the Code, U.S. Treasury regulations, and administrative and judicial interpretations, each as of the date of this prospectus supplement and all of which are subject to change, potentially with retroactive effect, or to different interpretations. We cannot assure you that the IRS will not challenge one or more of the tax consequences described in this summary, and we have not obtained, nor do we intend to obtain, any ruling from the IRS or opinion of counsel with respect to the tax consequences of an investment in the Notes. Investors should consult their own tax advisors with respect to tax considerations that pertain to their investment in the Notes.

This summary discusses only Notes held as capital assets within the meaning of the Code (generally, property held for investment purposes) and does not purport to address persons in special tax situations, such as banks and other financial institutions, insurance companies, controlled foreign corporations, passive foreign investment companies, real estate investment trusts and regulated investment companies (and shareholders of such corporations), dealers in securities or currencies, traders in securities, former citizens of the United States, persons holding the Notes as a position in a “straddle,” “hedge,” “constructive sale transaction,” “conversion transaction,” “wash sale” or other integrated transaction for U.S. federal income tax purposes, entities that are tax-exempt for U.S. federal income tax purposes, retirement plans, individual retirement accounts, tax-deferred accounts, persons subject to the alternative minimum tax, pass-through entities (including partnerships and entities and arrangements classified as partnerships for U.S. federal income tax purposes) and beneficial owners of pass-through entities, or U.S. holders (as defined below) whose functional currency (as defined in the Code) is not the U.S. dollar. It also does not address beneficial owners of the Notes other than original purchasers of the Notes who acquire the Notes in this offering for cash at a price equal to their issue price (i.e., the first price at which a substantial amount of the Notes is sold for money to investors (other than to bond houses, brokers, or similar persons or organizations acting in the capacity of underwriters, placements agents or wholesalers)). In addition, this summary only addresses U.S. federal income tax consequences, and does not address other U.S. federal tax consequences, including, for example, estate or gift tax consequences. This summary also does not address any U.S. state or local or non-U.S. tax consequences. Investors considering purchasing the Notes should consult their own tax advisors concerning the application of the U.S. federal income tax laws to their individual circumstances, as well as any consequences to such investors relating to purchasing, owning and disposing of the Notes under the laws of any state, local, foreign or other taxing jurisdiction.

If a partnership (including an entity or arrangement treated as a partnership for U.S. federal income tax purposes) holds any Notes, the U.S. federal income tax treatment of a partner of the partnership generally will depend upon the status of the partner, the activities of the partnership and certain determinations made at the partner level. Partnerships holding Notes, and persons holding interests in such partnerships, should each consult their own tax advisors as to the consequences of investing in the Notes in their individual circumstances.

Taxation of U.S. Holders

For purposes of this discussion, the term “U.S. holder” means a beneficial owner of a Note that is, for U.S. federal income tax purposes:

 

    an individual who is a citizen or resident of the United States;

 

    a corporation created or organized in or under the laws of the United States, any state thereof, or the District of Columbia;

 

   

a trust (i) the administration of which is subject to the primary supervision of a U.S. court and that has one or more “United States persons” (within the meaning of the Code) that have the authority to control all

 

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substantial decisions of the trust or (ii) that has made a valid election under applicable U.S. Treasury regulations to be treated as a “United States person” (within the meaning of the Code); or

 

    an estate the income of which is subject to U.S. federal income taxation regardless of its source.

Payments of Interest

Payments or accruals of interest on a Note generally will be taxable to a U.S. holder as ordinary interest income at the time they are received (actually or constructively) or accrued, in accordance with the U.S. holder’s regular method of tax accounting.

Sale, Exchange, Redemption, Retirement or Other Taxable Disposition of a Note

Upon the sale, exchange, redemption, retirement or other taxable disposition of a Note, a U.S. holder generally will recognize capital gain or loss equal to the difference between the amount realized on the sale, exchange, redemption, retirement or other taxable disposition (excluding amounts representing accrued and unpaid interest, which are treated as ordinary interest income to the extent not previously included in income) and the U.S. holder’s adjusted tax basis in the Note. A U.S. holder’s adjusted tax basis in a Note generally will equal the U.S. holder’s initial investment in the Note. Capital gain or loss generally will be long-term capital gain or loss if the Note was held for more than one year. Long-term capital gains recognized by individuals and certain other non-corporate U.S. holders generally are eligible for reduced rates of taxation. The deductibility of capital losses is subject to limitations under the Code.

Additional Tax on Net Investment Income

An additional tax of 3.8% is imposed on certain “net investment income” (or “undistributed net investment income,” in the case of certain U.S. holders that are estates and trusts) received by certain U.S. holders with adjusted gross income above certain threshold amounts. “Net investment income” generally includes interest payments on, and gain recognized from the sale, exchange, redemption, retirement or other taxable disposition of, the Notes, less certain deductions. U.S. holders should consult their own tax advisors regarding the effect, if any, of this tax on their ownership and disposition of the Notes.

Backup Withholding and Information Reporting

In general, a U.S. holder will be subject to U.S. federal backup withholding tax at the applicable rate with respect to payments on the Notes and the proceeds of a sale, exchange, redemption, retirement or other taxable disposition of the Notes, unless the U.S. holder is an exempt recipient and appropriately establishes that exemption, or provides its taxpayer identification number to the paying agent and certifies, under penalty of perjury, that it is not subject to backup withholding on an Internal Revenue Service (“IRS”) Form W-9 and otherwise complies with the applicable requirements of the backup withholding rules. Backup withholding is not an additional tax. The amount of any backup withholding from a payment to a U.S. holder may be allowed as a credit against such U.S. holder’s U.S. federal income tax liability and may entitle such U.S. holder to a refund, provided the required information is furnished to the IRS in a timely manner. In addition, payments on the Notes made to, and the proceeds of a sale, exchange, redemption, retirement or other taxable disposition by, a U.S. holder generally will be subject to information reporting requirements, unless such U.S. holder is an exempt recipient and appropriately establishes that exemption.

Taxation of Non-U.S. Holders

For purposes of this discussion, the term “non-U.S. holder” means a beneficial owner of a Note that is neither a U.S. holder nor a partnership for U.S. federal income tax purposes.

 

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Interest on the Notes

Subject to the discussions of backup withholding and Foreign Account Tax Compliance Act, or FATCA, withholding below, payments to a non-U.S. holder of interest on the Notes generally will not be subject to U.S. federal income tax and will be exempt from withholding of U.S. federal income tax under the “portfolio interest” exemption if such non-U.S. holder properly certifies as to such non-U.S. holder’s foreign status, as described below, and:

 

    such non-U.S. holder does not own, actually or constructively, 10% or more of the total combined voting power of all classes of our stock entitled to vote;

 

    such non-U.S. holder is not a “controlled foreign corporation” that is related to us (actually or constructively);

 

    such non-U.S. holder is not a bank whose receipt of interest on the Notes is in connection with an extension of credit made pursuant to a loan agreement entered into in the ordinary course of such non-U.S. holder’s trade or business; and

 

    interest on the Notes is not effectively connected with such non-U.S. holder’s conduct of a U.S. trade or business (or, in the case of an applicable income tax treaty, such interest is not attributable to a permanent establishment maintained by such non-U.S. holder in the United States).

The portfolio interest exemption generally applies only if a non-U.S. holder also appropriately certifies as to such non-U.S. holder’s foreign status. A non-U.S. holder can generally meet the certification requirement by providing a properly executed IRS Form W-8BEN or IRS Form W-8BEN-E (or applicable successor form) to the applicable withholding agent. If a non-U.S. holder holds the Notes through a financial institution or other agent acting on such non-U.S. holder’s behalf, such non-U.S. holder may be required to provide appropriate certifications to the agent. Such non-U.S. holder’s agent will then generally be required to provide appropriate certifications to the applicable withholding agent, either directly or through other intermediaries.

If a non-U.S. holder cannot satisfy the requirements described above, payments of interest made to such non-U.S. holder will be subject to U.S. federal withholding tax at a 30% rate, unless (i) such non-U.S. holder provides the applicable withholding agent with a properly executed IRS Form W-8BEN or IRS Form W-8BEN-E (or applicable successor form) claiming an exemption from (or a reduction of) withholding under the benefits of an income tax treaty, or (ii) the payments of such interest are effectively connected with such non-U.S. holder’s conduct of a trade or business in the United States and such non-U.S. holder meets the certification requirements described below. See “— Income or Gain Effectively Connected with a U.S. Trade or Business” below.

Disposition of the Notes

Subject to the discussions of backup withholding and FATCA withholding below, a non-U.S. holder generally will not be subject to U.S. federal income tax on any gain realized on the sale, redemption, exchange, retirement, or other taxable disposition of a Note unless:

 

    the gain is effectively connected with the conduct by such non-U.S. holder of a U.S. trade or business (and, if required by an applicable income tax treaty, such non-U.S. holder maintains a permanent establishment in the United States to which such gain is attributable); or

 

    such non-U.S. holder is a non-resident alien individual who has been present in the United States for 183 days or more in the taxable year of disposition and certain other requirements are met.

If a non-U.S. holder’s gain is described in the first bullet point above, such non-U.S. holder generally will be subject to U.S. federal income tax in the manner described under “— Income or Gain Effectively Connected with a U.S. Trade or Business” below. A non-U.S. holder described in the second bullet point above will be subject to a flat 30% (or lower applicable income tax treaty rate) U.S. federal income tax on the gain derived from the sale

 

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or other disposition, which may be offset by certain U.S. source capital losses. To the extent that any portion of the amount realized on a sale, redemption, exchange, retirement or other taxable disposition of a Note is attributable to accrued but unpaid interest on the Note, this amount generally will be taxed in the same manner as described above in “— Interest on the Notes.”

Income or Gain Effectively Connected with a U.S. Trade or Business

If any interest on the Notes or gain from the sale, redemption, exchange, retirement, or other taxable disposition of the Notes is effectively connected with a non-U.S. holder’s conduct of a U.S. trade or business (and, if required by an applicable income tax treaty, such non-U.S. holder maintains a permanent establishment in the United States to which such interest or gain is attributable), then the interest income or gain will be subject to U.S. federal income tax at regular graduated income tax rates generally in the same manner as if such non-U.S. holder were a U.S. holder (but without regard to the additional tax on net investment income described above). Effectively connected interest income will not be subject to U.S. federal withholding tax if a non-U.S. holder satisfies certain certification requirements by providing to the applicable withholding agent a properly executed IRS Form W-8ECI (or successor form). In addition, if a non-U.S. holder is a corporation, that portion of such non-U.S. holder’s earnings and profits that are effectively connected with such non-U.S. holder’s conduct of a U.S. trade or business may also be subject to a “branch profits tax” at a 30% rate, unless an applicable income tax treaty provides for a lower rate. For this purpose, interest received on a Note and gain recognized on the disposition of a Note will be included in earnings and profits if the interest or gain is effectively connected with the conduct by such non-U.S. holder of a U.S. trade or business.

Backup Withholding and Information Reporting

Under current U.S. Treasury regulations, the amount of interest paid to a non-U.S. holder and the amount of tax withheld, if any, from those payments must be reported annually to the IRS and each non-U.S. holder. These reporting requirements apply regardless of whether U.S. withholding tax on such payments was reduced or eliminated by any applicable tax treaty or otherwise. Copies of the information returns reporting those payments and the amounts withheld may also be made available to the tax authorities in the country where a non-U.S. holder is a resident under the provisions of an applicable income tax treaty or agreement.

Backup withholding generally will not apply to payments of interest to a non-U.S. holder on a Note if the certification described above in “— Interest on the Notes” is duly provided or such non-U.S. holder otherwise establishes an exemption.

Additionally, the gross proceeds from a non-U.S. holder’s disposition of Notes may be subject under certain circumstances to information reporting and backup withholding unless the non-U.S. holder provides an IRS Form W-8BEN or W-8BEN-E (or other applicable form) certifying that the non-U.S. holder is not a United States person or otherwise qualifies for an exemption.

Non-U.S. holders should consult their own tax advisors regarding application of the backup withholding rules to their particular circumstances and the availability of and procedure for obtaining an exemption from backup withholding. Backup withholding is not an additional tax and any amounts withheld under the backup withholding rules may be credited against a non-U.S. holder’s U.S. federal income tax liability (which may result in such non-U.S. holder being entitled to a refund of U.S. federal income tax), provided that the required information is timely provided to the IRS.

FATCA

Legislation commonly referred to as the “Foreign Account Tax Compliance Act,” or “FATCA,” generally imposes a 30% withholding tax on payments of certain types of income to foreign financial institutions (“FFIs”) unless such FFIs either (i) enter into an agreement with the U.S. Treasury to report certain required information

 

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with respect to accounts held by U.S. persons (or held by foreign entities that have U.S. persons as substantial owners) or (ii) reside in a jurisdiction that has entered into an intergovernmental agreement (“IGA”) with the United States to collect and share such information and are in compliance with the terms of such IGA and any enabling legislation or regulations. The types of income subject to the tax include U.S. source interest (including interest on a Note) and dividends and, after December 31, 2018, the gross proceeds from the sale of any property that could produce U.S. source interest (such as a Note) or dividends. The information required to be reported includes the identity and taxpayer identification number of each account holder that is a U.S. person and transaction activity within the holder’s account. In addition, subject to certain exceptions, this legislation also imposes a 30% withholding on payments to foreign entities that are not FFIs unless the foreign entity certifies that it does not have a greater than 10% U.S. owner or provides the withholding agent with identifying information on each greater than 10% U.S. owner. Depending on the status of a beneficial owner and the status of the intermediary through which it holds the Notes, a beneficial owner could be subject to this 30% withholding tax with respect to interest paid on the Notes and proceeds from the sale of the Notes. Under certain circumstances, a beneficial owner might be eligible for a refund or credit of such taxes.

Holders and beneficial owners should consult their own tax advisors regarding FATCA and whether it may be relevant to their acquisition, ownership and disposition of the Notes.

You should consult your own tax advisor with respect to the particular tax consequences to you of an investment in the Notes, including the possible effect of any pending legislation or proposed regulations.

 

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UNDERWRITING

Keefe, Bruyette & Woods, Inc. is acting as the representative of the underwriters for this offering. Subject to the terms and conditions set forth in an underwriting agreement dated December 12, 2017 between us and the underwriters, we have agreed to sell to the underwriters, and the underwriters have severally agreed to purchase from us, the aggregate principal amount of Notes indicated in the table below:

 

Underwriters

   Principal Amount of
Notes
 

Keefe, Bruyette & Woods, Inc.

   $ 21,000,000  

Janney Montgomery Scott LLC

   $ 11,000,000  

Ladenburg Thalmann & Co. Inc.

   $ 11,000,000  

BB&T Capital Markets, a division of BB&T Securities, LLC

   $ 3,500,000  

B. Riley FBR, Inc.

   $ 3,500,000  
  

 

 

 

Total

   $ 50,000,000  
  

 

 

 

Keefe, Bruyette & Woods, Inc. is acting as book-running manager of this offering. Janney Montgomery Scott LLC and Ladenburg Thalmann & Co. Inc. are acting as lead managers for this offering. BB&T Capital Markets, a division of BB&T Securities, LLC and B. Riley FBR, Inc. are acting as co-managers for this offering.

The underwriting agreement provides that the obligations of the several underwriters are subject to certain conditions precedent such as the receipt by the underwriters of officers’ certificates and legal opinions. The underwriting agreement provides that the underwriters will purchase all of the Notes if any of these Notes are purchased. If an underwriter defaults, the underwriting agreement provides that, under the circumstances, the purchase commitments of the non-defaulting underwriters may be increased or the underwriting agreement may be terminated. We have agreed to indemnify the underwriters and certain of their controlling persons against certain liabilities, including liabilities under the Securities Act of 1933, as amended, or the Securities Act, or to contribute to payments the underwriters may be required to make in respect of those liabilities.

The underwriters have advised us that they currently intend to make a market in the Notes. However, the underwriters are not obligated to do so and may discontinue any market-making activities at any time without notice. No assurance can be given as to the liquidity of the trading market for the Notes. If an active public trading market for the Notes does not develop, the market price and liquidity of the Notes may be adversely affected.

The underwriters are offering the Notes, subject to their acceptance of the Notes from us and subject to prior sale. The underwriters reserve the right to withdraw, cancel or modify offers to the public and to reject orders in whole or in part.

The underwriters have agreed to purchase the Notes from us at 97% of the aggregate principal amount of the Notes, which will result in aggregate proceeds to us of $48.5 million, assuming no exercise of the underwriters’ option to purchase additional Notes, and before deducting expenses payable by us, and $55.8 million, assuming full exercise of the underwriters’ option to purchase additional Notes.

The underwriters propose to offer the Notes for sale, from time to time, in one or more negotiated transactions, at prices that may be different than par. These sales may occur at market prices prevailing at the time of sale, at prices related to such prevailing market prices or at negotiated prices. The underwriters may effect such transactions by selling the Notes to or through dealers and such dealers may receive compensation in the form of discounts, concessions or commissions from the underwriters and/or purchasers of Notes for whom they may act as agents or to whom they may sell as principal. The difference between the price at which the underwriters purchase Notes and the price at which the underwriters resell such Notes may be deemed to be underwriting compensation.

 

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We estimate expenses payable by us in connection with this offering will be approximately $600,000, which includes an amount not to exceed $35,000 that we have agreed to reimburse the underwriters for fees of counsel incurred by them in connection with this offering.

Listing

We intend to list the Notes on The Nasdaq Global Select Market. We expect trading in the Notes on The Nasdaq Global Select Market to begin within 30 days after the original issue date under the trading symbol “CSWCL.” We offer no assurances that an active trading market for the Notes will develop and continue after the offering.

Option to Purchase Additional Notes

We have granted to the underwriters an option, exercisable for 30 days from the date of this prospectus supplement, to purchase up to an additional $7.5 million aggregate principal amount of the Notes at the price set forth on the cover of this prospectus supplement. If the underwriters exercise this option to purchase additional Notes, each will be obligated, subject to the specified conditions, to purchase a number of additional Notes proportionate to that underwriter’s initial principal amount reflected in the table above.

No Sales of Similar Securities

Subject to certain exceptions, we have agreed not to, directly or indirectly, offer, pledge, sell, contract to sell, grant any option for the sale of, make any short sale or otherwise transfer or dispose of any debt securities issued or guaranteed by the Company or any securities convertible into or exercisable or exchangeable for debt securities issued or guaranteed by the Company, enter into any swap or other derivatives transaction that transfers any of the economic benefits or risks of ownership of any debt securities issued or guaranteed by the Company or file any registration statement under the Securities Act with respect to any of the foregoing for a period of 45 days after the date of this prospectus supplement without first obtaining the written consent of Keefe, Bruyette & Woods, Inc., other than certain private sales of debt securities to a limited number of institutional investors. This consent may be given at any time without public notice.

Stabilization

The underwriters have advised us that, pursuant to Regulation M under the Exchange Act, certain persons participating in the offering may engage in transactions including over-allotment, covering transactions and stabilizing transactions, which may have the effect of stabilizing or maintaining the market price of the Notes at a level above that which might otherwise prevail in the open market. Over-allotment involves syndicate sales of securities in excess of the aggregate principal amount of securities to be purchased by the underwriters in the offering, which creates a short position for the underwriters. Covering transactions involve purchases of the securities in the open market after the distribution has been completed in order to cover short positions.

A stabilizing bid is a bid for the purchase of Notes on behalf of the underwriters for the purpose of fixing or maintaining the price of the Notes. A syndicate covering transaction is the bid for or the purchase of Notes on behalf of the underwriters to reduce a short position incurred by the underwriters in connection with the offering. Similar to other purchase transactions, the underwriter’s purchases to cover the syndicate short sales may have the effect of raising or maintaining the market price of the Notes or preventing or retarding a decline in the market price of the Notes. As a result, the price of the Notes may be higher than the price that might otherwise exist in the open market. A penalty bid is an arrangement permitting the underwriters to reclaim the selling concession otherwise accruing to a syndicate member in connection with the offering if the Notes originally sold by such syndicate member are purchased in a syndicate covering transaction and therefore have not been effectively placed by such syndicate member.

 

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Neither we, nor any of the underwriters makes any representation or prediction as to the direction or magnitude of any effect that the transactions described above may have on the price of the Notes. The underwriters are not obligated to engage in these activities and, if commenced, any of the activities may be discontinued at any time.

Electronic Distribution

A prospectus in electronic format may be made available by e-mail or on the web sites or through online services maintained by one or more of the underwriters and/or selling group members participating in this offering, or by their affiliates. In those cases, prospective investors may view offering terms online and, depending upon the particular underwriter or selling group member, prospective investors may be allowed to place orders online. The underwriters may agree with us to allocate a limited principal amount of the Notes for sale to online brokerage account holders. Any such allocation for online distributions will be made by the underwriters on the same basis as other allocations. Other than the prospectus in electronic format, information on the underwriters’ web sites and any information contained in any other web site maintained by any of the underwriters or selling group members is not part of this prospectus supplement or the registration statement of which this prospectus supplement is a part, has not been approved and/or endorsed by us or the underwriters and should not be relied on by investors.

Other Relationships

Certain of the underwriters and their affiliates have provided in the past and may provide from time to time in the future in the ordinary course of their business certain commercial banking, financial advisory, investment banking and other services to us, our portfolio companies or our affiliates for which they have received or will be entitled to receive separate fees. In particular, the underwriters or their affiliates may execute transactions with us, on behalf of us, any of our portfolio companies or our affiliates. In addition, the underwriters or their affiliates may act as arrangers, underwriters or placement agents for companies whose securities are sold to or whose loans are syndicated to us, our portfolio companies or our affiliates.

The underwriters or their affiliates may also trade in our securities, securities of our portfolio companies or other financial instruments related thereto for their own accounts or for the account of others and may extend loans or financing directly or through derivative transactions to us, any of our portfolio companies or our affiliates.

After the date of this prospectus supplement, the underwriters and their affiliates may from time to time obtain information regarding specific portfolio companies or us that may not be available to the general public. Any such information is obtained by the underwriters and their affiliates in the ordinary course of their business and not in connection with the offering of the Notes. In addition, after the offering period for the sale of the Notes, the underwriters or their affiliates may develop analyses or opinions related to us or our portfolio companies and buy or sell interests in one or more of our portfolio companies on behalf of their proprietary or client accounts and may engage in competitive activities. There is no obligation on behalf of these parties to disclose their respective analyses, opinions or purchase and sale activities regarding any portfolio company or regarding us to holders of the Notes or any other persons.

In the ordinary course of their various business activities, the underwriters and their respective affiliates may make or hold a broad array of investments and actively trade debt and equity securities (or related derivative securities) and financial instruments (including bank loans) for their own account and for the accounts of their customers. Such investments and securities activities may involve securities and/or instruments of ours or our affiliates. Certain of the underwriters and their affiliates that may have a lending relationship with us may routinely hedge their credit exposure to us consistent with their customary risk management policies. Typically, such underwriters and their affiliates would hedge such exposure by entering into transactions that consist of either the purchase of credit default swaps or the creation of short positions in our securities, including

 

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potentially the Notes offered hereby. Any such short positions could adversely affect future trading prices of the Notes offered hereby. The underwriters and their affiliates may also make investment recommendations and/or publish or express independent research views in respect of such securities or financial instruments and may hold, or recommend to clients that they acquire, long and/or short positions in such securities and instruments.

The principal business address of Keefe, Bruyette & Woods, Inc. is 787 Seventh Avenue, 4th Floor, New York, New York 10019. The principal business address of Janney Montgomery Scott LLC is 1717 Arch Street, Philadelphia, Pennsylvania 19103. The principal business address of Ladenburg Thalmann & Co. Inc. is 277 Park Avenue, 26th floor, New York, New York 10172.

Other Jurisdictions

The Notes offered by this prospectus supplement and the accompanying prospectus may not be offered or sold, directly or indirectly, nor may this prospectus supplement, the accompanying prospectus or any other offering material or advertisements in connection with the offer and sale of any such Notes be distributed or published, in any jurisdiction except under circumstances that will result in compliance with the applicable rules and regulations of that jurisdiction. Persons into whose possession this prospectus supplement and the accompanying prospectus come are advised to inform themselves about and to observe any restriction relating to the offering and the distribution of this prospectus supplement and the accompanying prospectus. This prospectus supplement and the accompanying prospectus do not constitute an offer to sell or a solicitation of an offer to buy the Notes offered by this prospectus supplement and the accompanying prospectus in any jurisdiction in which such an offer or a solicitation is unlawful.

Settlement

We expect that delivery of the Notes will be made against payment therefor on or about December 15, 2017, which will be the third business day following the date of pricing of the Notes (such settlement cycle being herein referred to as “T+3”). Under Rule 15c6-1 under the Exchange Act, trades in the secondary market generally are required to settle in two business days, unless the parties to any such trade expressly agree otherwise. Accordingly, purchasers who wish to trade the Notes prior to the delivery of the Notes hereunder will be required, by virtue of the fact that the Notes initially will settle T+3, to specify an alternate settlement cycle at the time of any such trade to prevent a failed settlement. Purchasers of the Notes who wish to trade the Notes prior to their date of delivery should consult their own advisor.

 

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LEGAL MATTERS

Certain legal matters regarding the Notes offered hereby will be passed upon for us by Jones Day, Dallas, Texas, and Eversheds Sutherland (US) LLP, Washington, D.C., and certain legal matters in connection with this offering will be passed upon for the underwriters by Fried, Frank, Harris, Shriver & Jacobson LLP, New York, New York.

INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

The audited consolidated financial statements, including the selected per share data and ratios, Schedule 12-14 and senior securities table as of March 31, 2017 of Capital Southwest Corporation and its subsidiaries included in the accompanying prospectus and elsewhere in the registration statement have been so included in reliance upon the reports of Grant Thornton LLP, independent registered public accountants, as stated in their reports appearing herein. Grant Thornton LLP’s principal business address is 171 N. Clark Street, Chicago, Illinois, 60601.

The audited consolidated financial statements of I-45 SLF LLC and its subsidiary included in the accompanying prospectus and elsewhere in the registration statement have been so included in reliance upon the reports of RSM US LLP, independent registered public accountants, as stated in their reports appearing herein. RSM US LLP’s principal business address is 1 South Wacker, Chicago, Illinois 60606.

The audited consolidated financial statements of Media Recovery, Inc. included in this prospectus supplement and elsewhere in the registration statement have been so included in reliance upon the report of Whitley Penn LLP, independent registered public accountants, as stated in their report appearing herein. Whitley Penn LLP’s principal business address is 8343 Douglas Avenue, Suite 400, Dallas, Texas 75225.

CHANGE IN INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

On June 12, 2017, the Audit Committee of Capital Southwest Corporation, following careful deliberation, approved the decision to change independent registered public accounting firms. On June 12, 2017, the Company notified Grant Thornton LLP, or Grant Thornton, of its decision to dismiss Grant Thornton as the Company’s independent registered public accounting firm, effective as of that date.

The reports of Grant Thornton on the Company’s consolidated financial statements for the fiscal years ended March 31, 2017 and 2016 did not contain an adverse opinion or a disclaimer of opinion, and they were not qualified or modified as to uncertainty, audit scope, or accounting principles.

On June 12, 2017, the Company engaged RSM US LLP, or RSM, as its new independent registered public accounting firm, effective immediately. The decision to engage RSM as the Company’s independent registered public accounting firm was approved by the Company’s Audit Committee. During the years ended March 31, 2017 and 2016, and during the subsequent interim period preceding RSM’s engagement, neither the Company nor anyone on its behalf has consulted with RSM regarding either: (1) the application of accounting principles to a specified transaction, either completed or proposed, or the type of audit opinion that might be rendered on the Company’s consolidated financial statements, and no written report or oral advice was provided that RSM concluded was an important factor considered by the Company in reaching a decision as to the accounting, auditing or financial reporting issue; or (2) any matter that was either the subject of a “disagreement,” as that term is defined in Item 304(a)(1)(iv) of Regulation S-K or a “reportable event,” as that term is defined in Item 304 (a)(1)(v) of Regulation S-K. RSM US LLP’s principal business address is 1 South Wacker, Chicago, Illinois 60606.

 

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AVAILABLE INFORMATION

We have filed with the SEC a registration statement on Form N-2, together with all amendments and related exhibits, under the Securities Act, with respect to the Notes offered by this prospectus supplement. The registration statement contains additional information about us and the Notes being offered by this prospectus supplement.

We file with or submit to the SEC annual, quarterly and current reports, proxy statements, code of ethics and other information meeting the informational requirements of the Exchange Act. This information is available free of charge by calling us at (214) 238-5700 or on our website at www.capitalsouthwest.com. Information contained on our website is not incorporated into this prospectus supplement and you should not consider such information to be part of this document. You also may inspect and copy these reports, proxy statements and other information, as well as the registration statement and related exhibits and schedules, at the Public Reference Room of the SEC at 100 F Street, N.E., Washington, D.C. 20549. You may obtain information on the operation of the Public Reference Room by calling the SEC at 1-800-SEC-0330. The SEC maintains an Internet site that contains reports, proxy and information statements and other information filed electronically by us with the SEC, which are available on the SEC’s website at www.sec.gov. Copies of these reports, proxy and information statements and other information may be obtained, after paying a duplicating fee, by electronic request at the following e-mail address: publicinfo@sec.gov, or by writing the SEC’s Public Reference Section, 100 F Street, N.E., Washington, D.C. 20549.

 

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INDEX TO FINANCIAL STATEMENTS

 

Consolidated Statements of Assets and Liabilities as of September  30, 2017 (Unaudited) and March 31, 2017

     SF-2  

Consolidated Statements of Operations (Unaudited) for the three and six months ended September 30, 2017 and 2016

     SF-3  

Consolidated Statements of Changes in Net Assets (Unaudited) for the six months ended September 30, 2017 and 2016

     SF-4  

Consolidated Statements of Cash Flows (Unaudited) for the six months ended September 30, 2017 and 2016

     SF-5  

Consolidated Schedule of Investments as of September  30, 2017 (Unaudited) and March 31, 2017

     SF-6  

Notes to Consolidated Financial Statements (Unaudited)

     SF-13  

Consolidated Schedule of Investments in and Advances to Affiliates (Unaudited) for the six months ended September 30, 2017

     SF-49  

INDEX TO OTHER FINANCIAL STATEMENTS

 

Media Recovery, Inc. dba SpotSee Holdings

  

Report of Independent Auditors

     SF-51  

Consolidated Balance Sheets as of September 30, 2017 and 2016

     SF-53  

Consolidated Statements of Operations and Comprehensive Income (Loss) for Years Ended September 30, 2017, 2016 and 2015

     SF-54  

Consolidated Statements of Stockholders’ Equity for Years Ended September 30, 2017, 2016 and 2015

     SF-55  

Consolidated Statements of Cash Flows for Years Ended September  30, 2017, 2016 and 2015

     SF-56  

Notes to Consolidated Financial Statements

     SF-57  

 

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CAPITAL SOUTHWEST CORPORATION AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF ASSETS AND LIABILITIES

(In thousands, except shares and per share data)

 

     September 30,
2017
    March 31,
2017
 
     (Unaudited)        

Assets

    

Investments at fair value:

    

Non-control/Non-affiliate investments (Cost: $197,653 and $172,437, respectively)

   $ 196,781     $ 175,731  

Affiliate investments (Cost: $5,932 and $5,925, respectively)

     6,491       7,138  

Control investments (Cost: $76,260 and $72,178, respectively)

     118,588       104,011  
  

 

 

   

 

 

 

Total investments (Cost: $279,845 and $250,540, respectively)

     321,860       286,880  

Cash and cash equivalents

     33,329       22,386  

Receivables:

    

Dividends and interest

     3,709       3,137  

Escrow

     545       545  

Other

     461       626  

Deferred tax asset

     1,846       2,017  

Debt issuance costs (net of accumulated amortization of $686 and $366, respectively)

     1,972       2,137  

Other assets

     4,948       8,024  
  

 

 

   

 

 

 

Total assets

   $ 368,670     $ 325,752  
  

 

 

   

 

 

 

Liabilities

    

Credit facility

   $ 56,000     $ 25,000  

Other liabilities

     14,077       5,996  

Dividends payable

     3,838       7,191  

Accrued restoration plan liability

     2,122       2,170  

Deferred income taxes

     119       323  
  

 

 

   

 

 

 

Total liabilities

     76,156       40,680  
  

 

 

   

 

 

 

Commitments and contingencies (Note 11)

    

Net Assets

    

Common stock, $0.25 par value: authorized, 25,000,000 shares; issued, 18,358,808 shares at September 30, 2017 and 18,350,808 shares at March 31, 2017

     4,590       4,588  

Additional paid-in capital

     262,019       261,472  

Net investment income in excess of (less than) distributions

     (1,277     (1,457

Accumulated undistributed net realized gain

     9,223       8,390  

Unrealized appreciation of investments, net of income taxes

     41,896       36,016  

Treasury stock — at cost, 2,339,512 shares

     (23,937     (23,937
  

 

 

   

 

 

 

Total net assets

     292,514       285,072  
  

 

 

   

 

 

 

Total liabilities and net assets

   $ 368,670     $ 325,752  
  

 

 

   

 

 

 

Net asset value per share (16,019,296 shares outstanding at September 30, 2017 and 16,011,296 shares outstanding at March 31, 2017)

   $ 18.26     $ 17.80  
  

 

 

   

 

 

 

The accompanying Notes are an integral part of these Consolidated Financial Statements.

 

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CAPITAL SOUTHWEST CORPORATION AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF OPERATIONS

(Unaudited)

(In thousands, except shares and per share data)

 

     Three Months Ended
September 30,
    Six Months Ended
September 30,
 
     2017     2016     2017     2016  

Investment income:

        

Interest income:

        

Non-control/Non-affiliate investments

   $ 5,136     $ 2,433     $ 9,438     $ 4,515  

Affiliate investments

     141       141       281       280  

Control investments

                        

Dividend income:

        

Non-control/Non-affiliate investments

     30             60        

Control investments

     3,058       1,995       6,103       3,765  

Interest income from cash and cash equivalents

     5       56       12       126  

Fees and other income

     139       101       339       197  
  

 

 

   

 

 

   

 

 

   

 

 

 

Total investment income

     8,509       4,726       16,233       8,883  
  

 

 

   

 

 

   

 

 

   

 

 

 

Operating expenses:

        

Compensation

     1,606       1,404       3,244       2,889  

Spin-off compensation plan

     173       172       345       345  

Share-based compensation

     384       255       752       494  

Interest

     911       103       1,649       103  

Professional fees

     481       331       960       849  

Net pension expense

     41       43       81       86  

General and administrative

     842       641       1,551       1,422  
  

 

 

   

 

 

   

 

 

   

 

 

 

Total operating expenses

     4,438       2,949       8,582       6,188  
  

 

 

   

 

 

   

 

 

   

 

 

 

Income before taxes

     4,071       1,777       7,651       2,695  

Income tax expense

     134       412       278       958  
  

 

 

   

 

 

   

 

 

   

 

 

 

Net investment income

   $ 3,937     $ 1,365     $ 7,373     $ 1,737  
  

 

 

   

 

 

   

 

 

   

 

 

 

Realized gain

        

Non-control/Non-affiliate investments

   $ 210     $ (459   $ 834     $ (260

Affiliate investments

           3,986             3,986  

Control investments

                        
  

 

 

   

 

 

   

 

 

   

 

 

 

Total net realized gain on investments before income tax

     210       3,527       834       3,726  

Change in unrealized appreciation of investments

        

Non-control/Non-affiliate investments

     (1,747     (1,911     (4,166     (1,437

Affiliate investments

     (322           (654     506  

Control investments

     6,445       3,937       10,495       5,606  

Income tax benefit (provision)

     120             205       (522
  

 

 

   

 

 

   

 

 

   

 

 

 

Total net change in unrealized appreciation of investments, net of tax

     4,496       2,026       5,880       4,153  
  

 

 

   

 

 

   

 

 

   

 

 

 

Net realized and unrealized gain on investments

   $ 4,706     $ 5,553     $ 6,714     $ 7,879  
  

 

 

   

 

 

   

 

 

   

 

 

 

Net increase in net assets from operations

   $ 8,643     $ 6,918     $ 14,087     $ 9,616  
  

 

 

   

 

 

   

 

 

   

 

 

 

Pre-tax net investment income per share — basic and diluted

   $ 0.25     $ 0.11     $ 0.48     $ 0.17  
  

 

 

   

 

 

   

 

 

   

 

 

 

Net investment income per share — basic and diluted

   $ 0.25     $ 0.09     $ 0.46     $ 0.11  
  

 

 

   

 

 

   

 

 

   

 

 

 

Net increase in net assets from operations — basic and diluted

   $ 0.54     $ 0.44     $ 0.88     $ 0.61  
  

 

 

   

 

 

   

 

 

   

 

 

 

Weighted average shares outstanding — basic

     16,010,231       15,726,419       16,009,968       15,728,476  
  

 

 

   

 

 

   

 

 

   

 

 

 

Weighted average shares outstanding — diluted

     16,077,837       15,805,577       16,075,193       15,801,535  
  

 

 

   

 

 

   

 

 

   

 

 

 

The accompanying Notes are an integral part of these Consolidated Financial Statements.

 

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CAPITAL SOUTHWEST CORPORATION AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CHANGES IN NET ASSETS

(Unaudited)

(In thousands)

 

     Six Months Ended
September 30,
 
     2017     2016  

Operations:

    

Net investment income

   $ 7,373     $ 1,737  

Net realized gain on investments

     834       3,726  

Net change in unrealized appreciation of investments, net of tax

     5,879       4,153  
  

 

 

   

 

 

 

Net increase in net assets from operations

     14,086       9,616  

Distributions from:

    

Undistributed net investment income

     (7,193     (2,664

Spin-Off Compensation Plan, net of tax of $117 and $346, respectively

     (227     (1,175

Capital share transactions:

    

Change in pension plan funded status

     24       23  

Share-based compensation expense

     752       494  
  

 

 

   

 

 

 

Increase in net assets

     7,442       6,294  

Net assets, beginning of period

     285,072       272,635  
  

 

 

   

 

 

 

Net assets, end of period

   $ 292,514     $ 278,929  
  

 

 

   

 

 

 

The accompanying Notes are an integral part of these Consolidated Financial Statements.

 

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CAPITAL SOUTHWEST CORPORATION AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited)

(In thousands)

 

     Six Months Ended
September 30,
 
     2017     2016  

Cash flows from operating activities

    

Net increase in net assets from operations

   $ 14,086     $ 9,616  

Adjustments to reconcile net increase in net assets from operations to net cash used in operating activities:

    

Purchases and originations of investments

     (69,170     (67,520

Proceeds from sales and repayments of debt investments in portfolio companies

     40,390       12,045  

Proceeds from sales and return of capital of equity investments in portfolio companies

     15       4,442  

Payment of accreted original issue discounts

     819       220  

Depreciation and amortization

     368       98  

Net pension benefit

     (24     (16

Realized gain on investments before income tax

     (834     (3,726

Net change in unrealized appreciation of investments

     (5,675     (4,675

Accretion of discounts on investments

     (383     (176

Payment-in-kind interest and dividends

     (142      

Stock option and restricted awards expense

     752       494  

Deferred income tax expense

     (182     1,480  

Changes in other assets and liabilities:

    

(Increase) decrease in dividend and interest receivable

     (572     14  

Decrease in escrow receivables

           1,173  

Decrease in other receivables

     166       115  

Decrease in tax receivable

           314  

Decrease (increase) in other assets

     3,029       (1,141

Increase (decrease) in other liabilities

     8,002       (1,523

Increase in payable for unsettled transaction

           15,421  
  

 

 

   

 

 

 

Net cash used in operating activities

     (9,355     (33,345
  

 

 

   

 

 

 

Cash flows from financing activities

    

Proceeds from credit facility

     31,000        

Dividends to shareholders

     (10,547     (940

Debt issuance costs paid

     (155     (2,495

Spin-off Compensation Plan distribution

           (1,349
  

 

 

   

 

 

 

Net cash provided by (used in) financing activities

     20,298       (4,784
  

 

 

   

 

 

 

Net increase (decrease) in cash and cash equivalents

     10,943       (38,129

Cash and cash equivalents at beginning of period

     22,386       95,969  
  

 

 

   

 

 

 

Cash and cash equivalents at end of period

   $ 33,329     $ 57,840  
  

 

 

   

 

 

 

Supplemental cash flow disclosures:

    

Cash paid for income taxes

   $ 255     $  

Cash paid for interest

     1,236        

Supplemental disclosure of noncash financing activities:

    

Dividend declared, not yet paid

     3,838       1,724  

Noncash adjustment to realized gain for escrow receivable

           493  

Spin-off Compensation Plan distribution accrued, not yet paid

     344       172  

The accompanying Notes are an integral part of these Consolidated Financial Statements.

 

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CAPITAL SOUTHWEST CORPORATION AND SUBSIDIARIES

CONSOLIDATED SCHEDULE OF INVESTMENTS

(Unaudited)

September 30, 2017

 

Portfolio Company1

 

Type of

Investment2

 

Industry

 

Current

Interest Rate3

  Maturity     Principal     Cost     Fair
Value4
 

Non-control/Non-affiliate Investments5

             
AAC HOLDINGS, INC.   First Lien   Healthcare services   L+6.75% (Floor 1.00%), Current Coupon 8.06%     6/30/2023     $ 9,440,625     $ 9,211,195     $ 9,440,625  
AG KINGS HOLDINGS INC.8   First Lien   Food, agriculture & beverage   L+9.37% (Floor 1.00%), Current Coupon 10.68%     8/8/2021       9,800,000       9,638,768       9,800,000  

ALLIANCE SPORTS GROUP, L.P.

  Senior subordinated debt   Consumer products & retail   11.00%     2/1/2023       10,100,000       9,902,459       9,902,459  
  3.88% membership interest                     2,500,000       2,500,000  
           

 

 

   

 

 

 
              12,402,459       12,402,459  

AMERICAN TELECONFERENCING SERVICES, LTD.

  First Lien   Telecommunications   L+6.50% (Floor 1.00%), Current Coupon 7.78%     12/8/2021       6,555,837       6,397,980       6,342,773  
  Second Lien     L+9.50% (Floor 1.00%), Current Coupon 10.74%     6/6/2022       2,005,714       1,935,209       1,991,925  

AMWARE FULFILLMENT LLC

  First Lien   Distribution   L+9.50% (Floor 1.00%), Current Coupon 10.82%     5/21/2019       12,730,000       12,569,184       12,730,000  

ARGON MEDICAL DEVICES, INC.

  Second Lien   Healthcare products   L+9.50% (Floor 1.00%), Current Coupon 10.74%     6/23/2022       5,000,000       4,880,347       5,000,000  

BINSWANGER HOLDING CORP.

  First Lien   Consumer products & retail   L+8.00% (Floor 1.00%), Current Coupon 9.32%     3/9/2022       13,135,807       12,894,738       12,894,738  
  900,000 shares of common stock                     900,000       762,000  
           

 

 

   

 

 

 
              13,794,738       13,656,738  

CALIFORNIA PIZZA KITCHEN, INC.

  First Lien   Restaurants   L+6.00% (Floor 1.00%), Current Coupon 7.24%     8/23/2022       4,950,000       4,907,795       4,917,008  

DEEPWATER CORROSION SERVICES, INC.

  127,004 shares of Series A convertible preferred stock   Energy services (upstream)                   8,000,000       4,629,000  

DIGITAL RIVER, INC.

  First Lien   Software & IT services   L+6.50% (Floor 1.00%), Current Coupon 7.82%     2/12/2021       7,032,285       7,005,050       7,067,446  

DIGITAL ROOM LLC

  Second Lien   Paper & forest products   L+10.00% (Floor 1.00%), Current Coupon 11.24%     5/21/2023       7,000,000       6,872,147       6,965,000  

 

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CAPITAL SOUTHWEST CORPORATION AND SUBSIDIARIES

CONSOLIDATED SCHEDULE OF INVESTMENTS (continued)

(Unaudited)

September 30, 2017

 

Portfolio Company1

 

Type of

Investment2

 

Industry

 

Current

Interest Rate3

  Maturity   Principal     Cost     Fair
Value4
 
DUNN PAPER, INC.   Second Lien   Paper & forest products   L+8.75% (Floor 1.00%), Current Coupon 9.99%   8/26/2023     3,000,000       2,946,215       2,970,000  
ELITE SEM, INC.8   First Lien   Media, marketing & entertainment   L+10.28% (Floor 1.00%), Current Coupon 11.60%   2/1/2022     12,150,000       11,886,728       12,150,000  
  1,000 shares of common stock     12% PIK             1,079,667       1,565,000  
           

 

 

   

 

 

 
              12,966,395       13,715,000  

LIGHTING RETROFIT INTERNATIONAL, LLC

  First Lien   Environmental services   L+9.25% (Floor 1.00%), Current Coupon 10.55%   6/30/2022     15,000,000       14,759,719       14,775,000  
  396,825 shares of Series B preferred stock                 500,000       500,000  
           

 

 

   

 

 

 
              15,259,719       15,275,000  

PRE-PAID LEGAL SERVICES, INC.

  Second Lien   Consumer services   L+9.00% (Floor 1.25%), Current Coupon 10.25%   7/1/2020     5,000,000       4,961,421       5,040,625  

REDBOX AUTOMATED RETAIL, LLC

  First Lien   Gaming & leisure   L+7.50% (Floor 1.00%), Current Coupon 8.74%   9/27/2021     7,000,000       6,812,899       7,070,000  

RESEARCH NOW GROUP, INC.

  Second Lien   Business services   L+8.75% (Floor 1.00%), Current Coupon 10.08%   3/18/2022     7,000,000       6,924,784       6,895,000  

RESTAURANT TECHNOLOGIES, INC.

  Second Lien   Restaurants   L+8.75% (Floor 1.00%), Current Coupon 10.06%   11/23/2023     3,500,000       3,452,009       3,482,500  

RJO HOLDINGS CORP. 14

  First Lien   Financial services   L+8.02% (Floor 1.00%), Current Coupon 9.26%   5/5/2022     7,406,250       7,337,022       7,337,022  

TAX ADVISORS GROUP, LLC13

  Senior subordinated debt   Consumer services   10.00% / 2.00% PIK   12/23/2022     4,600,000       4,511,370       4,511,370  
  143.3 Class A units9                 541,176       541,176  
           

 

 

   

 

 

 
              5,052,546       5,052,546  
VISTAR MEDIA INC.   First Lien   Media, marketing & entertainment   L+10.00% (Floor 1.00%), Current Coupon 11.32%   2/16/2022     8,250,000       7,495,327       8,250,000  
  Warrants                 886,000       1,500,000  
           

 

 

   

 

 

 
              8,381,327       9,750,000  

 

SF-7


Table of Contents

CAPITAL SOUTHWEST CORPORATION AND SUBSIDIARIES

CONSOLIDATED SCHEDULE OF INVESTMENTS (continued)

(Unaudited)

September 30, 2017

 

Portfolio Company1

 

Type of

Investment2

 

Industry

 

Current

Interest Rate3

  Maturity   Principal     Cost     Fair
Value4
 

WASTEWATER SPECIALTIES, LLC

  First Lien   Business services   L+8.75% (Floor 1.00%), Current Coupon 9.99%   4/18/2022     11,000,000       10,821,549       10,109,000  
ZENFOLIO INC.15   First Lien   Business services   L+9.00% (Floor 1.00%), Current Coupon 10.30%   7/17/2022     13,500,000       13,241,238       13,241,238  
  Revolving Loan     L+9.00% (Floor 1.00%)   7/17/2022           (19,364      
  190 shares of common stock                 1,900,000       1,900,000  
           

 

 

   

 

 

 
              15,121,874       15,141,238  
           

 

 

   

 

 

 

Total Non-control/Non-affiliate Investments Affiliate Investments6

            $ 197,652,632     $ 196,780,905  
           

 

 

   

 

 

 
CHANDLER SIGNS, LLC13   Senior subordinated debt   Business services   12.00%   7/4/2021   $ 4,500,000     $ 4,432,169     $ 4,432,169  
  1,500,000 units of Class A-1 common stock9                 1,500,000       2,059,000  
           

 

 

   

 

 

 
              5,932,169       6,491,169  
           

 

 

   

 

 

 
Total Affiliate Investments             $ 5,932,169     $ 6,491,169  
           

 

 

   

 

 

 

Control Investments7

             
I-45 SLF LLC9, 10, 11   80% LLC equity interest   Multi-sector holdings             $ 64,800,000     $ 67,401,334  
MEDIA RECOVERY, INC.11   800,000 shares of Series A convertible preferred stock   Industrial products               800,000       5,888,532  
  4,000,002 shares of common stock                 4,615,000       33,969,468  
           

 

 

   

 

 

 
              5,415,000       39,858,000  
TITANLINER, INC.   1,189,609 shares of Series B convertible preferred stock   Energy services (upstream)   6% PIK             2,841,007       5,026,000  
  339,277 shares of Series A convertible preferred stock                 3,204,222       6,303,000  
           

 

 

   

 

 

 
              6,045,229       11,329,000  
           

 

 

   

 

 

 
Total Control Investments             $ 76,260,229     $ 118,588,334  
           

 

 

   

 

 

 
TOTAL INVESTMENTS12             $ 279,845,030     $ 321,860,408  
           

 

 

   

 

 

 

 

1 All debt investments are income-producing, unless otherwise noted. Equity investments are non-income producing, unless otherwise noted.
2 All of the Company’s investments, unless otherwise noted, are encumbered as security for the Company’s senior secured credit facility.
3 The majority of investments bear interest at a rate that may be determined by reference to London Interbank Offered Rate (“LIBOR” or “L”) or Prime (“P”) and reset daily, monthly, quarterly, or semiannually. For each the Company has provided the spread over LIBOR or Prime and the current contractual interest rate in effect at September 30, 2017. Certain investments are subject to a LIBOR or Prime interest rate floor. Certain investments, as noted, accrue payment-in-kind (“PIK”) interest.

 

SF-8


Table of Contents

CAPITAL SOUTHWEST CORPORATION AND SUBSIDIARIES

CONSOLIDATED SCHEDULE OF INVESTMENTS (continued)

(Unaudited)

September 30, 2017

 

4 Investments are carried at fair value in accordance with the Investment Company Act of 1940 (the “1940 Act”) and Financial Accounting Standards Board (“FASB”) Accounting Standard Codification (“ASC”) 820, Fair Value Measurements and Disclosures. We determine in good faith the fair value of our Investment portfolio pursuant to a valuation policy in accordance with ASC 820 and a valuation process approved by our Board of Directors. See Note 4 to the consolidated financial statements.
5 Non-Control/Non-Affiliate investments are generally defined by the 1940 Act as investments that are neither control investments nor affiliate investments. At September 30, 2017, approximately 61.2% of the Company’s investment assets are non-control/non-affiliate investments. The fair value of these investments as a percent of net assets is 67.3%.
6 Affiliate investments are generally defined by the 1940 Act as investments in which between 5% and 25% of the voting securities are owned and the investments are not classified as control investments. At September 30, 2017, approximately 2.0% of the Company’s investment assets are affiliate investments. The fair value of these investments as a percent of net assets is 2.2%.
7 Control investments are generally defined by the 1940 Act as investments in which more than 25% of the voting securities are owned or where greater than 50% of the board representation is maintained. At September 30, 2017, approximately 36.8% of the Company’s investment assets are control investments. The fair value of these investments as a percent of net assets is 40.5%.
8 The investment is structured as a first lien last out term loan and earns interest in addition to the stated rate.
9 Indicates assets that are considered “non-qualifying assets” under section 55(a) of the 1940 Act. Qualifying assets must represent at least 70% of total assets at the time of acquisition of any additional non-qualifying assets. As of September 30, 2017, approximately 21.7% of the Company’s investment assets are non-qualifying assets.
10 The investment has approximately $3.2 million unfunded commitment as of September 30, 2017.
11 Income producing through dividends.
12 As of September 30, 2017, the cumulative gross unrealized appreciation for federal income tax purposes is approximately $45.8 million; cumulative gross unrealized depreciation for federal income tax purposes is $4.3 million. Cumulative net unrealized appreciation is $41.5 million, based on a tax cost of $280.0 million.
13 Tax Advisors Group Class A units and Chandler Signs, LP Class A-1 common stock are held through a wholly-owned taxable subsidiary.
14 The investment is structured as a first lien first out term loan and earns less interest than the stated rate.
15 The investment has approximately $2.0 million in an unfunded revolving commitment and $2.5 million in a delayed draw commitment as of September 30, 2017.

 

SF-9


Table of Contents

CAPITAL SOUTHWEST CORPORATION AND SUBSIDIARIES

CONSOLIDATED SCHEDULE OF INVESTMENTS

March 31, 2017

 

Portfolio Company1

 

Type of

Investment2

 

Industry

 

Current
Interest
Rate2

  Maturity     Principal     Cost     Fair
Value3
 

Non-control/Non-affiliate Investments4

             

AG KINGS HOLDINGS8

 

First Lien

 

Food, agriculture &

beverage

  L+8.50%
(Floor 1.00%)
    8/10/2021       9,900,000       9,720,743       9,900,000  

AMERICAN TELECONFERENCING

 

First Lien

 

Telecommunications

  L+6.50%
(Floor 1.00%)
    12/8/2021       6,733,503       6,559,616       6,720,709  
 

Second Lien

    L+9.50%
(Floor 1.00%)
    6/6/2022       2,005,714       1,929,670       1,965,600  

AMWARE FULFILLMENT

 

First Lien

 

Distribution

  L+9.50%
(Floor 1.00%)
    5/21/2019       13,065,000       12,858,885       12,934,350  

ARGON MEDICAL DEVICES

 

Second Lien

 

Healthcare products

  L+9.50%
(Floor 1.00%)
    6/23/2022       5,000,000       4,871,024       5,000,000  

BINSWANGER CORP.

 

First Lien

 

Consumer products &

retail

  L+8.00%
(Floor 1.00%)
    3/9/2022       13,251,760       12,988,847       12,988,848  
 

900,000 shares of common stock

            900,000       900,000  
           

 

 

   

 

 

 
              13,888,847       13,888,848  

CALIFORNIA PIZZA KITCHEN

 

First Lien

 

Restaurants

  L+6.00%
(Floor 1.00%)
    8/23/2022       4,975,000       4,929,234       4,975,995  

CAST AND CREW PAYROLL, LLC

 

Second Lien

 

Media, marketing &

entertainment

  L+7.75%
(Floor 1.00%)
    8/12/2023       3,705,263       3,685,537       3,671,916  

DEEPWATER CORROSION SERVICES, INC.

 

127,004 shares of Series A convertible

preferred stock

 

Energy services

(upstream)

                  8,000,000       9,956,000  

DIGITAL RIVER, INC.

 

First Lien

 

Software & IT

services

  L+6.50%
(Floor 1.00%)
    2/12/2021       7,032,285       7,001,500       7,067,446  

DIGITAL ROOM INC.

 

Second Lien

 

Paper & forest

products

  L+10.00%
(Floor 1.00%)
    5/21/2023       7,000,000       6,864,682       6,864,682  

DUNN PAPER, INC.

 

Second Lien

 

Paper & forest

products

  L+8.75%
(Floor 1.00%)
    8/26/2023       3,000,000       2,942,972       2,970,000  

ELITE SEM, INC.8

 

First Lien

 

Media, marketing &

entertainment

  L+8.50%
(Floor 1.00%)
    2/1/2022       12,150,000       11,864,161       11,864,161  
 

1,000 shares of common stock

    12% PIK                 1,019,667       1,020,000  
           

 

 

   

 

 

 
              12,883,828       12,884,161  

IMAGINE! PRINT SOLUTIONS, INC.

 

First Lien

 

Media, marketing &

entertainment

  L+6.00%
(Floor 1.00%)
    3/30/2022       4,853,233       4,800,146       4,913,898  

INFOGROUP INC.

 

First Lien

 

Software & IT

services

  L+5.50%
(Floor 1.50%)
    5/26/2018       4,895,007       4,822,951       4,890,112  

LIGHTING RETROFIT INTERNATIONAL

 

First Lien

 

Environmental

services

  L+9.75%
(Floor 0.5%)
    9/28/2021       10,222,222       10,126,394       10,126,394  

LTI HOLDINGS, INC.

 

Second Lien

 

Industrial products

  L+9.25%
(Floor 1.00%)
    4/17/2023       7,000,000       6,853,685       6,825,000  

PREPAID LEGAL SERVICES, INC.

 

Second Lien

 

Consumer services

  L+9.00%
(Floor 1.25%)
    7/1/2020       5,000,000       4,955,404       5,029,000  

REDBOX AUTOMATED RETAIL

 

First Lien

 

Gaming & leisure

  L+7.50%
(Floor 1.00%)
    9/27/2021       8,750,000       8,505,558       8,761,375  

 

SF-10


Table of Contents

CAPITAL SOUTHWEST CORPORATION AND SUBSIDIARIES

CONSOLIDATED SCHEDULE OF INVESTMENTS (continued)

March 31, 2017

 

Portfolio Company1

 

Type of

Investment2

 

Industry

 

Current
Interest
Rate2

  Maturity   Principal     Cost     Fair
Value3
 

RESEARCH NOW GROUP, INC.

 

Second Lien

 

Business services

  L+8.75%
(Floor 1.00%)
  3/18/2022     7,000,000       6,918,134       6,860,000  

RESTAURANT TECHNOLOGIES, INC.

 

Second Lien

 

Restaurants

  L+8.75%
(Floor 1.00%)
  11/23/2023     3,500,000       3,449,262       3,482,500  

TAXACT, INC.

 

First Lien

 

Financial services

  L+6.00%
(Floor 1.00%)
  12/31/2022     2,775,000       2,722,263       2,775,000  

VISTAR MEDIA INC.

 

First Lien

 

Media, marketing &

entertainment

  L+10.00%
(Floor 1.00%)
  2/16/2022     11,000,000       9,898,494       9,898,494  
 

Warrants

            886,000       886,000  
           

 

 

   

 

 

 
              10,784,494       10,784,494  

WATER PIK, INC.

 

Second Lien

 

Consumer products &

retail

  L+8.75%
(Floor 1.00%)
  2/8/2021     4,473,684       4,385,853       4,507,237  

WINZER CORPORATION

 

Senior subordinated debt

 

Distribution

  11.00%   6/1/2021     8,100,000       7,976,347       7,976,347  
           

 

 

   

 

 

 

Total Non-control/Non-affiliate Investments

            $ 172,437,029     $ 175,731,064  
           

 

 

   

 

 

 

Affiliate Investments6

             

CHANDLER SIGNS, LP13

 

Senior subordinated debt

 

Business services

  12.00%   7/4/2021   $ 4,500,000     $ 4,425,310     $ 4,477,500  
 

1,500,000 units of Class A-1 common stock

                1,500,000       2,661,000  
           

 

 

   

 

 

 
              5,925,310       7,138,500  
           

 

 

   

 

 

 

Total Affiliate Investments

            $ 5,925,310     $ 7,138,500  
           

 

 

   

 

 

 

Control Investments7

             

I-45 SLF LLC9, 10, 11

 

80% LLC equity interest

 

Multi-sector holdings

            $ 60,800,000     $ 63,394,679  

MEDIA RECOVERY, INC.11

 

800,000 shares of Series A convertible

preferred stock

 

Industrial products

              800,000       5,590,249  
 

4,000,002 shares of common stock

                4,615,000       32,248,751  
           

 

 

   

 

 

 
              5,415,000       37,839,000  
           

 

 

   

 

 

 

TITANLINER, INC.

 

1,189,609 shares of Series B convertible

preferred stock

 

Energy services

(upstream)

  6% PIK             2,758,528       2,777,000  
 

339,277 shares of Series A convertible

preferred stock

                3,204,222        
           

 

 

   

 

 

 
              5,962,750       2,777,000  
           

 

 

   

 

 

 

Total Control Investments

            $ 72,177,750     $ 104,010,679  
           

 

 

   

 

 

 

TOTAL INVESTMENTS12

            $ 250,540,089     $ 286,880,243  
           

 

 

   

 

 

 

 

1 All debt investments are income-producing, unless otherwise noted. Equity investments are non-income producing, unless otherwise noted.
2 All of the Company’s investments, unless otherwise noted, are encumbered as security for the Company’s senior secured credit facility.

 

SF-11


Table of Contents

CAPITAL SOUTHWEST CORPORATION AND SUBSIDIARIES

CONSOLIDATED SCHEDULE OF INVESTMENTS (continued)

March 31, 2017

 

3 The majority of investments bear interest at a rate that may be determined by reference to London Interbank Offered Rate (“LIBOR” or “L”) or Prime (“P”) and reset daily, monthly, quarterly, or semiannually. For each the Company has provided the spread over LIBOR or Prime and the current contractual interest rate in effect at March 31, 2017. Certain investments are subject to a LIBOR or Prime interest rate floor.
4 Investments are carried at fair value in accordance with the Investment Company Act of 1940 (the “1940 Act”) and Financial Accounting Standards Board (“FASB”) Accounting Standard Codification (“ASC”) 820, Fair Value Measurements and Disclosures. We determine in good faith the fair value of our Investment portfolio pursuant to a valuation policy in accordance with ASC 820 and a valuation process approved by our Board of Directors. See Note 4 to the consolidated financial statements.
5 Non-Control/Non-Affiliate investments are generally defined by the 1940 Act as investments that are neither control investments nor affiliate investments. At March 31, 2017, approximately 61.3% of the Company’s investment assets were non-control/non-affiliate investments.
6 Affiliate investments are generally defined by the 1940 Act as investments in which between 5% and 25% of the voting securities are owned and the investments are not classified as control investments. At March 31, 2017, approximately 2.5% of the Company’s investment assets were affiliate investments.
7 Control investments are generally defined by the 1940 Act as investments in which more than 25% of the voting securities are owned or maintains greater than 50% of the board representation. At March 31, 2017, approximately 36.2% of the Company’s investment assets were control investments.
8 The investment is structured as a first lien last out term loan and earns interest in addition to the stated rate.
9 Indicates assets that the Company believes do not represent “qualifying assets” under section 55(a) of the 1940 Act. Qualifying assets must represent at least 70% of total assets at the time of acquisition of any additional non-qualifying assets.
10 The investment has approximately $7.2 million unfunded commitment as of March 31, 2017.
11 Income producing through dividends on distributions.
12 As of March 31, 2017, the cumulative gross unrealized appreciation for federal income tax purposes is approximately $40.1 million; cumulative gross unrealized depreciation for federal income tax purposes is $3.4 million. Cumulative net unrealized appreciation is $36.7 million, based on a tax cost of $250.1 million.
13 Chandler Signs, LP Class A-1 common stock is held through a wholly-owned taxable subsidiary.

 

SF-12


Table of Contents

Notes to Consolidated Financial Statements

1. ORGANIZATION AND BASIS OF PRESENTATION

References to “we,” “our,” “us,” “CSWC,” or the “Company” refer to Capital Southwest Corporation, unless the context requires otherwise.

Organization

Capital Southwest Corporation is an internally managed investment company that specializes in providing customized financing to middle market companies in a broad range of industry segments located primarily in the United States. Our common stock currently trades on The Nasdaq Global Select Market under the ticker symbol “CSWC.”

CSWC was organized as a Texas corporation on April 19, 1961. Until September 1969, we operated as a Small Business Investment Company (“SBIC”) licensed under the Small Business Investment Act of 1958. At that time, CSWC transferred to its then wholly-owned subsidiary, Capital Southwest Venture Corporation (“CSVC”), certain assets including our license as an “SBIC”. CSVC was a closed-end, non-diversified investment company registered under the Investment Company Act of 1940, as amended (the “1940 Act”). Effective June 14, 2016, CSVC was dissolved and its SBIC license was surrendered. All assets held in CSVC were transferred to CSWC upon dissolution. Prior to March 30, 1988, CSWC was registered as a closed-end, non-diversified investment company under the 1940 Act. On that date, we elected to be treated as a Business Development Company (“BDC”) subject to the provisions of the 1940 Act, as amended by the Small Business Incentive Act of 1980. In order to remain a BDC, we must meet certain specified requirements under the 1940 Act, including investing at least 70% of our assets in eligible portfolio companies and limiting the amount of leverage we incur.

We are also a regulated investment company (“RIC”) under Subchapter M of the U.S. Internal Revenue Code of 1986 (the “Code”). As such, we are not required to pay corporate-level income tax on our investment income. We intend to maintain our RIC status, which requires that we annually qualify as a RIC by meeting certain specified requirements.

Capital Southwest Management Company (“CSMC”), a wholly-owned subsidiary of CSWC, is the management company for CSWC. CSMC generally incurs all normal operating and administrative expenses, including, but not limited to, salaries and related benefits, rent, office expenses and other administrative costs required for its day-to-day operations.

CSWC also has a direct wholly owned subsidiary that has been elected to be a taxable entity (the “Taxable Subsidiary”). The primary purpose of the Taxable Subsidiary is to permit CSWC to hold certain interests in portfolio companies that are organized as limited liability companies, or LLCs (or other forms of pass-through entities) and still allow us to satisfy the RIC tax requirement that at least 90% of our gross income for federal income tax purposes must consist of qualifying investment income. The Taxable Subsidiary is taxed at normal corporate tax rates based on its taxable income.

We focus on investing in companies with histories of generating revenues and positive cash flow, established market positions and proven management teams with strong operating discipline. We target senior debt, subordinated debt, and equity investments in lower middle market (“LMM”) companies, as well as first and second lien syndicated loans in upper middle market (“UMM”) companies. Our target LMM companies typically have annual earnings before interest, taxes, depreciation and amortization (“EBITDA”) between $3.0 million and $15.0 million, and our LMM investments generally range from $5.0 million to $20.0 million. Our UMM investments generally include syndicated first and second lien loans in companies with EBITDA generally greater than $50.0 million, and our UMM investments typically range from $5.0 million to $10.0 million. We make available significant managerial assistance to the companies in which we invest as we believe that providing managerial assistance to an investee company is critical to its business development activities.

 

SF-13


Table of Contents

Basis of Presentation

The consolidated financial statements have been prepared in accordance with Generally Accepted Accounting Principles in the United States of America (“U.S. GAAP”). We meet the definition of an investment company and follow the accounting and reporting guidance in the Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) Topic 946 — Financial Services — Investment Companies (“ASC Topic 946”). Under the rules and regulations applicable to investment companies, we are generally precluded from consolidating any entity other than another investment company subject to certain exceptions. One of the exceptions to this general principle occurs if the investment company has an investment in an operating company that provides services to the investment company. Accordingly, the consolidated financial statements include CSMC, our management company, and the Taxable Subsidiary.

The consolidated financial statements are presented in conformity with U.S. GAAP for interim financial information and pursuant to the requirements for reporting on Form 10-Q and Article 10 of Regulation S-X. Accordingly, certain disclosures accompanying annual consolidated financial statements prepared in accordance with U.S. GAAP are omitted. In the opinion of our management, the unaudited consolidated financial results included herein contain all adjustments, consisting solely of normal recurring accruals, considered necessary for the fair presentation of consolidated financial statements for the interim periods included herein. The results of operations for the three and six months ended September 30, 2017 are not necessarily indicative of the operating results to be expected for the full fiscal year. Also, the unaudited consolidated financial statements and notes should be read in conjunction with the audited consolidated financial statements and notes thereto for the fiscal years ended March 31, 2017 and 2016. Consolidated financial statements prepared on a U.S. GAAP basis require management to make estimates and assumptions that affect the amounts and disclosures reported in the consolidated financial statements and accompanying notes. Such estimates and assumptions could change in the future as more information becomes known, which could impact the amounts reported and disclosed herein.

Portfolio Investment Classification

We classify our investments in accordance with the requirements of the 1940 Act. Under the 1940 Act, “Control Investments” are generally defined as investments in which we own more than 25% of the voting securities or have rights to maintain greater than 50% of the board representation; “Affiliated Investments” are generally defined as investments in which we own between 5% and 25% of the voting securities, and the investments are not classified as “Control Investments”; and “Non-Control/Non-Affiliated Investments” are generally defined as investments that are neither “Control Investments” nor “Affiliated Investments.”

Under the 1940 Act, a BDC must meet certain requirements, including investing at least 70% of our assets in qualifying assets. As of September 30, 2017, the Company met the requirements under the 1940 Act for a BDC. The principal categories of qualifying assets relevant to our business are:

(1) Securities purchased in transactions not involving any public offering from the issuer of such securities, which issuer (subject to certain limited exceptions) is an eligible portfolio company, or from any person who is, or has been during the preceding 13 months, an affiliated person of an eligible portfolio company, or from any other person, subject to such rules as may be prescribed by the SEC.

(2) Securities of any eligible portfolio company that we control.

(3) Securities purchased in a private transaction from a U.S. issuer that is not an investment company or from an affiliated person of the issuer, or in transactions incident thereto, if the issuer is in bankruptcy and subject to reorganization or if the issuer, immediately prior to the purchase of its securities was unable to meet its obligations as they came due without material assistance other than conventional lending or financing arrangements.

 

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(4) Securities of an eligible portfolio company purchased from any person in a private transaction if there is no readily available market for such securities and we already own 60% of the outstanding equity of the eligible portfolio company.

(5) Securities received in exchange for or distributed on or with respect to securities described in (1) through (4) above, or pursuant to the exercise of warrants or rights relating to such securities.

(6) Cash, cash equivalents, U.S. government securities or high-quality debt securities maturing in one year or less from the time of investment.

Additionally, in order to qualify as a RIC for U.S. federal income tax purposes, we must, among other things meet the following tests:

(1) Continue to qualify as a BDC under the 1940 Act at all times during each taxable year.

(2) Derive in each taxable year at least 90.0% of our gross income from dividends, interest, payments with respect to certain securities, loans, gains from the sale of stock or other securities, net income from certain “qualified publicly traded partnerships,” or other income derived with respect to our business of investing in such stock or securities (the “90% Income Test”).

(3) Diversify our holdings such that at the end of each quarter of the taxable year at least 50% of the value of our assets consists of cash, cash equivalents, U.S. Government securities, securities of other RICs, and other securities if such other securities of any one issuer do not represent more than 5% of the value of our assets or more than 10% of the outstanding voting securities of the issuer; and no more than 25% of the value of our assets is invested in the securities, other than U.S. government securities or securities of other RICs, (i) of one issuer, (ii) of two or more issuers that are controlled, as determined under applicable Code rules, by us and that are engaged in the same or similar or related trades or businesses or (iii) of certain “qualified publicly traded partnerships” (collectively, the “Diversification Tests”).

The two Diversification Tests must be satisfied quarterly. If a RIC satisfies the tests for one quarter, and then, due solely to fluctuations in market value, fails to meet one of the tests in the next quarter, it retains RIC status. A RIC that fails to meet the Diversification Tests as a result of a nonqualified acquisition may be subject to excess taxes unless the nonqualified acquisition is disposed of and the tests are satisfied within 30 days of the close of the quarter in which the tests are failed.

This quarter we satisfied all RIC tests and have 14.5% in nonqualified assets according to measurement criteria established in Section 851(d) of the Internal Revenue Code (as amended, the “IRC”).

2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

The following is a summary of significant accounting policies followed in the preparation of the consolidated financial statements of CSWC.

Fair Value Measurements We account for substantially all of our financial instruments at fair value in accordance with ASC Topic 820 — Fair Value Measurements and Disclosures (“ASC Topic 820”). ASC Topic 820 defines fair value, establishes a framework used to measure fair value and requires disclosures for fair value measurements, including the categorization of financial instruments into a three-level hierarchy based on the transparency of valuation inputs. ASC Topic 820 requires disclosure of the fair value of financial instruments for which it is practical to estimate such value. We believe that the carrying amounts of our financial instruments such as cash, receivables and payables approximate the fair value of these items due to the short maturity of these instruments. This is considered a Level 1 valuation technique. The carrying value of our credit facility approximates fair value because the interest rate adjusts to the market interest rate (Level 3 input). See Note 4 below for further discussion regarding the fair value measurements and hierarchy.

 

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Investments Investments are stated at fair value and are reviewed and approved by our Board of Directors as described in the Notes to the Consolidated Schedule of Investments and Notes 3 and 4 below. Investments are recorded on a trade date basis.

Net Realized Gains or Losses and Net Change in Unrealized Appreciation or Depreciation Realized gains or losses are measured by the difference between the net proceeds from the sale or redemption of an investment or a financial instrument and the cost basis of the investment or financial instrument, without regard to unrealized appreciation or depreciation previously recognized, and includes investments written-off during the period net of recoveries and realized gains or losses from in-kind redemptions. Net change in unrealized appreciation or depreciation reflects the net change in the fair value of the investment portfolio and financial instruments and the reclassification of any prior period unrealized appreciation or depreciation on exited investments and financial instruments to realized gains or losses.

Cash and Cash Equivalents Cash and cash equivalents, which consist of cash and highly liquid investments with an original maturity of three months or less at the date of purchase, are carried at cost, which approximates fair value. Cash and cash equivalents includes deposits at financial institutions. We deposit our cash balances in financial institutions and, at times, such balances may be in excess of the Federal Deposit Insurance Corporation (“FDIC”) insurance limits. At September 30, 2017 and March 31, 2017, cash balances totaling $32.0 million and $19.6 million, respectively, exceeded FDIC insurance limits, subjecting us to risk related to the uninsured balance. All of our cash deposits are held at large established high credit quality financial institutions and management believes that the risk of loss associated with any uninsured balances is remote.

Segment Information We operate and manage our business in a singular segment. As an investment company, we invest in portfolio companies in various industries and geographic areas as discussed in Note 3.

Consolidation As permitted under Regulation S-X and ASC Topic 946, we generally do not consolidate our investment in a portfolio company other than an investment company subsidiary or a controlled operating company whose business consists of providing services to CSWC. Accordingly, we consolidated the results of CSWC’s wholly-owned Taxable Subsidiary and CSWC’s wholly-owned management company, CSMC. Prior to its dissolution, we consolidated the results of CSWC’s wholly-owned subsidiary, CSVC. All intercompany balances have been eliminated upon consolidation.

Use of Estimates The preparation of consolidated financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect amounts reported in the consolidated financial statements and accompanying notes. Actual results could differ from those estimates. We have identified investment valuation and revenue recognition as our most critical accounting estimates.

Interest and Dividend Income Interest and dividend income is recorded on an accrual basis to the extent amounts are expected to be collected. Dividend income is recorded as dividends are declared by the portfolio company or at the point an obligation exists for the portfolio company to make a distribution. Discounts/premiums received to par on loans purchased are capitalized and accreted or amortized into income over the life of the loan using the effective interest method. In accordance with our valuation policy, accrued interest and dividend income is evaluated quarterly for collectability. When we do not expect the debtor to be able to service all of its debt or other obligations, we will generally establish a reserve against interest income receivable, thereby placing the loan or debt security on non-accrual status, and cease to recognize interest income on that loan or debt security until the borrower has demonstrated the ability and intent to pay contractual amounts due. If a loan or debt security’s status significantly improves regarding its ability to service debt or other obligations, it will be restored to accrual basis. As of September 30, 2017 and March 31, 2017, we did not have any investments on non-accrual status.

To maintain RIC tax treatment, non-cash sources of income such as accretion of interest income may need to be paid out to shareholders in the form of distributions, even though CSWC may not have collected the interest

 

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income. For the three and six months ended September 30, 2017, approximately 2.3% and 2.4%, respectively, of CSWC’s total investment income was attributable to interest income for the accretion of discounts associated with debt investments, net of any premium reduction. For the three and six months ended September 30, 2016, approximately 2.1% and 2.0%, respectively, of CSWC’s total investment income was attributable to interest income for the accretion of discounts associated with debt investments, net of any premium reduction.

Payment-in-Kind Interest The Company currently holds, and expects to hold in the future, some investments in its portfolio that contain payment-in-kind (“PIK”) interest and dividend provisions. The PIK interest and dividends, computed at the contractual rate specified in each loan agreement, are added to the principal balance of the loan, rather than being paid to the Company in cash, and are recorded as interest and dividend income. Thus, the actual collection of PIK interest and dividends may be deferred until the time of debt principal repayment or disposition of the equity investment. PIK interest and dividends, which are non-cash sources of income, are included in the Company’s taxable income and therefore affect the amount the Company is required to distribute to shareholders to maintain its qualification as a RIC for federal income tax purposes, even though the Company has not yet collected the cash. Generally, when current cash interest and/or principal payments on a loan become past due, or if the Company otherwise does not expect the borrower to be able to service its debt and other obligations, the Company will place the investment on non-accrual status and will generally cease recognizing PIK interest and dividend income on that loan for financial reporting purposes until all principal and interest have been brought current through payment or due to a restructuring such that the interest and dividend income is deemed to be collectible. The Company writes off any accrued and uncollected PIK interest and dividends when it is determined that the PIK interest and dividends are no longer collectible. For the three and six months ended September 30, 2017, approximately 0.8% and 0.9%, respectively, of CSWC’s total investment income was attributable to non-cash PIK interest and dividend income. For the three and six months ended September 30, 2016, none of CSWC’s investment income was attributable to non-cash PIK interest and dividend income.

Debt Issuance Costs Debt issuance costs include commitment fees and other costs related to CSWC’s senior secured credit facility (as discussed further in Note 5). These costs have been capitalized and are amortized into interest expense over the term of the credit facility.

Federal Income Taxes CSWC has elected and intends to comply with the requirements of the IRC necessary to qualify as a RIC. By meeting these requirements, we will not be subject to corporate federal income taxes on ordinary income distributed to shareholders. In order to qualify as a RIC, the company is required to timely distribute to its shareholders at least 90.0% of investment company taxable income, as defined by the IRC, each year. Investment company taxable income generally differs from net income for financial reporting purposes due to temporary and permanent differences in the recognition of income and expenses. Investment company taxable income generally excludes net unrealized appreciation or depreciation, as investment gains and losses are not included in investment company taxable income until they are realized.

In addition to the requirement that we must annually distribute at least 90.0% of our investment company taxable income, we may either distribute or retain our realized net capital gains from investments, but any net capital gains not distributed may be subject to corporate level tax. If we retain the capital gains, they are subject to a corporate tax rate of 35.0% and are classified as a “deemed distribution” to our shareholders. As an investment company that qualifies as a RIC, federal income taxes payable on security gains that we elect to retain are accrued only on the last day of our tax year, December 31. Any capital gains actually distributed to shareholders are generally taxable to the shareholders as long-term capital gains. See Note 6 for further discussion.

CSMC, a wholly owned subsidiary of CSWC, and the Taxable Subsidiary are not RICs and are required to pay taxes at the current corporate rate of 34%. For tax purposes, CSMC and the Taxable Subsidiary have elected to be treated as taxable entities, and therefore are not consolidated for tax purposes and are taxed at normal corporate tax rates based on taxable income and, as a result of their activities, may generate income tax expense

 

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or benefit. The taxable income, or loss, of each of CSMC and the Taxable Subsidiary may differ from its book income, or loss, due to temporary book and tax timing differences and permanent differences. This income tax expense, or benefit, if any, and the related tax assets and liabilities, are reflected in our consolidated financial statements.

Management evaluates tax positions taken or expected to be taken in the course of preparing the Company’s consolidated financial statements to determine whether the tax positions are “more-likely-than-not” to be sustained by the applicable tax authority. Tax positions with respect to tax at the CSWC level not deemed to meet the “more-likely-than-not” threshold would be recorded as an expense in the current year. Management’s conclusions regarding tax positions will be subject to review and may be adjusted at a later date based on factors including, but not limited to, on-going analyses of tax laws, regulations and interpretations thereof. The Company has concluded that it does not have any uncertain tax positions that meet the recognition of measurement criteria of ASC 740 for the current period. Also, we account for interest and, if applicable, penalties for any uncertain tax positions as a component of income tax expense. No interest or penalties expense was recorded during the three and six months ended September 30, 2017 and 2016.

Deferred Taxes Deferred tax assets and liabilities are recorded for losses or income at our taxable subsidiaries using statutory tax rates. A valuation allowance is provided against deferred tax assets when it is more likely than not that some portion or all of the deferred tax asset will not be realized. See Note 6 for further discussion.

Stock-Based Compensation We account for our stock-based compensation using the fair value method, as prescribed by ASC Topic 718, Compensation — Stock Compensation. Accordingly, we recognize stock-based compensation cost on a straight-line basis for all share-based payments and awards granted to employees. The fair value of stock options are determined on the date of grant using the Black-Scholes pricing model and are expensed over the requisite service period of the related stock options. For restricted stock awards, we measured the grant date fair value based upon the market price of our common stock on the date of the grant. For restricted stock awards, we amortize this fair value to share-based compensation expense over the vesting term. The unvested shares of restricted stock awarded pursuant to CSWC’s equity compensation plans are participating securities and are included in the basic and diluted earnings per share calculation. On October 26, 2010, we received an exemptive order from the SEC permitting us to issue restricted stock to our executive officers and certain key employees. On August 22, 2017, we received an exemptive order that allows us to withhold shares to satisfy tax withholding obligations related to the vesting of restricted stock granted pursuant to the 2010 Restricted Stock Award Plan (the “2010 Plan”) and to pay the exercise price of options to purchase shares of our common stock granted pursuant to the 2009 Stock Incentive Plan (the “2009 Plan”).

At the three and six months ended September 30, 2017, weighted-average basic shares were adjusted for the diluted effect of stock-based awards of 67,606 and 65,225, respectively. At the three and six months ended September 30, 2016, weighted-average basic shares were adjusted for the diluted effect of stock-based awards of 79,157 and 73,060, respectively. For individual cash incentive awards, the option value of the individual cash incentive awards is calculated based on the changes in net asset value (“NAV”) of our Company. In connection with the Share Distribution, we entered into an Employee Matters Agreement (the “Employee Matters Agreement”) with CSW Industrials, Inc. (“CSWI”). Under the Employee Matters Agreement, the value of individual cash incentive awards was determined based upon the net asset value of CSWC as of June 30, 2015. See Note 9 for further discussion.

Shareholder Distributions Distributions to common shareholders are recorded on the ex-dividend date. The amount of distributions, if any, is determined by the Board of Directors each quarter.

Presentation Presentation of certain amounts on the Consolidated Statements of Operations for the prior year comparative consolidated financial statements is updated to conform to the current period presentation. This mainly includes disclosure of amounts at a more disaggregated level.

 

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Recently Issued or Adopted Accounting Standards In February 2016, the FASB issued ASU 2016-02, Leases, which requires lessees to recognize on the balance sheet a right-of-use asset, representing its right to use the underlying asset for the lease term, and a lease liability for all leases with terms greater than 12 months. The guidance also requires qualitative and quantitative disclosures designed to assess the amount, timing, and uncertainty of cash flows arising from leases. The standard requires the use of a modified retrospective transition approach, which includes a number of optional practical expedients that entities may elect to apply. The new guidance is effective for annual periods beginning after December 15, 2018, and interim periods therein. Early application is permitted. CSWC is currently evaluating the impact the adoption of this new accounting standard will have on its consolidated financial statements, but the impact of the adoption is not expected to be material.

In May 2014, the FASB issued ASU 2014-09, Revenue from Contracts with Customers (Topic 606). ASU 2014-09 supersedes the revenue recognition requirements under SAC Topic 605, Revenue Recognition, and most industry-specific guidance throughout the Industry Topics of the ASC. The core principle of the guidance is that an entity should recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which an entity expects to be entitled in exchange for those goods or services. Under the new guidance, an entity is required to perform the following five steps: (1) identify the contract(s) with a customer; (2) identify the performance obligations in the contract; (3) determine the transaction price; (4) allocate the transaction price to the performance obligations in the contract, and (5) recognize revenue when (or as) the entity satisfies a performance obligation. The new guidance will significantly enhance comparability of revenue recognition practices across entities, industries, jurisdictions and capital markets. Additionally, the guidance requires improved disclosures as to the nature, amount, timing and uncertainty of revenue that is recognized. In May 2016, the FASB issued ASU No. 2016-12, Revenue from Contracts with Customers (Topic 606)—Narrow-Scope Improvements and Practical Expedients. This ASU clarified guidance on assessing collectability, presenting sales tax, measuring noncash consideration, and certain transition matters. The FASB tentatively decided to defer the effective date of the new revenue standard for public entities under U.S. GAAP for one year. The new guidance will be effective for the annual reporting period beginning after December 15, 2017, including interim periods within that reporting period. Early adoption would be permitted for annual reporting periods beginning after December 15, 2016. CSWC completed its initial assessment in evaluating the potential impact on its consolidated financial statements and based on its initial assessment, determined that its financial contracts are excluded from the scope of ASU 2014-09. As a result of the scope exception for financial contracts, the Company’s management has determined that there will be no material changes to the recognition timing and classification of revenues and expenses; additionally, the Company’s management does not expect the adoption of ASU 2014-09 to have a significant impact to pretax income or on its consolidated financial statement disclosures upon adoption. The Company will continue to evaluate the impacts of ASU 2014-09 through the date of adoption to ensure that its initial assessment continues to remain accurate.

In August 2016, the FASB issued ASU 2016-15, Statement of Cash Flows (Topic 230), which is intended to reduce the existing diversity in practice in how certain cash receipts and cash payments are presented and classified in the statement of cash flows. The guidance is effective for annual periods beginning after December 15, 2017, and interim periods therein. Early application is permitted. The impact of the adoption of this new accounting standard on the Company’s consolidated financial statements is not expected to be material.

 

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3. INVESTMENTS

The following table shows the composition of the investment portfolio, at fair value and cost (with corresponding percentage of total portfolio investments) as of September 30, 2017 and March 31, 2017:

 

     Fair Value      Percentage of
Total Portfolio
    Percentage of
Net Assets
    Cost      Percentage of
Total Portfolio
 
     (dollars in millions)  

September 30, 2017:

            

First lien loans1

   $ 136.1        42.3     46.5   $ 135.0        48.2

Second lien loans

     32.4        10.1       11.1       32.0        11.4  

Subordinated debt

     18.9        5.9       6.5       18.8        6.7  

Preferred equity

     22.3        6.9       7.6       15.3        5.5  

Common equity & warrants

     44.8        13.9       15.3       13.9        5.0  

I-45 SLF LLC2

     67.4        20.9       23.0       64.8        23.2  
  

 

 

    

 

 

   

 

 

   

 

 

    

 

 

 
   $ 321.9        100.0     110.0   $ 279.8        100.0
  

 

 

    

 

 

   

 

 

   

 

 

    

 

 

 

March 31, 20173:

            

First lien loans

   $ 107.8        37.6     37.8   $ 106.8        42.6

Second lien loans

     47.2        16.5       16.6       46.9        18.7  

Subordinated debt

     12.5        4.3       4.4       12.4        4.9  

Preferred equity

     18.3        6.4       6.4       14.8        5.9  

Common equity & warrants

     37.7        13.1       13.2       8.8        3.6  

I-45 SLF LLC2

     63.4        22.1       22.2       60.8        24.3  
  

 

 

    

 

 

   

 

 

   

 

 

    

 

 

 
   $ 286.9        100.0     100.6   $ 250.5        100.0
  

 

 

    

 

 

   

 

 

   

 

 

    

 

 

 

 

1 Included in First lien loans are loans structured as first lien last out loans. These loans may in certain cases be subordinated in payment priority to other senior secured lenders. As of September 30, 2017 and March 31, 2017, the fair value of the first lien last out loans are $22.0 million and $21.8 million, respectively.
2 I-45 SLF LLC (“I-45 SLF”) is a joint venture between CSWC and Main Street Capital Corporation (“Main Street”). This entity primarily invests in syndicated senior secured loans to the UMM. The portfolio companies held by I-45 SLF represent a diverse set of industry classifications, which are similar to those in which CSWC invests directly. See Note 15 for further discussion.
3 Presentation of March 31, 2017 disclosure is updated to conform to the current period presentation.

 

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The following table shows the composition of the investment portfolio by industry, at fair value and cost (with corresponding percentage of total portfolio investments) as of September 30, 2017 and March 31, 2017:

 

     Fair Value      Percentage of
Total Portfolio
    Percentage of
Net Assets
    Cost      Percentage of
Total Portfolio
 
     (dollars in millions)  

September 30, 2017:

            

I-45 SLF LLC1

   $ 67.4        20.9     23.0   $ 64.8        23.2

Industrial Products

     39.9        12.4       13.6       5.4        1.9  

Business Services

     28.5        8.9       9.7       28.0        10.0  

Consumer Products and Retail

     26.1        8.1       8.9       26.2        9.4  

Media, Marketing, & Entertainment

     23.5        7.3       8.0       21.4        7.6  

Energy Services (Upstream)

     16.0        5.0       5.5       14.0        5.0  

Environmental Services

     15.3        4.7       5.2       15.3        5.5  

Distribution

     12.7        4.0       4.3       12.6        4.5  

Industrial Services

     10.1        3.1       3.5       10.8        3.9  

Consumer Services

     10.1        3.1       3.5       10.0        3.6  

Paper & Forest Products

     9.9        3.1       3.4       9.8        3.5  

Food, Agriculture & Beverage

     9.8        3.0       3.4       9.6        3.4  

Healthcare Services

     9.4        2.9       3.2       9.2        3.3  

Restaurants

     8.4        2.6       2.9       8.4        3.0  

Telecommunications

     8.3        2.6       2.9       8.3        3.0  

Financial Services

     7.3        2.3       2.5       7.3        2.6  

Gaming & Leisure

     7.1        2.2       2.4       6.8        2.4  

Software & IT Services

     7.1        2.2       2.4       7.0        2.5  

Healthcare Products

     5.0        1.6       1.7       4.9        1.7  
  

 

 

    

 

 

   

 

 

   

 

 

    

 

 

 
   $ 321.9        100.0     110.0   $ 279.8        100.0