13.1 * Annual Report to Shareholders for the fiscal year
ended March 31, 2006.
21.1 * List of subsidiaries of the Company.
23.1 * Consent of Independent Registered Public Accounting
Firm - Grant Thornton LLP.
23.2 * Consent of Independent Registered Public Accounting
Firm - Ernst & Young LLP.
31.1 * Certification of President and Chairman of the Board
required by Rule 13a-14(a) or Rule 15d-14(a) of the
Securities Exchange Act of 1934, as amended (the
"Exchange Act"), filed herewith.
31.2 * Certification of Secretary-Treasurer required by Rule
13a-14(a) or Rule 15d-14(a) of the Exchange Act,
filed herewith.
32.1 ** Certification of President and Chairman of the Board
required by Rule 13a-14(b) or Rule 15d-14(b) of the
Exchange Act and Section 1350 of Chapter 63 of Title
18 of the United States Code, furnished herewith.
32.2 ** Certification of Secretary-Treasurer required by Rule
13a-14(b) or Rule 15d-14(b) of the Exchange Act and
Section 1350 of Chapter 63 of Title 18 of the United
States Code, furnished herewith.
Exhibit 13.1
Twelve Largest Investments - March 31, 2006
Palm Harbor Homes, Inc. $98,189,000
- --------------------------------------------------------------------------------
Palm Harbor Homes, Dallas, Texas, is an integrated manufacturer and
retailer of manufactured and modular housing produced in 19 plants and sold in
32 states by 116 company-owned retail stores and builder locations and
approximately 350 independent dealers, builders and developers. The company
provides financing through its 80% owned subsidiary, CountryPlace Mortgage, and
sells insurance through its subsidiary, Standard Casualty. Palm Harbor's
traditional manufactured homes and the upscale modular homes are designed to
meet the need for attractive, affordable housing.
During the year ended March 31, 2006, Palm Harbor reported net income of
$11,114,000 ($0.49 per share) on net sales of $710,635,000, compared with a net
loss of $3,823,000 ($0.17 per share) on net sales of $610,538,000 in the
previous year. The March 31, 2006 closing Nasdaq bid price of Palm Harbor's
common stock was $21.31 per share.
At March 31, 2006, the $10,931,955 investment in Palm Harbor by Capital
Southwest and its subsidiary was valued at $98,189,000 ($12.50 per share),
consisting of 7,855,121 restricted shares of common stock, representing a
fully-diluted equity interest of 30.5%.
================================================================================
The RectorSeal Corporation $87,500,000
- --------------------------------------------------------------------------------
The RectorSeal Corporation, Houston, Texas, with facilities in Texas, New
York and Idaho, manufactures specialty chemical products including pipe thread
sealants, firestop sealants, plastic cements and other formulations for
plumbing, HVAC, electrical and industrial applications. The company also makes
special tools for plumbers and systems for containing smoke from building fires.
RectorSeal's subsidiary, Jet-Lube, Inc., with plants in Texas, England and
Canada, produces anti-seize compounds, specialty lubricants and other products
used in industrial and oil field applications. Another subsidiary produces and
sells automotive chemical products. RectorSeal owns a 20% equity interest in The
Whitmore Manufacturing Company (described on page 10).
During the year ended March 31, 2006, RectorSeal earned $8,655,000 on
revenues of $95,060,000, compared with earnings of $7,598,000 on revenues of
$76,072,000 in the previous year. RectorSeal's earnings do not reflect its 20%
equity in The Whitmore Manufacturing Company.
At March 31, 2006, Capital Southwest owned 100% of RectorSeal's common
stock having a cost of $52,600 and a value of $87,500,000.
================================================================================
Encore Wire Corporation $81,735,000
- --------------------------------------------------------------------------------
Encore Wire Corporation, McKinney, Texas, manufactures a broad line of
copper electrical building wire and cable including non-metallic sheathed,
underground feeder and THHN wire and cable and also armored cable for
residential, commercial and industrial construction. Encore's products are sold
through large-volume distributors and building materials retailers.
For the year ended December 31, 2005, Encore reported net income of
$50,079,000 ($2.13 per share) on net sales of $758,089,000, compared with net
income of $33,360,000 ($1.42 per share) on net sales of $603,225,000 in the
previous year. The March 31, 2006 closing market price of Encore's common stock
was $33.88 per share.
At March 31, 2006, the $5,800,000 investment in 4,086,750 shares of
Encore's restricted common stock by Capital Southwest and its subsidiary was
valued at $81,735,000 ($20.00 per share), representing a fully-diluted equity
interest of 17.1%.
================================================================================
Alamo Group Inc. $45,141,000
- --------------------------------------------------------------------------------
Alamo Group Inc., Seguin, Texas, is a leading designer, manufacturer and
distributor of heavy-duty, tractor and truck mounted mowing and other vegetation
maintenance equipment, mobile excavators, street-sweeping equipment and
replacement parts. Founded in 1969, Alamo Group operates 14 manufacturing
facilities and serves governmental, industrial and agricultural markets in North
America, Europe, and Australia.
For the year ended December 31, 2005, Alamo reported consolidated earnings
of $11,291,000 ($1.14 per share) on net sales of $368,110,000, compared with
earnings of $13,396,000 ($1.36 per share) on net sales of $342,171,000 in the
previous year. The March 31, 2006 closing NYSE market price of Alamo's common
stock was $22.14 per share.
At March 31, 2006, the $2,065,047 investment in Alamo by Capital Southwest
and its subsidiary was valued at $45,141,000 ($16.00 per share), consisting of
2,821,300 restricted shares of common stock, representing a fully-diluted equity
interest of 26.2%.
================================================================================
Lifemark Group $42,000,000
- --------------------------------------------------------------------------------
Lifemark Group (formerly Skylawn Corporation), Hayward, California, owns
and operates cemeteries, mausoleums and mortuaries. Lifemark's operations, all
of which are in California, include a major cemetery in San Mateo, a mausoleum
and an adjacent mortuary in Oakland and cemeteries, mausoleums and mortuaries in
Hayward and Sacramento. The company also owns a funeral home in San Bruno and is
building a major funeral home on the grounds of its San Mateo County cemetery.
Its funeral and cemetery trusts enable Lifemark's clients to make pre-need
arrangements. The company's assets also include excess real estate holdings.
For the fiscal year ended March 31, 2006, Lifemark reported earnings of
$2,457,000 on revenues of $27,178,000, compared with earnings of $2,153,000 on
revenues of $24,964,000 in the previous year.
At March 31, 2006, Capital Southwest owned 100% of Lifemark Group's common
stock, which had a cost of $4,510,400 and was valued at $42,000,000.
================================================================================
Media Recovery, Inc. $42,000,000
- --------------------------------------------------------------------------------
Media Recovery, Inc., Graham, Texas, distributes computer and office
automation supplies and accessories to corporate customers through its direct
sales force. Its Shockwatch division manufactures impact and tilt monitoring
devices used to detect mishandled shipments and devices for monitoring material
handling equipment. Media Recovery's subsidiary, The Damage Prevention Company,
Denver, Colorado, manufactures dunnage products used to prevent damage in
trucking, rail and export container shipments.
During the year ended September 30, 2005, Media Recovery reported net
income of $5,028,000 on net sales of $142,574,000, compared with net income of
$3,943,000 on net sales of $123,664,000 in the previous year.
At March 31, 2006, the $5,415,000 investment in Media Recovery by Capital
Southwest and its subsidiary was valued at $42,000,000, consisting of 4,800,000
shares of Series A convertible preferred stock, representing a fully-diluted
equity interest of 87.4%.
================================================================================
Heeling, Inc. $30,000,000
- --------------------------------------------------------------------------------
Heeling, Inc., Carrollton, Texas, manufacturers and markets specialty
stealth skate footwear incorporating a patented "wheel in the heel" design under
the brand name Heelys. The company manufactures its products in Korea and China
and distributes them through domestic and international sporting goods chains,
department and lifestyle stores, specialty footwear retailers and on-line at
Heelys.com.
During the year ended December 31, 2005, Heeling reported net income of
$4,347,000 on net sales of $43,950,000, compared with net income of $803,000 on
net sales of $21,309,000 in the previous year.
At March 31, 2006, the $120,000 investment in Heeling by Capital
Southwest's subsidiary was valued at $30,000,000 consisting of 436,364 shares of
Series B convertible preferred stock, convertible into 436,364 shares of common
stock at $0.275 per share, representing a 43.0% fully-diluted equity interest.
================================================================================
The Whitmore Manufacturing Company $22,000,000
- --------------------------------------------------------------------------------
The Whitmore Manufacturing Company, Rockwall, Texas, manufactures specialty
lubricants for heavy equipment used in surface mining, railroads and other
industries, and produces water-based coatings for the automotive and primary
metals industries. Whitmore's subsidiary, Fluid Protection Corporation,
manufactures fluid contamination control devices. The company's assets also
include several commercial real estate tracts.
During the year ended March 31, 2006, Whitmore reported net income of
$1,776,000 on net sales of $18,010,000, compared with net income of $1,475,000
on net sales of $16,469,000 in the previous year. The company is owned 80% by
Capital Southwest and 20% by Capital Southwest's subsidiary, The RectorSeal
Corporation (described on page 9).
At March 31, 2006, the direct investment in Whitmore by Capital Southwest
was valued at $22,000,000 and had a cost of $1,600,000.
Hologic, Inc. $17,513,294
- --------------------------------------------------------------------------------
Hologic, Inc., Bedford, Massachusetts, is a leading developer, manufacturer
and supplier of bone densitometers, mammography and breast biopsy devices,
direct-to-digital x-ray systems and other x-ray based imaging systems. These
products are generally targeted to address women's healthcare and general
radiographic applications.
For the year ended September 24, 2005, Hologic reported net income of
$28,256,000 ($0.63 per share) on net sales of $287,684,000, compared with net
income of $12,164,000 ($0.29 per share) on net sales of $228,705,000 in the
previous year. The March 31, 2006 closing Nasdaq bid price of Hologic's common
stock was $55.35 per share.
At March 31, 2006, Capital Southwest and its subsidiary owned 316,410
unrestricted shares of common stock, having a cost of $220,000 and a market
value of $17,513,294 ($55.35 per share).
================================================================================
Texas Capital Bancshares, Inc. $11,697,882
- --------------------------------------------------------------------------------
Texas Capital Bancshares, Inc. of Dallas, Texas, formed in 1998, has total
assets of approximately $3.0 billion. With banks in Austin, Dallas, Fort Worth,
Houston, Plano and San Antonio, Texas Capital Bancshares conducts its business
through its wholly-owned subsidiary, Texas Capital Bank, N.A., which targets
middle market commercial and wealthy private client customers in Texas.
For the year ended December 31, 2005, Texas Capital reported net income of
$27,192,000 ($1.02 per share), compared with net income of $19,560,000 ($0.75
per share) in the previous year. The March 31, 2006 closing Nasdaq bid price of
Texas Capital's common stock was $23.89 per share.
At March 31, 2006, Capital Southwest owned 489,656 unrestricted shares of
common stock, having a cost of $3,550,006 and a market value of $11,697,882
($23.89 per share).
================================================================================
PETsMART, Inc. $8,439,000
- --------------------------------------------------------------------------------
PETsMART, Inc., Phoenix, Arizona, is the largest specialty retailer of
services and solutions for the lifetime needs of pets. The company operates more
than 825 pet superstores in the United States and Canada, many of which offer
pet grooming services and operate PETsHOTELS. It is also a direct marketer of
pet products through its e-commerce site and its pet and equine catalog
businesses.
For the year ended January 29, 2006, PETsMART, Inc. reported net income of
$182,490,000 ($1.25 per share) on net sales of $3.760 billion, compared with net
income of $157,453,000 ($1.05 per share) on net sales of $3.363 billion in the
previous year. The March 31, 2006 closing Nasdaq bid price of PETsMART's common
stock was $28.13 per share.
At March 31, 2006, Capital Southwest and its subsidiary owned 300,000
unrestricted shares of common stock, having a cost of $1,318,771 and a market
value of $8,439,000 ($28.13 per share).
================================================================================
Cenveo, Inc. $8,290,000
- --------------------------------------------------------------------------------
Cenveo, Inc., Englewood, Colorado, is one of North America's largest
providers of visual communication solutions delivered through print and
electronic media. Its products include offset and digital printing, custom and
stock envelopes, and business documents.
For the year ended December 31, 2005, Cenveo reported a net loss of
$135,052,000 ($2.70 per share) on net sales of $1.749 billion, compared with a
net loss of $19,708,000 ($0.41 per share) on net sales of $1.743 billion in the
previous year. The March 31, 2006 closing NYSE market price of Cenveo's common
stock was $16.58 per share.
At March 31, 2006, Capital Southwest owned 500,000 unrestricted shares of
common stock, having a cost of $712,317 and a market value of $8,290,000 ($16.58
per share).
Portfolio of Investments - March 31, 2006
Company Equity (a) Investment (b) Cost Value (c)
- ------------------------------------------------------------------------------------------------------------------------------------
+AT&T, INC. <1% ++20,770 shares common stock
New York, New York (acquired 3-9-99) $ 12 $ 561,621
Global leader in local, long distance,
Internet and transaction- based voice
and data services.
- ------------------------------------------------------------------------------------------------------------------------------------
+ALAMO GROUP INC. 26.2% 2,821,300 shares common stock
Seguin, Texas (acquired 4-1-73 thru 10-4-99) 2,065,047 45,141,000
Tractor-mounted mowing and mobile excavation
equipment for governmental, industrial and
agricultural markets; street-sweeping
equipment for municipalities.
- ------------------------------------------------------------------------------------------------------------------------------------
ALL COMPONENTS, INC. 56.9% 10% subordinated note due 2008
Addison, Texas (acquired 10-28-03 thru 10-3-05) 3,000,000 3,000,000
Electronics contract manufacturing; distribution 150,000 shares Series A convertible
and production of memory and other components for preferred stock, convertible
computer manufacturers, retailers and value-added into 600,000 shares of common
resellers; distribution of automotive accessories. stock at $0.25 per share
(acquired 9-16-94) 150,000 2,000,000
----------- ------------
3,150,000 5,000,000
- ------------------------------------------------------------------------------------------------------------------------------------
+ALLTEL CORPORATION <1% ++8,880 shares common stock
Little Rock, Arkansas (acquired 7-1-98) 108,355 574,980
Wireless and wireline local, long-distance,
network access and Internet services.
- ------------------------------------------------------------------------------------------------------------------------------------
BALCO, INC. 88.5% 445,000 shares common stock and
Wichita, Kansas 60,920 shares Class B non-voting
Specialty architectural products used common stock (acquired 10-25-83
in the construction and remodeling of and 5-30-02) 624,920 2,500,000
commercial and institutional buildings
- ------------------------------------------------------------------------------------------------------------------------------------
BOXX TECHNOLOGIES, INC. 15.2% 3,125,354 shares Series B
Austin, Texas convertible preferred stock,
Workstations for computer graphics convertible into 3,125,354
imaging and design. shares of common stock at
$0.50 per share (acquired
8-20-99 thru 8-8-01) 1,500,000 2
- ------------------------------------------------------------------------------------------------------------------------------------
CMI HOLDING COMPANY, INC. 18.5% 10% convertible subordinated
Richardson, Texas notes, convertible into
Owns Chase Medical, which develops 568,182 shares of common
and sells devices used in cardiac stock at $1.32 per share,
surgery to relieve congestive heart due 2007 (acquired 4-16-04
failure; develops and supports cardiac thru 12-17-04) 750,000 750,000
imaging systems. 2,327,658 shares Series A
convertible preferred stock,
convertible into 2,327,658
shares of common stock at
$1.72 per share (acquired
8-21-02 and 6-4-03) 4,000,000 2,000,000
Warrants to purchase 109,012
shares of common stock at
$1.72 per share, expiring
2012 (acquired 4-16-04) -- --
----------- ------------
4,750,000 2,750,000
- ------------------------------------------------------------------------------------------------------------------------------------
+Publicly-owned company ++Unrestricted securities as defined in Note (b)
Company Equity (a) Investment (b) Cost Value (c)
- ------------------------------------------------------------------------------------------------------------------------------------
+CENVEO, INC. <1% ++500,000 shares common
Englewood, Colorado stock (acquired 2-18-94
Envelopes and commercial printing. thru 11-10-98) $ 712,317 $ 8,290,000
- ------------------------------------------------------------------------------------------------------------------------------------
+COMCAST CORPORATION <1% ++43,104 shares common
Philadelphia, Pennsylvania stock (acquired 11-18-02) 21 1,127,601
Leading provider of cable, entertainment and
communications products and services.
- ------------------------------------------------------------------------------------------------------------------------------------
DENNIS TOOL COMPANY 67.4% 20,725 shares 5%
Houston, Texas convertible preferred
Polycrystalline diamond compacts (PDCs) stock, convertible into
used in oil field drill bits and in 20,725 shares of common
mining and industrial applications. stock at $48.25 per share
(acquired 8-10-98 ) 999,981 999,981
140,137 shares common stock
(acquired 3-7-94
and 8-10-98) 2,329,963 2
----------- ------------
3,329,944 999,983
- ------------------------------------------------------------------------------------------------------------------------------------
+DISCOVERY HOLDING COMPANY <1% ++70,501 shares Series A
Englewood, Colorado common stock (acquired
Provider of creative content, media 7-21-05) 20,262 1,056,810
management and network services worldwide.
- ------------------------------------------------------------------------------------------------------------------------------------
+ENCORE WIRE CORPORATION 17.1% 4,086,750 shares common stock
McKinney, Texas (acquired 7-16-92 thru
Electric wire and cable for residential 10-7-98) 5,800,000 81,735,000
and commercial use.
- ------------------------------------------------------------------------------------------------------------------------------------
EXTREME INTERNATIONAL, INC. 53.3% 12% subordinated note due 2008,
Sugar Land, Texas $1,413,247 principal amount
Owns Bill Young Productions, Texas Video (acquired 9-30-03) 782,481 1,413,247
and Post, and Extreme Communications, which 39,359.18 shares Series C
produce radio and television commercials and convertible preferred stock,
corporate communications videos. convertible into 157,436.72
shares of common stock at
$25.00 per share (acquired
9-30-03) 2,625,000 3,935,918
3,750 shares 8% Series A
convertible preferred stock,
convertible into 15,000 shares
of common stock at $25.00
per share (acquired 9-30-03) 375,000 375,000
Warrants to purchase 13,035 shares
of common stock at $25.00 per
share, expiring 2008 (acquired
8-11-98 thru 9-30-03) -- --
----------- ------------
3,782,481 5,724,165
- ------------------------------------------------------------------------------------------------------------------------------------
+FMC CORPORATION <1% ++6,430 shares common stock
Chicago, Illinois (acquired 6-6-86) 66,726 398,531
Chemicals for agricultural, industrial and
consumer markets.
- ------------------------------------------------------------------------------------------------------------------------------------
+FMC TECHNOLOGIES, INC. <1% ++11,057 shares common stock
Chicago, Illinois (acquired 1-2-02) 57,051 566,340
Equipment and systems for the energy, food
processing and air transportation industries.
- ------------------------------------------------------------------------------------------------------------------------------------
+Publicly-owned company ++Unrestricted securities as defined in Note (b)
Company Equity (a) Investment (b) Cost Value (c)
- ------------------------------------------------------------------------------------------------------------------------------------
HEELING, INC. 43.0% 436,364 shares Series B
Carrollton, Texas convertible preferred
Heelys stealth skate shoes sold through stock, convertible into
sporting goods chains, department stores, 436,364 shares of common
footwear retailers and on-line at stock at $0.275 per share
Heelys.com. (acquired 5-26-00) $ 120,000 $ 30,000,000
- ------------------------------------------------------------------------------------------------------------------------------------
HIC-STAR CORPORATION 34.9% 10% subordinated note due
(formerly AmPro Mortgage Corporation) 2007 (acquired 10-19-04
Dallas, Texas and 1-13-05) 352,646 352,646
Holding company previously engaged in 12% subordinated notes due
mortgage banking operations, which have 2008 (acquired 3-25-05
now been sold. thru 2-27-06) 819,978 819,978
5,000 shares Series A
cumulative preferred stock
(acquired 2-28-03) 5,000,000 --
1,500 shares Series B cumulative
preferred stock (acquired
3-31-04) 1,500,000 --
29,167 shares Series A common
stock (acquired 2-28-03) 29,167 --
Warrants to purchase 463,162
shares of Series A common
stock at $1.00 per share,
expiring 2014 (acquired
3-31-04 thru 1-13-05) -- --
----------- ------------
7,701,791 1,172,624
- ------------------------------------------------------------------------------------------------------------------------------------
+HOLOGIC, INC. <1% ++316,410 shares common stock
Bedford, Massachusetts (acquired 8-27-99) 220,000 17,513,294
Medical instruments including bone
densitometers, mammography devices and digital
radiography systems.
- ------------------------------------------------------------------------------------------------------------------------------------
+KIMBERLY-CLARK CORPORATION <1% ++77,180 shares common stock
Dallas, Texas (acquired 12-18-97) 2,358,518 4,461,004
Manufacturer of tissue, personal care and
health care products.
- ------------------------------------------------------------------------------------------------------------------------------------
+LIBERTY GLOBAL, INC. <1% ++42,463 shares Series A common
Englewood, Colorado stock (acquired 6-15-05) 106,553 867,094
Owns interests in broadband, distribution ++42,463 shares Series C common
and content companies. stock (acquired 9-6-05) 100,870 835,672
----------- ------------
207,423 1,702,766
- ------------------------------------------------------------------------------------------------------------------------------------
+LIBERTY MEDIA CORPORATION <1% ++705,010 shares Series A common
Englewood, Colorado stock (acquired 3-9-99 thru
Holding company owning interests in electronic 12-12-02) 118,253 5,788,132
retailing, media, communications and entertainment
businesses.
- ------------------------------------------------------------------------------------------------------------------------------------
LIFEMARK GROUP (formerly Skylawn Corporation) 100.0% 1,449,026 shares common stock
Hayward, California (acquired 7-16-69) 4,510,400 42,000,000
Cemeteries, mausoleums and mortuaries located
in northern California.
- ------------------------------------------------------------------------------------------------------------------------------------
+Publicly-owned company ++Unrestricted securities as defined in Note (b)
Company Equity (a) Investment (b) Cost Value (c)
- ------------------------------------------------------------------------------------------------------------------------------------
MEDIA RECOVERY, INC. 87.4% 4,800,000 shares Series A
Graham, Texas convertible preferred stock,
Computer and office automation supplies and convertible into 4,800,000
accessories; impact and tilt monitoring shares of common stock at
devices to detect mishandled shipments; dunnage $1.00 per share (acquired
for protecting shipments. 11-4-97) $ 5,415,000 $ 42,000,000
- ------------------------------------------------------------------------------------------------------------------------------------
PALLETONE, INC. 9.7% 1,796,850 shares Series A
Bartow, Florida preferred stock (acquired
Wood pallet manufacturer with 14 manufacturing 10-18-01) 1,350,000 1,796,850
facilities. 150,000 shares common stock
(acquired 10-18-01) 150,000 730,000
Warrant to purchase 15,294 shares
of common stock at $1.00 per
share, expiring 2011 (acquired
2-17-06) 45,746 59,000
----------- ------------
1,545,746 2,585,850
- ------------------------------------------------------------------------------------------------------------------------------------
+PALM HARBOR HOMES, INC. 30.5% 7,855,121 shares common stock
Dallas, Texas (acquired 1-3-85 thru 7-31-95) 10,931,955 98,189,000
Integrated manufacturing, retailing, financing
and insuring of manufactured housing and modular
homes.
- ------------------------------------------------------------------------------------------------------------------------------------
+PETSMART, INC. <1% ++300,000 shares common stock
Phoenix, Arizona (acquired 6-1-95) 1,318,771 8,439,000
Retail chain of more than 825 stores selling pet
foods, supplies and services.
- ------------------------------------------------------------------------------------------------------------------------------------
PHARMAFAB, INC. 67.5% 6% convertible subordinated
Grand Prairie, Texas notes, $4,205,616 principal
Contract manufacturer of branded and generic amount, convertible into
pharmaceutical drugs; developer of drug delivery Series A or B convertible
technology. preferred stock, convertible
into 560,750 shares of
common stock at $7.50 per
share, due 2013 (acquired
2-28-06) 4,000,000 4,000,000
54,000 shares Series A
convertible preferred stock,
convertible into 720,000 shares
of common stock at $7.50 per
share (acquired 8-1-03 and
2-24-06) 5,400,000 --
1,000 shares Series B
convertible preferred stock,
convertible into 13,334 shares
of common stock at $7.50 per
share (acquired 8-1-03) 100,000 --
Warrants to purchase 16,668 shares
of Series A or B convertible
preferred stock at $100.00
per share, convertible into
111,120 shares of common
stock at $7.50 per share,
expiring 2012 and 2013
(acquired 6-16-05 and 2-28-06) -- --
----------- ------------
9,500,000 4,000,000
- ------------------------------------------------------------------------------------------------------------------------------------
THE RECTORSEAL CORPORATION 100.0% 27,907 shares common stock
Houston, Texas (acquired 1-5-73 and
Specialty chemicals for plumbing, HVAC, 3-31-73) 52,600 87,500,000
electrical, construction, industrial,
oil field and automotive applications;
smoke containment systems for building
fires; owns 20% of Whitmore Manufacturing
Company.
- ------------------------------------------------------------------------------------------------------------------------------------
+Publicly-owned company ++Unrestricted securities as defined in Note (b)
Company Equity (a) Investment (b) Cost Value (c)
- ------------------------------------------------------------------------------------------------------------------------------------
+SPRINT NEXTEL CORPORATION <1% ++90,000 shares common stock
Westwood, Kansas (acquired 6-20-84) $ 503,645 $ 2,325,600
Diversified telecommunications company.
- ------------------------------------------------------------------------------------------------------------------------------------
TCI HOLDINGS, INC. - 21 shares 12% Series C
Denver, Colorado cumulative compounding preferred
Cable television systems and microwave stock (acquired 1-30-90) -- 677,250
- ------------------------------------------------------------------------------------------------------------------------------------
+TEXAS CAPITAL BANCSHARES, INC. 1.6% ++489,656 shares common stock
Dallas, Texas (acquired 5-1-00) 3,550,006 11,697,882
Regional bank holding company with banking
operations in six Texas cities.
- ------------------------------------------------------------------------------------------------------------------------------------
VIA HOLDINGS, INC. 28.8% 9,118 shares Series B preferred
Sparks, Nevada stock (acquired 9-19-05) 4,559,000 4,559,000
Designer, manufacturer and distributor of
high-quality office seating.
- ------------------------------------------------------------------------------------------------------------------------------------
WELLOGIX, INC. 19.6% 4,231,861 shares Series A-1
Houston, Texas convertible participating
Developer and supporter of software preferred stock, convertible
used by the oil and gas Industry to control into 4,231,861 shares of common
drilling and maintenance expenses. stock at $1.1815 per share
(acquired 8-19-05) 5,000,000 5,000,000
- ------------------------------------------------------------------------------------------------------------------------------------
THE WHITMORE MANUFACTURING COMPANY 80.0% 80 shares common stock
Rockwall, Texas (acquired 8-31-79) 1,600,000 22,000,000
Specialized mining, industrial and railroad
lubricants; coatings for automobiles and primary
metals; fluid contamination control devices.
- ------------------------------------------------------------------------------------------------------------------------------------
MISCELLANEOUS - Diamond State Ventures, L.P.
- 1.9% limited partnership
interest (acquired 10-12-99
thru 8-26-05) 210,000 210,000
- First Capital Group of Texas III,
L.P. - 3.3% limited partnership
interest (acquired 12-26-00 thru
8-12-05) 964,604 964,604
100.0% Humac Company - 1,041,000 shares
common stock (acquired 1-31-75
and 12-31-75) -- 152,000
- STARTech Seed Fund I - 12.1%
limited partnership interest
(acquired 4-17-98 thru 1-5-00) 178,066 1
- STARTech Seed Fund II - 3.2%
limited partnership interest
(acquired 4-28-00 thru 2-23-05) 1,000,000 1
- Sterling Group Partners I, L.P.
- 1.7% limited partnership
interest (acquired 4-20-01 thru
1-24-05) 1,064,042 1,064,042
- ------------------------------------------------------------------------------------------------------------------------------------
TOTAL INVESTMENTS $88,596,956 $550,428,083
=========== ============
- ------------------------------------------------------------------------------------------------------------------------------------
+Publicly-owned company ++Unrestricted securities as defined in Note (b)
Notes to Portfolio of Investments
(a) The percentages in the "Equity" column express the potential equity
interests held by Capital Southwest Corporation and Capital Southwest Venture
Corporation (together, the "Company") in each issuer. Each percentage represents
the amount of the issuer's common stock the Company owns or can acquire as a
percentage of the issuer's total outstanding common shares, plus shares reserved
for all warrants, convertible securities and employee stock options. The symbol
"<1%" indicates that the Company holds a potential equity interest of less than
one percent.
(b) Unrestricted securities (indicated by ++) are freely marketable securities
having readily available market quotations. All other securities are restricted
securities which are subject to one or more restrictions on resale and are not
freely marketable. At March 31, 2006, restricted securities represented
approximately 88.3% of the value of the consolidated investment portfolio.
(c) Under the valuation policy of the Company, unrestricted securities are
valued at the closing sale price for listed securities and at the lower of the
closing bid price or the last sale price for Nasdaq securities on the valuation
date. Restricted securities, including securities of publicly-owned companies
which are subject to restrictions on resale, are valued at fair value as
determined by the Board of Directors. Fair value is considered to be the amount
which the Company may reasonably expect to receive for portfolio securities if
such securities were sold on the valuation date. Valuations as of any particular
date, however, are not necessarily indicative of amounts which may ultimately be
realized as a result of future sales or other dispositions of securities.
Among the factors considered by the Board of Directors in determining the
fair value of restricted securities are the financial condition and operating
results of the issuer, the long-term potential of the business of the issuer,
the market for and recent sales prices of the issuer's securities, the values of
similar securities issued by companies in similar businesses, the proportion of
the issuer's securities owned by the Company, the nature and duration of resale
restrictions and the nature of any rights enabling the Company to require the
issuer to register restricted securities under applicable securities laws. In
determining the fair value of restricted securities, the Board of Directors
considers the inherent value of such securities without regard to the
restrictive feature and adjusts for any diminution in value resulting from
restrictions on resale.
(d) Agreements between certain issuers and the Company provide that the issuers
will bear substantially all costs in connection with the disposition of common
stocks, including those costs involved in registration under the Securities Act
of 1933 but excluding underwriting discounts and commissions. These agreements
cover common stocks owned at March 31, 2006 and common stocks which may be
acquired thereafter through exercise of warrants and conversion of debentures
and preferred stocks. They apply to restricted securities of all issuers in the
investment portfolio of the Company except securities of the following issuers,
which are not obligated to bear registration costs: Humac Company, Lifemark
Group and The Whitmore Manufacturing Company.
(e) The descriptions of the companies and ownership percentages shown in the
portfolio of investments were obtained from published reports and other sources
believed to be reliable, are supplemental and are not covered by the report of
independent auditors. Acquisition dates indicated are the dates specific
securities were acquired, which may differ from the original investment dates.
Certain securities were received in exchange for or upon conversion or exercise
of other securities previously acquired.
Portfolio Changes During the Year
New Investments and Additions to Previous Investments
Amount
-----------
All Components, Inc. ..................................... $ 500,000
Diamond State Ventures, L.P. ............................. 19,375
First Capital Group of Texas III, L.P. ................... 200,000
Hic-Star Corporation (formerly AmPro Mortgage Corporation) 723,923
PalletOne, Inc. .......................................... 45,746
PharmaFab, Inc. .......................................... 4,000,000
VIA Holdings, Inc. ....................................... 4,559,000
Wellogix, Inc. ........................................... 5,000,000
Miscellaneous ............................................ 6,697
-----------
$15,054,741
===========
Dispositions
Amount
Cost Received
----------- -----------
Cenveo, Inc. ....................................... $ 2,274,553 $15,833,234
Exopack Holding Corp. .............................. 623,790 2,054,880
Heeling, Inc. ...................................... 480,000 480,000
Organized Living, Inc. ............................. 6,000,000 --
Sterling Group Partners I, L.P...................... 284,366 1,241,751
Tekelec ............................................ 54,580 73,533
Texas Capital Bancshares, Inc....................... 725,000 2,327,408
Texas Shredder, Inc. ............................... 75,000 8,783,891
Miscellaneous ...................................... 6,697 7,855
----------- -----------
$10,523,986 $30,802,552
=========== ===========
Repayments Received ................................ $ 480,197
===========
Capital Southwest Corporation and Subsidiaries
Consolidated Statements of Financial Condition
March 31
---------------------------
Assets 2006 2005
------------ ------------
Investments at market or fair value
Companies more than 25% owned
(Cost: 2006 - $23,114,866,
2005 - $23,114,866) .......... $298,481,983 $259,628,981
Companies 5% to 25% owned
(Cost: 2006 - $18,595,746,
2005 - $19,050,000) .......... 92,070,852 44,890,852
Companies less than 5% owned
(Cost: 2006 - $46,886,344,
2005 - $42,381,532) .......... 159,875,248 117,502,389
------------ ------------
Total investments
(Cost: 2006 - $88,596,956,
2005 - $84,546,398) .......... 550,428,083 422,022,222
Cash and cash equivalents ......... 11,503,866 5,104,935
Receivables ....................... 135,887 136,401
Other assets ...................... 7,300,297 7,120,043
------------ ------------
Totals ......................... $569,368,133 $434,383,601
============ ============
March 31
------------------------------
Liabilities and Shareholders' Equity 2006 2005
------------- -------------
Note payable to bank ............................ $ 8,000,000 $ 8,000,000
Note payable to portfolio company ............... -- 5,000,000
Accrued interest and other liabilities .......... 1,697,086 1,842,587
Income taxes payable ............................ 982,653 --
Deferred income taxes ........................... 162,070,285 117,007,107
------------- -------------
Total liabilities ........... 172,750,024 131,849,694
------------- -------------
Shareholders' equity
Common stock, $1 par value: authorized,
5,000,000 shares; issued, 4,297,616
shares at March 31, 2006 and 4,294,416
shares at March 31, 2005 ................... 4,297,616 4,294,416
Additional capital ........................... 8,109,797 7,904,997
Undistributed net investment
income ..................................... 3,744,830 3,669,805
Undistributed net realized gain on
investments ................................ 86,432,040 73,316,166
Unrealized appreciation of investments -
net of deferred income taxes ............... 301,067,128 220,381,825
Treasury stock - at cost
(437,365 shares) ........................... (7,033,302) (7,033,302)
------------- -------------
Net assets at market or fair value, equivalent
to $102.74 per share at March 31, 2006 on
the 3,860,251 shares outstanding and
$78.44 per share at March 31, 2005 on the
3,857,051 shares outstanding ............... 396,618,109 302,533,907
------------- -------------
Totals ....................................... $ 569,368,133 $ 434,383,601
============= =============
See Notes to Consolidated Financial Statements
Capital Southwest Corporation and Subsidiaries
Consolidated Statements of Operations
Years Ended March 31
-----------------------------------------------
2006 2005 2004
------------- ------------- -------------
Investment income:
Interest .......................................................... $ 505,536 $ 437,753 $ 213,987
Dividends ......................................................... 3,485,430 3,778,190 3,860,937
Management and directors' fees .................................... 848,070 637,000 632,864
------------- ------------- -------------
4,839,036 4,852,943 4,707,788
------------- ------------- -------------
Operating expenses:
Salaries .......................................................... 1,211,584 1,132,510 997,079
Net pension benefit ............................................... (116,747) (254,872) (272,912)
Other operating expenses .......................................... 859,702 1,068,313 775,847
------------- ------------- -------------
1,954,539 1,945,951 1,500,014
------------- ------------- -------------
Income before interest expense and income taxes ...................... 2,884,497 2,906,992 3,207,774
Interest expense ..................................................... 436,021 420,351 531,068
------------- ------------- -------------
Income before income taxes ........................................... 2,448,476 2,486,641 2,676,706
Income tax expense ................................................... 59,220 80,693 89,646
------------- ------------- -------------
Net investment income ................................................ $ 2,389,256 $ 2,405,948 $ 2,587,060
============= ============= =============
Proceeds from disposition of investments ............................. $ 30,802,552 $ 4,565,232 $ 16,486,067
Cost of investments sold ............................................. 10,523,986 14,677,252 3,883,188
------------- ------------- -------------
Realized gain (loss) on investments before income taxes .............. 20,278,566 (10,112,020) 12,602,879
Income tax expense (benefit) ......................................... 7,162,692 (4,046,206) 4,411,007
------------- ------------- -------------
Net realized gain (loss) on investments .............................. 13,115,874 (6,065,814) 8,191,872
------------- ------------- -------------
Increase in unrealized appreciation of investments before income taxes 124,355,303 27,809,654 114,067,574
Increase in deferred income taxes on appreciation of investments ..... 43,670,000 9,925,000 39,379,000
------------- ------------- -------------
Net increase in unrealized appreciation of investments ............... 80,685,303 17,884,654 74,688,574
------------- ------------- -------------
Net realized and unrealized gain on investments ...................... $ 93,801,177 $ 11,818,840 $ 82,880,446
============= ============= =============
Increase in net assets from operations ............................... $ 96,190,433 $ 14,224,788 $ 85,467,506
============= ============= =============
See Notes to Consolidated Financial Statements
Capital Southwest Corporation and Subsidiaries
Consolidated Statements of Changes in Net Assets
Years Ended March 31
-----------------------------------------------
2006 2005 2004
------------- ------------- -------------
Operations
Net investment income ................................ $ 2,389,256 $ 2,405,948 $ 2,587,060
Net realized gain (loss) on investments .............. 13,115,874 (6,065,814) 8,191,872
Net increase in unrealized appreciation of investments 80,685,303 17,884,654 74,688,574
------------- ------------- -------------
Increase in net assets from operations ............... 96,190,433 14,224,788 85,467,506
Distributions from:
Undistributed net investment income .................. (2,314,231) (2,314,231) (2,308,631)
Capital share transactions
Exercise of employee stock options ................... 208,000 -- 997,500
------------- ------------- -------------
Increase in net assets ............................... 94,084,202 11,910,557 84,156,375
Net assets, beginning of year .......................... 302,533,907 290,623,350 206,466,975
------------- ------------- -------------
Net assets, end of year ................................ $ 396,618,109 $ 302,533,907 $ 290,623,350
============= ============= =============
See Notes to Consolidated Financial Statements
Capital Southwest Corporation and Subsidiaries
Consolidated Statements of Cash Flows
Years Ended March 31
--------------------------------------------
2006 2005 2004
------------ ------------ ------------
Cash flows from operating activities
Increase in net assets from operations ........................... $ 96,190,433 $ 14,224,788 $ 85,467,506
Adjustments to reconcile increase in net assets from operations
to net cash provided by operating activities:
Proceeds from disposition of investments .................... 30,802,552 4,510,652 16,486,067
Purchases of securities ..................................... (15,054,741) (2,280,690) (12,458,840)
Maturities of securities .................................... 480,197 394,269 2,754,845
Depreciation and amortization ............................... 16,136 17,597 19,089
Net pension benefit ......................................... (116,747) (254,872) (272,912)
Realized (gain) loss on investments before income taxes ..... (20,278,566) 10,112,020 (12,602,879)
Deferred taxes on realized (gain) loss on investments ....... 2,335,031 (4,046,206) 4,411,007
Net increase in unrealized appreciation of investments ...... (80,685,303) (17,884,654) (74,688,574)
(Increase) decrease in receivables .......................... 514 (59,924) 221,187
(Increase) decrease in other assets ......................... (3,226) (10,477) 5,023
Increase (decrease) in accrued interest and other liabilities (67,245) 121,196 41,701
Decrease in accrued pension cost ............................ (154,673) (164,129) (167,281)
Deferred income taxes ....................................... 40,800 88,800 95,600
------------ ------------ ------------
Net cash provided by operating activities ........................ 13,505,162 4,768,370 9,311,539
------------ ------------ ------------
Cash flows from financing activities
Decrease in note payable to bank ................................. -- (7,500,000) --
Decrease in notes payable to portfolio company ................... (5,000,000) -- (2,500,000)
Distributions from undistributed net investment income ........... (2,314,231) (2,314,231) (2,308,631)
Proceeds from exercise of employee stock options ................. 208,000 -- 997,500
------------ ------------ ------------
Net cash used in financing activities ............................ (7,106,231) (9,814,231) (3,811,131)
------------ ------------ ------------
Net increase (decrease) in cash and cash equivalents ............. 6,398,931 (5,045,861) 5,500,408
Cash and cash equivalents at beginning of year ................... 5,104,935 10,150,796 4,650,388
------------ ------------ ------------
Cash and cash equivalents at end of year ......................... $ 11,503,866 $ 5,104,935 $ 10,150,796
============ ============ ============
Supplemental disclosure of cash flow information:
Cash paid during the year for: Interest .......................... $ 436,920 $ 420,446 $ 531,194
Income taxes ...................... $ 4,846,081 $ -- $ --
See Notes to Consolidated Financial Statements
Notes to Consolidated Financial Statements
1. Summary of Significant Accounting Policies
Capital Southwest Corporation ("CSC") is a business development company
subject to regulation under the Investment Company Act of 1940. Capital
Southwest Venture Corporation ("CSVC"), a wholly-owned subsidiary of CSC, is a
Federal licensee under the Small Business Investment Act of 1958. Capital
Southwest Management Corporation ("CSMC"), a wholly-owned subsidiary of CSC, is
the management company for CSC and CSVC. The following is a summary of
significant accounting policies followed in the preparation of the consolidated
financial statements of CSC, CSVC and CSMC (together, the "Company"):
Principles of Consolidation. The consolidated financial statements have
been prepared in accordance with accounting principles generally accepted in the
United States of America for investment companies. Under rules and regulations
applicable to investment companies, we are precluded from consolidating any
entity other than another investment company. An exception to this general
principle occurs if the investment company has an investment in an operating
company that provides services to the investment company. Our consolidated
financial statements include our management company, CSMC.
Cash and Cash Equivalents. All temporary cash investments having a maturity
of three months or less when purchased are considered to be cash equivalents.
Investments. Investments are stated at market or fair value determined by
the Board of Directors as described in the Notes to Portfolio of Investments and
Note 2 below. The average cost method is used in determining cost of investments
sold. Investments are recorded on a trade date basis. Dividends are recognized
on the ex-dividend date and interest income is accrued daily.
Segment Information. The Company operates and manages its business in a
singular segment. As an investment company, the Company invests in portfolio
companies in various industries and geographic areas as presented in the
portfolio of investments.
Use of Estimates. The preparation of financial statements in conformity
with accounting principles generally accepted in the United States of America
requires management to make estimates and assumptions that affect the amounts
reported in the financial statements and accompanying notes. Actual results
could differ from those estimates.
Stock-Based Compensation. Effective April 1, 2003, the Company adopted the
fair value method of recording compensation expense related to all stock options
granted after March 31, 2003, in accordance with Financial Accounting Standards
("FASB") Statement Nos. 123 and 148. Accordingly, the fair value of stock
options as determined on the date of grant using the Black-Scholes pricing model
will be expensed over the vesting period of the related stock options. On July
19, 2004, 7,500 stock options were granted to a new investment associate who
resigned on December 31, 2004 with no options vested.
The following table illustrates the effect on net asset value and net asset
value per share if the Company had applied the fair value recognition provisions
of FASB Statement No. 123 to stock-based compensation for options granted prior
to the implementation of FASB Statement No. 123.
Years Ended March 31
------------------------------------------
2006 2005 2004
------------ ------------ ------------
Net asset value, as reported $396,618,109 $302,533,907 $290,623,350
Deduct: Total fair value computed
stock-based compensation 150,936 160,764 179,440
------------ ------------ ------------
Pro forma net asset value $396,467,173 $302,373,143 $290,443,910
============ ============ ============
Net asset value per share:
Basic - as reported $102.74 $78.44 $75.35
======= ====== ======
Basic - pro forma $102.71 $78.39 $75.30
======= ====== ======
Diluted - as reported $102.49 $78.38 $75.32
======= ====== ======
Diluted- pro forma $102.45 $78.34 $75.27
======= ====== ======
The diluted net asset value per share calculation assumes all vested
outstanding options for which the market price exceeds the exercise price have
been exercised.
In December 2004, the FASB issued SFAS No. 123 (revised 2004), Share-Based
Payment ("SFAS 123R)", which revises SFAS 123. SFAS 123R also supersedes APB 25
and amends SFAS No. 95, Statement of Cash Flows. SFAS 123R eliminates the
alternative to account for employee stock options under APB 25 and requires the
fair value of all share-based payments to employees, including the fair value of
grants of employee stock options, be recognized in the income statement,
generally over the vesting period.
In March 2005, the Securities and Exchange Commission issued Staff
Accounting Bulletin ("SAB") No. 107, which provides additional implementation
guidance for SFAS 123R. Among other things, SAB 107 provides guidance on
share-based payment valuations, income statement classification and
presentation, capitalization of costs and related income tax accounting.
SFAS 123R provides for adoption using either the modified prospective or
modified retrospective transition method. The Company will adopt SFAS 123R on
April 1, 2006 using the modified prospective transition method in which
compensation cost is recognized beginning April 1, 2006 for all share-based
payments granted on or after that date and for all awards granted to employees
prior to April 1, 2006 that remain unvested on that date. The Company will
continue to use the Black-Scholes pricing model to determine the fair value of
stock option awards.
The future impact of SFAS 123R on results of operations cannot be predicted
at this time because it will depend on levels of share-based payments granted.
However, had SFAS 123R been adopted in prior periods, the effect would have
approximated the SFAS 123 pro forma net asset value and net asset value per
share disclosures as shown above.
SFAS 123R also requires the benefits of tax deductions in excess of
recognized compensation cost to be reported as a financing cash flow, rather
than as an operating cash flow as currently required, thereby reducing net
operating cash flows and increasing net financing cash flows in periods after
adoption. Those amounts cannot be estimated for future periods (because they
depend on, among other things, when employees will exercise the stock options
and the market price of the Company's common stock at the time of exercise).
2. Valuation of Investments
The consolidated financial statements as of March 31, 2006 and 2005 include
securities valued at $485,924,522 (88.3% of the value of the consolidated
investment portfolio) and $364,732,932 (86.4% of the value of the consolidated
investment portfolio), respectively, whose values have been determined by the
Board of Directors in the absence of readily ascertainable market values.
Because of the inherent uncertainty of valuation, these values may differ
significantly from the values that would have been used had a ready market for
the securities existed, and the differences could be material.
3. Income Taxes
For the tax years ended December 31, 2005, 2004 and 2003, CSC and CSVC
qualified to be taxed as regulated investment companies ("RICs") under
applicable provisions of the Internal Revenue Code. As RICs, CSC and CSVC must
distribute at least 90% of their taxable net investment income (investment
company taxable income) and may either distribute or retain their taxable net
realized gain on investments (capital gains). Both CSC and CSVC intend to meet
the applicable qualifications to be taxed as RICs in future years; however,
either company's ability to meet certain portfolio diversification requirements
of RICs in future years may not be controllable by such company.
For the year ended December 31, 2005, CSC and CSVC had net investment
income for book and tax purposes of $2,314,231 and $574,794, respectively, all
of which has been distributed. During 2005, CSC and CSVC had a net capital gain
for book purposes of $12,625,800 and $6,958,957, respectively, and a net capital
gain for tax purposes of $16,783,112 and $6,958,957, respectively.
The aggregate cost of investments for federal income tax purposes as of
March 31, 2006 was $91,104,094. Such investments had unrealized appreciation of
$480,868,317 and unrealized depreciation of $19,037,190 for book purposes, or
net unrealized appreciation of $461,831,127. They had unrealized appreciation of
$478,614,873 and unrealized depreciation of $19,290,884 for tax purposes, or net
unrealized appreciation of $459,323,989 at March 31, 2006. The difference
between book basis and tax basis net unrealized appreciation is attributable
primarily to interest income that was accrued for tax purposes, but not for book
purposes.
CSC and CSVC may not qualify or elect to be taxed as RICs in future years.
Therefore, consolidated deferred Federal income taxes of $160,764,000 and
$117,094,000 have been provided on net unrealized appreciation of investments of
$461,831,127 and $337,475,824 at March 31, 2006 and 2005, respectively. Such
appreciation is not included in taxable income until realized. Deferred income
taxes on net unrealized appreciation of investments have been provided at the
then currently effective maximum Federal corporate tax rate on capital gains of
35% at March 31, 2006 and 2005.
4. Notes Payable
The note payable to bank at March 31, 2006 and 2005 was from an unsecured
revolving line of credit of $25,000,000 of which $8,000,000 had been drawn at
March 31, 2006 and 2005. The revolving line of credit bears interest at the
bank's base rate less .50% or LIBOR plus 1.25% and matures on August 31, 2007.
The note payable to portfolio company was a demand promissory note to
Lifemark Group (formerly Skylawn Corporation) with interest payable at the
greater of prime minus 2.0% or the Applicable Federal Rate established by the
Internal Revenue Service. Interest expense on this portfolio company note was
$32,329 in 2006 and $134,542 in 2005.
5. Employee Stock Option Plan
Under the 1984 Incentive Stock Option Plan, 28,000 options were exercised
in 2004. The 1984 Incentive Stock Option Plan expired in 1994.
On July 19, 1999, shareholders approved the 1999 Stock Option Plan
("Plan"), which provides for the granting of stock options to employees and
officers of the Company and authorizes the issuance of common stock upon the
exercise of such options for up to 140,000 shares of common stock. All options
are granted at or above market price and generally expire ten years from the
date of grant and are generally exercisable on or after the first anniversary of
the date of grant in five to ten annual installments.
At March 31, 2006, there were 91,500 shares available for grant under the
Plan. The per share weighted-average fair value of stock options granted during
2005 was $23.53 on the date of grant using the Black Scholes option-pricing
model with the following assumptions: expected dividend yield of .79%, risk-free
interest rate of 4.07%, expected volatility of 22.6%, and expected life of 7
years.
The following summarizes activity in the stock option plans for the years
ended March 31, 2006, 2005 and 2004:
Number Weighted Average
of shares Exercise Price
--------- --------------
Balance at April 1, 2003 82,500 $58.336
Granted -- --
Exercised (28,000) 35.625
Canceled -- --
------- -------
Balance at March 31, 2004 54,500 70.004
Granted 7,500 76.000
Exercised -- --
Canceled (13,500) 79.870
------- -------
Balance at March 31, 2005 48,500 68.186
Granted -- --
Exercised (3,200) 65.000
Canceled -- --
------- -------
Balance at March 31, 2006 45,300 $68.411
======= =======
At March 31, 2006, the range of exercise prices and weighted-average
remaining contractual life of outstanding options was $65.00 - $77.00 and 4.81
years, respectively.
At March 31, 2006, 2005 and 2004, the number of options exercisable was
29,500, 25,650 and 24,200, respectively and the weighted-average exercise price
of those options was $69.01, $68.98 and $73.24, respectively.
6. Employee Stock Ownership Plan
The Company and one of its wholly-owned portfolio companies sponsor a
qualified employee stock ownership plan ("ESOP") in which certain employees
participate. Contributions to the plan, which are invested in Company stock, are
made at the discretion of the Board of Directors. A participant's interest in
contributions to the ESOP fully vests after five years of active service. During
the three years ended March 31, 2006, the Company made contributions to the
ESOP, which were charged against net investment income, of $99,167 in 2006,
$93,588 in 2005 and $88,937 in 2004.
7. Retirement Plans
The Company sponsors a qualified defined benefit pension plan which covers
its employees and employees of certain of its wholly-owned portfolio companies.
The following information about the plan represents amounts and information
related to the Company's participation in the plan and is presented as though
the Company sponsored a single-employer plan. Benefits are based on years of
service and an average of the highest five consecutive years of compensation
during the last ten years of employment. The funding policy of the plan is to
contribute annual amounts that are currently deductible for tax reporting
purposes. No contribution was made to the plan during the three years ended
March 31, 2006.
The following tables set forth the qualified plan's benefit obligations and
fair value of plan assets at March 31, 2006, 2005 and 2004:
Years Ended March 31
--------------------------------------------
2006 2005 2004
------------ ------------ ------------
Change in benefit obligation
Benefit obligation at beginning
of year ........................ $ 3,833,411 $ 3,799,113 $ 3,676,599
Service cost ......................... 95,590 92,434 81,309
Interest cost ........................ 223,374 214,076 215,511
Actuarial loss ....................... 228,122 94,812 189,566
Benefits paid ........................ (376,480) (367,024) (363,872)
------------ ------------ ------------
Benefit obligation at end of year .... $ 4,004,017 $ 3,833,411 $ 3,799,113
============ ============ ============
Change in plan assets
Fair value of plan assets at beginning
of year ........................ $ 9,326,254 $ 10,030,763 $ 6,881,723
Actual return on plan assets ......... 2,690,919 (337,485) 3,512,912
Benefits paid ........................ (376,480) (367,024) (363,872)
------------ ------------ ------------
Fair value of plan assets at end of
year ............................ $ 11,640,693 $ 9,326,254 $ 10,030,763
============ ============ ============
The following table sets forth the qualified plan's funded status and
amounts recognized in the Company's consolidated statements of financial
condition:
March 31
--------------------------
2006 2005
----------- -----------
Actuarial present value of benefit obligations:
Accumulated benefit obligation ................ $(3,475,899) $(3,392,308)
=========== ===========
Projected benefit obligation for service rendered to
date .......................................... $(4,004,017) $(3,833,411)
Plan assets
at fair value* ................................ 11,640,693 9,326,254
----------- -----------
Excess of plan assets over
the projected benefit obligation .............. 7,636,676 5,492,843
Unrecognized net (gain) loss from past experience
different from that assumed and effects of
changes in assumptions ........................ (670,478) 1,272,655
Unrecognized prior service costs ................... 195,281 202,816
----------- -----------
Prepaid pension cost included in other assets ...... $ 7,161,479 $ 6,968,314
=========== ===========
- --------------------
*Primarily equities and bonds including approximately 28,000 shares of common
stock of the Company.
Components of net pension benefit related to the qualified plan include the
following:
Years Ended March 31
-----------------------------------
2006 2005 2004
--------- --------- ---------
Service cost - benefits earned during
the year ......................... $ 95,590 $ 92,434 $ 81,309
Interest cost on projected benefit
obligation ....................... 223,374 214,076 215,511
Expected return on assets ............. (551,026) (564,627) (576,020)
Net amortization and deferral ......... 38,897 (66,280) (66,296)
--------- --------- ---------
Net pension benefit from qualified plan $(193,165) $(324,397) $(345,496)
========= ========= =========
The Company also sponsors an unfunded Retirement Restoration Plan, which is
a nonqualified plan that provides for the payment, upon retirement, of the
difference between the maximum annual payment permissible under the qualified
retirement plan pursuant to Federal limitations and the amount which would
otherwise have been payable under the qualified plan.
The following table sets forth the Retirement Restoration Plan's benefit
obligations at March 31, 2006, 2005 and 2004:
Years Ended March 31
--------------------------------------
2006 2005 2004
---------- ---------- ----------
Change in benefit obligation
Benefit obligation at beginning
of year ................... $1,302,368 $1,414,091 $1,353,386
Service cost .................... 19,094 10,380 5,464
Interest cost ................... 72,886 74,711 82,683
Actuarial (gain) loss ........... 40,867 (32,685) 139,839
Benefits paid ................... (154,673) (164,129) (167,281)
---------- ---------- ----------
Benefit obligation at end of year $1,280,542 $1,302,368 $1,414,091
========== ========== ==========
The following table sets forth the status of the Retirement Restoration
Plan and the amounts recognized in the consolidated statements of financial
condition:
March 31
--------------------------
2006 2005
----------- -----------
Projected benefit obligation ..................... $(1,280,542) $(1,302,368)
Unrecognized net loss from past ex-
perience different from that assumed
and effects of changes in assumptions........ 93,049 52,182
Unrecognized prior service costs ................. (239,573) (255,136)
----------- -----------
Accrued pension cost included in other liabilities $(1,427,066) $(1,505,322)
=========== ===========
The Retirement Restoration Plan expenses recognized during the years ended
March 31, 2006, 2005 and 2004 of $76,417, $69,528 and $72,584, respectively, are
offset against the net pension benefit from the qualified plan.
The following assumptions were used in estimating the actuarial present
value of the projected benefit obligations:
Years Ended March 31
--------------------------------
2006 2005 2004
-------- -------- --------
Discount rate ...................... 5.75% 5.75% 5.75%
Rate of compensation increases...... 5.0% 5.0% 5.0%
The following assumptions were used in estimating the net periodic
(income)/expense:
Years Ended March 31
--------------------------------
2006 2005 2004
-------- -------- --------
Discount rate....................... 5.75% 5.75% 6.0%
Expected return on plan assets...... 6.0% 6.0% 6.0%
Rate of compensation increases...... 5.0% 5.0% 5.0%
The expected rate of return on assets assumption was determined based on
the anticipated performance of the various asset classes in the plan's portfolio
and the allocation of assets to each class. The anticipated asset class return
is developed using historical and predicted asset return performance,
considering the investments underlying each asset class and expected investment
performance based on forecasts of inflation, interest rates and market indices
for fixed income and equity securities.
The Company's pension plan asset allocations are as follows:
Percentage of plan assets
at March 31
-------------------------
Asset Category 2006 2005
- ----------------- -------- --------
Equity securities......... 83.6% 78.6%
Debt securities........... 12.9% 16.2%
Cash ..................... 3.5% 5.2%
------ ------
100.0% 100.0%
====== ======
The Company's pension plan is administered by a board-appointed committee
that has fiduciary responsibility for the plan's management. The trustee of the
plan is JPMorgan Asset Management. Currently approximately 20% of the assets are
selected and managed by the trustee and the remainder of the assets are managed
by the committee, invested mostly in equity securities, including the Company's
stock.
Following are the expected benefit payments for the next five years and in
the aggregate for the years 2012-2016:
Years Ended March 31
---------------------------------------------------
2012-
(In Thousands) 2007 2008 2009 2010 2011 2016
------ ------ ------ ------ ------ ------
$ 352 $ 334 $ 316 $ 296 $ 276 $1,132
8. Commitments
The Company has agreed, subject to certain conditions, to invest up to
$1,191,154 in three portfolio companies.
The Company leases office space under an operating lease which requires
base annual rentals of approximately $80,000 through February, 2008. For the
three years ended March 31, total rental expense charged to investment income
was $76,877 in 2006, $75,248 in 2005 and $74,122 in 2004.
9. Sources of Income
Income was derived from the following sources:
Investment Income Realized Gain
Years Ended --------------------------------- (Loss) on
March 31 Investments
- -------- Other Before Income
2006 Interest Dividends Income Taxes
- ---- --------------------------------- -------------
Companies more than
25% owned ......... $ -- $2,926,964 $642,500 $ --
Companies 5% to 25%
owned ............. (55,236) 188,233 10,000 --
Companies less than
5% owned .......... 302,622 370,233 195,570 20,278,566
Other sources,
including temporary
investments ....... 258,150 -- -- --
--------------------------------------------------
$505,536 $3,485,430 $848,070 $ 20,278,566
==================================================
2005
- ----
Companies more than
25% owned ......... $ -- $3,361,345 $637,000 $ --
Companies 5% to 25%
owned ............. 55,236 80,858 -- (12,097,124)
Companies less than
5% owned .......... 346,396 335,987 -- 1,985,104
Other sources,
including temporary
investments ....... 36,121 -- -- --
--------------------------------------------------
$437,753 $3,778,190 $637,000 $ (10,112,020)
==================================================
Investment Income Realized Gain
Years Ended --------------------------------- (Loss) on
March 31 Investments
- -------- Other Before Income
2004 Interest Dividends Income Taxes
- ---- --------------------------------- -------------
Companies more than
25% owned ......... $ -- $3,577,800 $629,000 $ --
Companies 5% to 25
owned ............. -- -- 3,864 (188,900)
Companies less than
5% owned .......... 203,304 283,137 -- 12,791,779
Other sources,
including temporary
investments ....... 10,683 -- -- --
--------------------------------------------------
$213,987 $3,860,937 $632,864 $ 12,602,879
==================================================
Selected Per Share Data and Ratios
Years Ended March
-------------------------------------------------------------
Per Share Data 2006 2005 2004 2003 2002
-------------------------------------------------------------
Investment income .............................................. $ 1.25 $ 1.26 $ 1.22 $ 1.06 $ 1.08
Operating expenses ............................................. (.51) (.51) (.39) (.30) (.27)
Interest expense ............................................... (.11) (.11) (.14) (.12) (.24)
Income taxes ................................................... (.01) (.02) (.02) (.04) (.04)
-------------------------------------------------------------
Net investment income .......................................... .62 .62 .67 .60 .53
Distributions from undistributed net investment income ......... (.60) (.60) (.60) (.60) (.60)
Net realized gain (loss) on investments ........................ 3.40 (1.57) 2.13 .35 (.14)
Net increase (decrease) in unrealized appreciation of
investments after deferred taxes ........................... 20.90 4.64 19.37 (11.85) 6.31
Exercise of employee stock options* ............................ (.02) -- (.14) -- (.08)
-------------------------------------------------------------
Increase (decrease) in net asset value ......................... 24.30 3.09 21.43 (11.50) 6.02
Net asset value
Beginning of year ............................................ 78.44 75.35 53.92 65.42 59.40
-------------------------------------------------------------
End of year .................................................. $ 102.74 $ 78.44 $ 75.35 $ 53.92 $ 65.42
=============================================================
Increase (decrease) in deferred taxes on unrealized appreciation $ 11.29 $ 2.57 $ 10.09 $ (6.35) $ 3.26
Deferred taxes on unrealized appreciation:
Beginning of year ............................................ 30.36 27.79 17.70 24.05 20.79
-------------------------------------------------------------
End of year .................................................. $ 41.65 $ 30.36 $ 27.79 $ 17.70 $ 24.05
=============================================================
Ratios and Supplemental Data
Ratio of operating expenses to average net assets .............. .58% .67% .63% .52% .42%
Ratio of operating expenses to average net assets plus average
deferred taxes on unrealized appreciation .................. .42% .49% .47% .39% .31%
Ratio of net investment income to average net assets ........... .71% .83% 1.09% 1.04% .85%
Portfolio turnover rate ........................................ 2.36% .56% 3.74% 1.53%
1.05%
Net asset value total return ................................... 33.69% 4.90% 41.16% (16.75)% 11.18%
Shares outstanding at end of period (000s omitted) ............. 3,860 3,857 3,857 3,829 3,829
- ------------
* Net decrease is due to the exercise of employee stock options at prices less
than beginning of period net asset value.
Management's Report on Internal Control Over Financial Reporting
Management is responsible for establishing and maintaining adequate
internal control over financial reporting, as such term is defined in Rules
13a-15(f) and 15d-15(f) under the Securities Exchange Act of 1934. The Company's
internal control over financial reporting is designed to provide reasonable
assurance regarding the reliability of financial reporting and the preparation
of financial statements for external purposes in accordance with accounting
principles generally accepted in the United States.
Because of its inherent limitations, internal controls over financial
reporting may not prevent or detect misstatements. Also, projections of any
evaluation of effectiveness to future periods are subject to risk that controls
may become inadequate because of changes in conditions, or that the degree of
compliance with the policies or procedures may deteriorate.
The Company has assessed the effectiveness of its internal control over
financial reporting as of March 31, 2006. In making this assessment, it used the
criteria described in "Internal Control-Integrated Framework" issued by the
Committee of Sponsoring Organizations of the Treadway Commission (COSO). Based
on this assessment, management believes that, as of March 31, 2006, the
Company's internal control over financial reporting was effective.
Grant Thornton LLP has issued its attestation report on management's
assessment and on the effectiveness of the Company's internal control over
financial reporting. That report appears on the next page.
Date: May 24, 2006
/s/ William R. Thomas
- ---------------------
William R. Thomas
President & Chairman of the Board
/s/ Susan K. Hodgson
- ---------------------
Susan K. Hodgson
Secretary-Treasurer
(chief financial/accounting officer)
To the Board of Directors and Shareholders of
Capital Southwest Corporation
We have audited management's assessment, included in Management's Report on
Internal Control Over Financial Reporting, that Capital Southwest Corporation
and subsidiaries (the "Company") maintained effective internal control over
financial reporting as of March 31, 2006, based on criteria established in
Internal Control-Integrated Framework issued by the Committee of Sponsoring
Organizations of the Treadway Commission (COSO). The Company's management is
responsible for maintaining effective internal control over financial reporting
and for its assessment of the effectiveness of internal control over financial
reporting. Our responsibility is to express an opinion on management's
assessment and an opinion on the effectiveness of the Company's internal control
over financial reporting based on our audit.
We conducted our audit in accordance with the standards of the Public
Company Accounting Oversight Board (United States). Those standards require that
we plan and perform the audit to obtain reasonable assurance about whether
effective internal control over financial reporting was maintained in all
material respects. Our audit included obtaining an understanding of internal
control over financial reporting, evaluating management's assessment, testing
and evaluating the design and operating effectiveness of internal control, and
performing such other procedures as we considered necessary in the
circumstances. We believe that our audit provides a reasonable basis for our
opinions.
A company's internal control over financial reporting is a process designed
to provide reasonable assurance regarding the reliability of financial reporting
and the preparation of financial statements for external purposes in accordance
with generally accepted accounting principles. A company's internal control over
financial reporting includes those policies and procedures that (1) pertain to
the maintenance of records that, in reasonable detail, accurately and fairly
reflect the transactions and dispositions of the assets of the company; (2)
provide reasonable assurance that transactions are recorded as necessary to
permit preparation of financial statements in accordance with generally accepted
accounting principles, and that receipts and expenditures of the company are
being made only in accordance with authorizations of management and directors of
the company; and (3) provide reasonable assurance regarding prevention or timely
detection of unauthorized acquisition, use, or disposition of the company's
assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial
reporting may not prevent or detect misstatements. Also, projections of any
evaluation of effectiveness to future periods are subject to the risk that
controls may become inadequate because of changes in conditions, or that the
degree of compliance with the policies or procedures may deteriorate.
In our opinion, management's assessment that Capital Southwest Corporation
and subsidiaries maintained effective internal control over financial reporting
as of March 31, 2006, is fairly stated, in all material respects, based on
criteria established in Internal Control-Integrated Framework issued by the
Committee of Sponsoring Organizations of the Treadway Commission (COSO). Also,
in our opinion, Capital Southwest Corporation and subsidiaries maintained, in
all material respects, effective internal control over financial reporting as of
March 31, 2006, based on criteria established in Internal Control-Integrated
Framework issued by the Committee of Sponsoring Organizations of the Treadway
Commission (COSO).
We have also audited, in accordance with the standards of the Public
Company Accounting Oversight Board (United States), the consolidated statements
of financial condition of Capital Southwest Corporation and subsidiaries as of
March 31, 2006 and 2005, including the portfolio of investments as of March 31,
2006, on pages 12-17, and the related statements of operations, changes in net
assets, and cash flows, and the selected per share data and ratios on page 29
for each of the two years in the period ended March 31, 2006, and our report
dated May 26, 2006 expressed an unqualified opinion on those financial
statements and per share data and ratios.
/s/Grant Thornton LLP
Dallas, Texas
May 26, 2006
Report of Independent Registered Public Accounting Firm
To the Board of Directors and Shareholders of
Capital Southwest Corporation
We have audited the accompanying consolidated statements of financial
condition of Capital Southwest Corporation (a Texas Corporation) and
subsidiaries as of March 31, 2006 and 2005, including the portfolio of
investments as of March 31, 2006, on pages 12-17, and the related consolidated
statements of operations, changes in net assets, and cash flows, and the
selected per share data and ratios on page 29, for each of the two years in the
period ended March 31, 2006. These financial statements and per share data and
ratios are the responsibility of the Company's management. Our responsibility is
to express an opinion on these financial statements and per share data and
ratios based on our audits.
We conducted our audits in accordance with the standards of the Public
Company Accounting Oversight Board (United States). Those standards require that
we plan and perform the audit to obtain reasonable assurance about whether the
financial statements are free of material misstatement. An audit includes
examining, on a test basis, evidence supporting the amounts and disclosures in
the financial statements. Our procedures included verification by examination of
securities held by the custodian as of March 31, 2006 and 2005, and confirmation
of securities not held by the custodian by correspondence with others. An audit
also includes assessing the accounting principles used and significant estimates
made by management, as well as evaluating the overall financial statement
presentation. We believe that our audits provide a reasonable basis for our
opinion.
In our opinion, the consolidated financial statements and the selected per
share data and ratios referred to above present fairly, in all material re-
spects, the consolidated financial position of Capital Southwest Corporation and
subsidiaries as of March 31, 2006 and 2005, and the consolidated results of
operations, changes in net assets, and cash flows, and the selected per share
data and ratios for the years then ended, in conformity with accounting
principles generally accepted in the United States of America.
We have also audited, in accordance with the standards of the Public
Company Accounting Oversight Board (United States), the effectiveness of Capital
Southwest Corporation and subsidiaries' internal control over financial
reporting as of March 31, 2006 and 2005, based on criteria established in
Internal Control-Integrated Framework issued by the Committee of Sponsoring
Organizations of the Treadway Commission (COSO), and our accompanying report
dated May 26, 2006 expressed an unqualified opinion on management's assessment
of, and the effective operation of Capital Southwest Corporation and
subsidiaries' internal control over financial reporting.
/S/GRANT THORNTON LLP
Dallas, Texas
May 26, 2006
Report of Independent Registered Public Accounting Firm
The Board of Directors and Shareholders
Capital Southwest Corporation:
We have audited the accompanying consolidated statements of operations,
changes in net assets, and cash flows of Capital Southwest Corporation and
subsidiaries for the year ended March 31, 2004, and the selected per share data
and ratios for the year then ended. These financial statements and per share
data and ratios are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements and per
share data and ratios based on our audit.
We conducted our audit in accordance with the standards of the Public
Company Accounting Oversight Board (United States). Those standards require that
we plan and perform the audit to obtain reasonable assurance about whether the
financial statements are free of material misstatement. An audit includes
examining, on a test basis, evidence supporting the amounts and disclosures in
the financial statements. Our procedures included verification by examination of
securities held by the custodian as of March 31, 2004 and confirmation of
securities not held by the custodian by correspondence with others. An audit
also includes assessing the accounting principles used and significant estimates
made by management, as well as evaluating the overall financial statement
presentation. We believe that our audit provides a reasonable basis for our
opinion.
In our opinion, the consolidated financial statements and selected per
share data and ratios referred to above present fairly, in all material
respects, the consolidated results of operations, and the changes in net assets
and cash flows for the year ended March 31, 2004, and the selected per share
data and ratios for the year then ended, of Capital Southwest Corporation and
subsidiaries in conformity with U.S. generally accepted accounting principles.
ERNST & YOUNG LLP
Dallas, Texas
May 12, 2004
Management's Discussion and Analysis of
Financial Condition and Results of Operations
Results of Operations
The composite measure of the Company's financial performance in the
Consolidated Statements of Operations is captioned "Increase in net assets from
operations" and consists of three elements. The first is "Net investment
income", which is the difference between the Company's income from interest,
dividends and fees and its combined operating and interest expenses, net of
applicable income taxes. The second element is "Net realized gain (loss) on
investments", which is the difference between the proceeds received from
disposition of portfolio securities and their stated cost, net of applicable
income tax expense or benefit. The third element is the "Net increase in
unrealized appreciation of investments", which is the net change in the market
or fair value of the Company's investment portfolio, compared with stated cost,
net of an increase in deferred income taxes which would become payable if the
unrealized appreciation were realized through the sale or other disposition of
the investment portfolio. It should be noted that the "Net realized gain (loss)
on investments" and "Net increase in unrealized appreciation of investments" 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.
Net Investment Income
The Company's principal objective is to achieve capital appreciation.
Therefore, a significant portion of the investment portfolio is structured to
maximize the potential return from equity participation and provides minimal
current yield in the form of interest or dividends. The Company also earns
interest income from the short-term investment of cash funds, and the annual
amount of such income varies based upon the average level of funds invested
during the year and fluctuations in short-term interest rates. During the three
years ended March 31, the Company had interest income from temporary cash
investments of $257,374 in 2006, $35,048 in 2005 and $10,247 in 2004. The
Company also receives management fees primarily from its wholly-owned portfolio
companies which aggregated $792,570 in 2006 and $597,000 in 2005 and 2004.
During the three years ended March 31, 2006, the Company recorded dividend
income from the following sources:
Years Ended March 31
------------------------------------
2006 2005 2004
---------- ---------- ----------
Alamo Group Inc. ................... $ 677,112 $ 677,112 $ 677,112
Balco, Inc. ........................ 252,960 252,960 252,960
Dennis Tool Company ................ 49,999 25,000 49,999
Kimberly-Clark Corporation ......... 142,011 127,347 109,596
Lifemark Group ..................... 600,000 600,000 950,000
PalletOne, Inc. .................... 179,685 80,858 --
The RectorSeal Corporation ......... 1,106,893 960,000 1,407,729
Sprint Nextel Corporation .......... 18,000 45,000 36,000
TCI Holdings, Inc. ................. 81,270 81,270 81,270
The Whitmore Manufacturing Company 240,000 846,273 240,000
Other .............................. 137,500 82,370 56,271
---------- ---------- ----------
$3,485,430 $3,778,190 $3,860,937
========== ========== ==========
Total operating expenses, excluding interest expense, increased by $445,937
or 29.7% during the year ended March 31, 2005. Due to the nature of its
business, the majority of the Company's operating expenses are related to
employee and director compensation, office expenses, legal and accounting fees
and the net pension benefit. Interest expense decreased by $110,717 during the
year ended March 31, 2005 primarily due to a decrease in notes payable.
Net Realized Gain (Loss) on Investments
Net realized gain on investments was $13,115,874 (after income tax expense
of $7,162,692) during the year ended March 31, 2006, compared with a loss of
$6,065,814 (after income tax benefit of $4,046,206) during 2005 and a gain of
$8,191,872 (after income tax expense of $4,411,007) during 2004. Management does
not attempt to maintain a comparable level of realized gains from year to year,
but instead attempts to maximize total investment portfolio appreciation. This
strategy often dictates the long-term holding of portfolio securities in pursuit
of increased values and increased unrealized appreciation, but may at opportune
times dictate realizing gains or losses through the disposition of certain
portfolio investments.
Net Increase in Unrealized Appreciation of Investments
For the three years ended March 31, the Company recorded an increase in
unrealized appreciation of investments before income taxes of $124,355,303,
$27,809,654 and $114,067,574 in 2006, 2005 and 2004, respectively. As explained
in the first paragraph of this discussion and analysis, the realization of gains
or losses results in a corresponding decrease or increase in unrealized
appreciation of investments. Set forth in the following table are the
significant increases and decreases in unrealized appreciation (before the
related change in deferred income taxes and excluding the effect of gains or
losses realized during the year) by portfolio company for securities held at the
end of each year.
Years Ended March 31
--------------------------------------------
2006 2005 2004
------------ ------------ ------------
Alamo Group Inc. ......... $ (5,642,000) $ 19,749,000 $ 8,464,000
Encore Wire Corporation .. 49,041,000 (27,245,000) 46,316,000
Heeling, Inc. ............ 27,000,000 1,400,000 1,480,000
Hologic, Inc. ............ 12,472,883 1,836,760 1,833,596
Media Recovery, Inc. ..... 15,744,000 9,256,000 7,000,000
Palm Harbor Homes, Inc. .. 27,493,000 (15,710,000) 15,710,000
The RectorSeal Corporation 15,000,000 12,500,000 5,000,000
As shown in the above table, the three investments achieving the largest
increases in value during the year ended March 31, 2006 were Encore Wire
Corporation, Palm Harbor Homes, Inc. and Heeling, Inc. The major increase in
Encore's value was attributable to significant increases in gross profit margins
as copper prices soared to record levels. The increase in Palm Harbor's value
reflected the improved condition of the markets for manufactured housing and
modular homes. The other major increase in value was experienced by Heeling,
Inc. as sales of its Heelys skate shoes doubled in 2005 and its order backlog
reached a record high level.
A description of the investments listed above and other material components
of the investment portfolio is included elsewhere in this report under the
caption "Portfolio of Investments - March 31, 2006."
Deferred Taxes on Unrealized Appreciation of Investments
The Company provides for deferred Federal income taxes on net unrealized
appreciation of investments. Such taxes would become payable at such time as
unrealized appreciation is realized through the sale or other disposition of
those components of the investment portfolio which would result in taxable
transactions. At March 31, 2006 consolidated deferred Federal income taxes of
$160,764,000 were provided on net unrealized appreciation of investments of
$461,831,127 compared with deferred taxes of $117,094,000 on net unrealized
appreciation of $337,475,824 at March 31, 2005. Deferred income taxes at March
31, 2006 and 2005 were provided at the then currently effective maximum Federal
corporate tax rate on capital gains of 35%.
Portfolio Investments
During the year ended March 31, 2006, the Company invested $15,054,741 in
various portfolio securities listed elsewhere in this report under the caption
"Portfolio Changes During the Year," which also lists dispositions of portfolio
securities. During the 2005 and 2004 fiscal years, the Company invested a total
of $2,280,690 and $12,458,840, respectively.
Financial Liquidity and Capital Resources
At March 31, 2006, the Company had cash and cash equivalents of
approximately $11.5 million. Pursuant to Small Business Administration ("SBA")
regulations, cash and cash equivalents of $0.3 million held by CSVC may not be
transferred or advanced to CSC without the consent of the SBA. Under current SBA
regulations and subject to SBA's approval of its credit application, CSVC would
be entitled to borrow up to $72.0 million. The Company also has an unsecured
$25.0 million revolving line of credit from a commercial bank, of which $17.0
million was available at March 31, 2006. With the exception of a capital gain
distribution made in the form of a distribution of the stock of a portfolio
company in the fiscal year ended March 31, 1996, the Company has elected to
retain all gains realized during the past 38 years. Retention of future gains is
viewed as an important source of funds to sustain the Company's investment
activity. Approximately $64.5 million of the Company's investment portfolio is
represented by unrestricted publicly-traded securities and represent a source of
liquidity.
Funds to be used by the Company for operating or investment purposes may be
transferred in the form of dividends, management fees or loans from Lifemark
Group (formerly Skylawn Corporation), The RectorSeal Corporation and The
Whitmore Manufacturing Company, wholly-owned portfolio companies of the Company,
to the extent of their available cash reserves and borrowing capacities.
Management believes that the Company's cash and cash equivalents and cash
available from other sources described above are adequate to meet its expected
requirements. Consistent with the long-term strategy of the Company, the
disposition of investments from time to time may also be an important source of
funds for future investment activities.
Contractual Obligations
As shown below, the Company had the following contractual obligations as of
March 31, 2006. For further information see Note 4 and Note 8 of the
Consolidated Financial Statements.
Payments Due By Period ($ in Thousands)
---------------------------------------
Less than More Than
Contractual Obligations Total 1 Year 1-3 Years 3-5 Years 5 Years
- -----------------------------------------------------------------------------------
Long-term debt obligations $8,000 -- $8,000 -- --
Capital lease obligations -- -- -- -- --
Operating lease obligations 80 -- $ 80 -- --
Purchase obligations -- -- -- -- --
Other long-term liabilities
reflected on the Company's
balance sheet under GAAP -- -- -- -- --
---------------------------------------------------
Total $8,080 -- $8,080 -- --
---------------------------------------------------
Critical Accounting Policies
Valuation of Investments
In accordance with the Investment Company Act of 1940, investments in
unrestricted securities (freely marketable securities having readily available
market quotations) are valued at market and investments in restricted securities
(securities subject to one or more resale restrictions) are valued at fair value
determined in good faith by the Company's Board of Directors. Under the
valuation policy of the Company, unrestricted securities are valued at the
closing sale price for listed securities and at the lower of the closing bid
price or the last sale price for Nasdaq securities on the valuation date.
Restricted securities, including securities of publicly-owned companies which
are subject to restrictions on resale, are valued at fair value, which is
considered to be the amount the Company may reasonably expect to receive if such
securities were sold on the valuation date. Valuations as of any particular
date, however, are not necessarily indicative of amounts which may ultimately be
realized as a result of future sales or other dispositions of securities.
Among the factors considered by the Board of Directors in determining the
fair value of restricted securities are the financial condition and operating
results of the issuer, the long-term potential of the business of the issuer,
the market for and recent sales prices of the issuer's securities, the values of
similar securities issued by companies in similar businesses, the proportion of
the issuer's securities owned by the Company, the nature and duration of resale
restrictions and the nature of any rights enabling the Company to require the
issuer to register restricted securities under applicable securities laws.
Deferred Income Taxes
In future years, the Company may not qualify or elect to be taxed as a
regulated investment company ("RIC") under applicable provisions of the Internal
Revenue Code. Therefore, deferred Federal income taxes have been provided on net
unrealized appreciation of investments at the then currently effective corporate
tax rate on capital gains.
Impact of Inflation
The Company does not believe that its business is materially affected by
inflation, other than the impact which inflation may have on the securities
markets, the valuations of business enterprises and the relationship of such
valuations to underlying earnings, all of which will influence the value of the
Company's investments.
Risks
Pursuant to Section 64(b)(1) of the Investment Company Act of 1940, a
business development company is required to describe the risk factors involved
in an investment in the securities of such company due to the nature of the
company's investment portfolio. Accordingly the Company states that:
The Company's objective is to achieve capital appreciation through
investments in businesses believed to have favorable growth potential. Such
businesses are often undercapitalized small companies which lack management
depth and have not yet attained profitability. The Company's venture investments
often include securities which do not yield interest or dividends and are
subject to legal or contractual restrictions on resale, which restrictions
adversely affect the liquidity and marketability of such securities.
Because of the speculative nature of the Company's investments and the lack
of any market for the securities initially purchased by the Company, there is a
significantly greater risk of loss than is the case with traditional investment
securities. The high-risk, long-term nature of the Company's venture investment
activities may prevent shareholders of the Company from achieving price
appreciation and dividend distributions.
Selected Consolidated Financial Data
(all figures in thousands except per share data)
1996 1997 1998 1999 2000 2001
- -------------------------------------------------------------------------------------------------------------------
Financial Position (as of March 31)
Investments at cost ........................ $ 58,544 $ 59,908 $ 61,154 $ 73,580 $ 85,002 $ 87,602
Unrealized appreciation .................... 198,386 233,383 340,132 276,698 238,627 228,316
-------- -------- -------- -------- -------- --------
Investments at market or
fair value .............................. 256,930 293,291 401,286 350,278 323,629 315,918
Total assets ............................... 326,972 310,760 522,324 360,786 392,586 322,668
Notes payable * ............................ 11,000 5,000 5,000 5,000 10,000 16,000
Deferred taxes on
unrealized appreciation ................. 69,121 81,313 118,674 96,473 83,151 79,310
Net assets ................................. 189,048 218,972 296,023 256,232 236,876 226,609
Shares outstanding ......................... 3,767 3,767 3,788 3,815 3,815 3,815
- -------------------------------------------------------------------------------------------------------------------
Changes in Net Assets (years ended March 31)
Net investment income ...................... $ 2,855 $ 2,574 $ 2,726 $ 1,762 $ 1,663 $ 1,723
Net realized gain (loss) on
investments ............................. 11,174 6,806 6,485 995 6,020 (3,231)
Net increase (decrease) in
unrealized appreciation
before distributions .................... 38,746 22,804 69,388 (41,233) (24,750) (6,470)
-------- -------- -------- -------- -------- --------
Increase (decrease) in net
assets from operations
before distributions .................... 52,775 32,184 78,599 (38,476) (17,067) (7,978)
Cash dividends paid ........................ (2,270) (2,260) (2,268) (2,280) (2,289) (2,289)
Securities distributed ..................... (9,402) -- -- -- -- --
Employee stock options
exercised ............................... 575 -- 720 965 -- --
-------- -------- -------- -------- -------- --------
Increase (decrease) in net assets .......... 41,678 29,924 77,051 (39,791) (19,356) (10,267)
- -------------------------------------------------------------------------------------------------------------------
Per Share Data (as of March 31)
Deferred taxes on
unrealized appreciation ................. $ 18.35 $ 21.59 $ 31.33 $ 25.29 $ 21.80 $ 20.79
Net assets ................................. 50.18 58.13 78.15 67.16 62.09 59.40
Closing market price ....................... 60.00 67.875 94.00 73.00 54.75 65.00
Cash dividends paid ........................ .60 .60 .60 .60 .60 .60
Securities distributed ..................... 2.50 -- -- -- -- --
o Excludes quarter-end borrowing which is repaid on the first business day after
year end.
Selected Consolidated Financial Data (continued)
(all figures in thousands except per share data)
2002 2003 2004 2005 2006
- -------------------------------------------------------------------------------------------------------
Financial Position (as of March 31)
Investments at cost ........................ $ 82,194 $ 91,462 $ 97,283 $ 84,546 $ 88,597
Unrealized appreciation .................... 265,287 195,598 309,666 337,476 461,831
-------- -------- -------- -------- --------
Investments at market or
fair value .............................. 347,481 287,060 406,949 422,022 550,428
Total assets ............................... 357,183 298,490 423,979 434,384 569,368
Notes payable * ............................ 14,000 23,000 20,500 13,000 8,000
Deferred taxes on
unrealized appreciation ................. 92,107 67,790 107,169 117,094 160,764
Net assets ................................. 250,491 206,467 290,623 302,534 396,618
Shares outstanding ......................... 3,829 3,829 3,857 3,857 3,860
- -------------------------------------------------------------------------------------------------------
Changes in Net Assets (years ended March 31)
Net investment income ...................... $ 2,042 $ 2,299 $ 2,587 $ 2,406 2,389
Net realized gain (loss) on
investments ............................. (538) 1,346 8,192 (6,066) 13,116
Net increase (decrease) in
unrealized appreciation
before distributions .................... 24,174 (45,372) 74,689 17,885 80,685
-------- -------- -------- -------- --------
Increase (decrease) in net
assets from operations
before distributions .................... 25,678 (41,727) 85,468 14,225 96,190
Cash dividends paid ........................ (2,295) (2,297) (2,309) (2,314) (2,314)
Securities distributed ..................... -- -- -- -- --
Employee stock options
exercised ............................... 499 -- 997 -- 208
-------- -------- -------- -------- --------
Increase (decrease) in net assets .......... 23,882 (44,024) 84,156 11,911 94,084
- -------------------------------------------------------------------------------------------------------
Per Share Data (as of March 31)
Deferred taxes on
unrealized appreciation ................. $ 24.05 $ 17.70 $ 27.79 $ 30.36 $ 41.65
Net assets ................................. 65.42 53.92 75.35 78.44 102.74
Closing market price ....................... 68.75 48.15 75.47 79.10 95.50
Cash dividends paid ........................ .60 .60 .60 .60 .60
Securities distributed ..................... -- -- -- -- --
Shareholder Information
Stock Transfer Agent
American Stock Transfer & Trust Company, 59 Maiden Lane, New York, NY 10038
(telephone 800-937-5449) serves as transfer agent for the Company's common
stock. Certificates to be transferred should be mailed directly to the transfer
agent, preferably by registered mail.
Shareholders
The Company had approximately 700 record holders of its common stock at
March 31, 2006. This total does not include an estimated 3,000 shareholders with
shares held under beneficial ownership in nominee name or within clearinghouse
positions of brokerage firms or banks.
Market Prices
The Company's common stock trades on The Nasdaq Stock Market under the
symbol CSWC. The following high and low selling prices for the shares during
each quarter of the last two fiscal years were taken from quotations provided to
the Company by Nasdaq:
Quarter Ended High Low
- --------------------------------------------------------------------------------
June 30, 2004.................................... $84.28 $72.68
September 30, 2004............................... 81.40 69.55
December 31, 2004................................ 80.44 73.00
March 31, 2005................................... 79.87 74.25
Quarter Ended High Low
- --------------------------------------------------------------------------------
June 30, 2005.................................... $89.68 $74.98
September 30, 2005............................... 95.18 81.84
December 31, 2005............................... 92.71 82.10
March 31, 2006................................... 99.01 89.24
Dividends
The payment dates and amounts of cash dividends per share since April 1,
2004 are as follows:
Payment Date Cash Dividend
- --------------------------------------------------------------------------------
May 28, 2004.............................................. $0.20
November 30, 2004......................................... 0.40
May 31, 2005.............................................. 0.20
November 30, 2005......................................... 0.40
May 31, 2006.............................................. 0.20
The amounts and timing of cash dividend payments have generally been
dictated by requirements of the Internal Revenue Code regarding the distribution
of taxable net investment income (ordinary income) of regulated investment
companies. Instead of distributing realized long-term capital gains to
shareholders, the Company has ordinarily elected to retain such gains to fund
future investments.
Automatic Dividend Reinvestment and Optional Cash Contribution Plan
As a service to its shareholders, the Company offers an Automatic Dividend
Reinvestment and Optional Cash Contribution Plan for shareholders of record who
own a minimum of 25 shares. The Company pays all costs of administration of the
Plan except brokerage transaction fees. Upon request, shareholders may obtain
information on the Plan from the Company, 12900 Preston Road, Suite 700, Dallas,
Texas 75230. Telephone (972) 233-8242.
Annual Meeting
The Annual Meeting of Shareholders of Capital Southwest Corporation will be
held on Monday, July 17, 2006, at 10:00 a.m. in the North Dallas Bank Tower
Meeting Room (second floor), 12900 Preston Road, Dallas, Texas.
EXHIBIT 21.1
CAPITAL SOUTHWEST CORPORATION
List of Subsidiaries
Name of Subsidiary State of Incorporation
- ------------------ ----------------------
Balco, Inc. Delaware
Humac Company Texas
The RectorSeal Corporation Delaware
Lifemark Group (formerly Skylawn Corporation) Nevada
The Whitmore Manufacturing Company Delaware
Exhibit 23.1
Consent of Registered Independent Public Accounting Firm
We have issued our reports dated May 26, 2006, accompanying the consolidated
financial statements and management's assessment of the effectiveness of
internal control over financial reporting included in the Annual Report of
Capital Southwest Corporation and subsidiaries on Form 10-K for the year ended
March 31, 2006 which are incorporated by reference in the March 31, 2006 Annual
Report on Form 10-K of this Registration Statement. We consent to the
incorporation by reference of the aforementioned reports in the Registration
Statement of Capital Southwest Corporation and subsidiaries on Form S-8 (File
No. 33-43881).
/s/ GRANT THORNTON LLP
May 26, 2006
Dallas, Texas
Exhibit 23.2
Consent of Independent Registered Public Accounting Firm
We consent to the incorporation by reference in the Registration Statement (Form
S-8 No. 33-43881) pertaining to Capital Southwest Corporation of our report
dated May 12, 2004, with respect to the consolidated financial statements of
Capital Southwest Corporation for the year ended March 31, 2004 included in the
March 31, 2006 Annual Report to Shareholders of Capital Southwest Corporation
and incorporated by reference in this Annual Report (Form 10-K) for the year
ended March 31, 2006.
Ernst & Young LLP
May 24, 2006
Dallas, Texas
Exhibit 31.1
CERTIFICATIONS
I, William R. Thomas, President and Chairman of the Board of Capital Southwest
Corporation, certify that:
1. I have reviewed this annual report on Form 10-K of Capital Southwest
Corporation (the "registrant");
2. Based on my knowledge, this report does not contain any untrue
statement of a material fact or omit to state a material fact necessary
to make the statements made, in light of the circumstances under which
such statements were made, not misleading with respect to the period
covered by this report;
3. Based on my knowledge, the financial statements, and other financial
information included in this report, fairly present in all material
respects the financial condition, results of operations and cash flows
of the registrant as of, and for, the periods presented in this report;
4. The registrant's other certifying officer and I are responsible for
establishing and maintaining disclosure controls and procedures (as
defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal
control over financial reporting (as defined in Exchange Act Rules
13a-15(f) and 15d-15(f)) for the registrant and have:
a) Designed such disclosure controls and procedures, or caused
such disclosure controls and procedures to be designed under
our supervision, to ensure that material information relating
to the registrant, including its consolidated subsidiaries, is
made known to us by others within those entities, particularly
during the period in which this report is being prepared;
b) Designed such internal control over financial reporting, or
caused such internal control over financial reporting to be
designed under our supervision, to provide reasonable
assurance regarding the reliability of financial reporting and
the preparation of financial statements for external purposes
in accordance with generally accepted accounting principles;
c) Evaluated the effectiveness of the registrant's disclosure
controls and procedures and presented in this report our
conclusions about the effectiveness of the disclosure controls
and procedures, as of the end of the period covered by this
report based on such evaluation; and
d) Disclosed in this report any change in the registrant's
internal control over financial reporting that occurred during
the registrant's most recent fiscal quarter (the registrant's
fourth fiscal quarter in the case of an annual report) that
has materially affected, or is reasonably likely to materially
affect, the registrant's internal control over financial
reporting; and
5. The registrant's other certifying officer and I have disclosed, based
on our most recent evaluation of internal control over financial
reporting, to the registrant's auditors and the audit committee of the
registrant's board of directors (or persons performing the equivalent
functions):
a) All significant deficiencies and material weaknesses in the
design or operation of internal control over financial
reporting which are reasonably likely to adversely affect the
registrant's ability to record, process, summarize and report
information; and
b) Any fraud, whether or not material, that involves management
or other employees who have a significant role in the
registrant's internal control over financial reporting.
Date: May 26, 2006 By: /s/ William R. Thomas
---------------- --------------------------------
William R. Thomas, President and
Chairman of the Board
Exhibit 31.2
CERTIFICATIONS
I, Susan K. Hodgson, Secretary-Treasurer of Capital Southwest Corporation,
certify that:
1. I have reviewed this annual report on Form 10-K of Capital Southwest
Corporation (the "registrant");
2. Based on my knowledge, this report does not contain any untrue
statement of a material fact or omit to state a material fact necessary
to make the statements made, in light of the circumstances under which
such statements were made, not misleading with respect to the period
covered by this report;
3. Based on my knowledge, the financial statements, and other financial
information included in this report, fairly present in all material
respects the financial condition, results of operations and cash flows
of the registrant as of, and for, the periods presented in this report;
4. The registrant's other certifying officer and I are responsible for
establishing and maintaining disclosure controls and procedures (as
defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal
control over financial reporting (as defined in Exchange Act Rules
13a-15(f) and 15d-15(f)) for the registrant and have:
a) Designed such disclosure controls and procedures, or caused
such disclosure controls and procedures to be designed under
our supervision, to ensure that material information relating
to the registrant, including its consolidated subsidiaries, is
made known to us by others within those entities, particularly
during the period in which this report is being prepared;
b) Designed such internal control over financial reporting, or
caused such internal control over financial reporting to be
designed under our supervision, to provide reasonable
assurance regarding the reliability of financial reporting and
the preparation of financial statements for external purposes
in accordance with generally accepted accounting principles;
c) Evaluated the effectiveness of the registrant's disclosure
controls and procedures and presented in this report our
conclusions about the effectiveness of the disclosure controls
and procedures, as of the end of the period covered by this
report based on such evaluation; and
d) Disclosed in this report any change in the registrant's
internal control over financial reporting that occurred during
the registrant's most recent fiscal quarter (the registrant's
fourth fiscal quarter in the case of an annual report) that
has materially affected, or is reasonably likely to materially
affect, the registrant's internal control over financial
reporting; and
5. The registrant's other certifying officer and I have disclosed, based
on our most recent evaluation of internal control over financial
reporting, to the registrant's auditors and the audit committee of the
registrant's board of directors (or persons performing the equivalent
functions):
a) All significant deficiencies and material weaknesses in the
design or operation of internal control over financial
reporting which are reasonably likely to adversely affect the
registrant's ability to record, process, summarize and report
financial information; and
b) Any fraud, whether or not material, that involves management
or other employees who have a significant role in the
registrant's internal control over financial reporting.
Date: May 26, 2006 By: /s/ Susan K. Hodgson
--------------- -------------------------------------
Susan K. Hodgson, Secretary-Treasurer
Exhibit 32.1
Certification of President and Chairman of the Board
Pursuant to Section 1350 of Chapter 63 of Title 18 of the United States Code
I, William R. Thomas, President and Chairman of the Board of Capital
Southwest Corporation, certify that, to my knowledge:
1. the Form 10-K, filed with the Securities and Exchange Commission on
May 26, 2006 ("accompanied report") fully complies with the requirements of
Section 13(a) or 15(d) of the Securities Exchange Act of 1934; and
2. the information contained in the accompanied report fairly presents,
in all material respects, the consolidated financial condition and results of
operations of Capital Southwest Corporation.
Date: May 26, 2006 By: /s/ William R. Thomas
------------ --------------------------------
William R. Thomas, President and
Chairman of the Board
Exhibit 32.2
Certification of Secretary-Treasurer
Pursuant to Section 1350 of Chapter 63 of Title 18 of the United States Code
I, Susan K. Hodgson, Secretary-Treasurer of Capital Southwest
Corporation, certify that, to my knowledge:
1. the Form 10-K, filed with the Securities and Exchange Commission on
May 26, 2006 ("accompanied report") fully complies with the requirements of
Section 13(a) or 15(d) of the Securities Exchange Act of 1934; and
2. the information contained in the accompanied report fairly presents,
in all material respects, the consolidated financial condition and results of
operations of Capital Southwest Corporation.
Date: May 26, 2006 /s/ Susan K. Hodgson
------------ -------------------------------------
Susan K. Hodgson, Secretary-Treasurer
