UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 2007
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from ..............to ..............
Commission File Number: 814-61
CAPITAL SOUTHWEST CORPORATION
(Exact name of registrant as specified in its charter)
Texas 75-1072796
(State or other jurisdiction of incorporation (I.R.S. Employer
or organization) Identification No.)
12900 Preston Road, Suite 700, Dallas, Texas 75230
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (972) 233-8242
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes X No
Indicate by check mark whether the registrant is a large accelerated filer, an
accelerated filer, or a non-accelerated filer. See definition of "accelerated
filer and large accelerated filer" in Rule 12b-2 of the Exchange Act. (Check
One):
Large accelerated filer ____ Accelerated filer X Non-accelerated filer ____
Indicate by check mark whether the registrant is a shell company (as defined in
Rule 12b-2 of the Act). Yes No X
Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practicable date.
3,889,151 shares of Common Stock, $1 Par Value as of January 9, 2008
TABLE OF CONTENTS
PART I. FINANCIAL INFORMATION Page No.
- ----------------------------- --------
ITEM 1. Consolidated Financial Statements (1)
Consolidated Statements of Financial Condition
September 30, 2007 (Unaudited) and March 31, 2007........3
Consolidated Statements of Operations (Unaudited)
For the three and six months ended September 30, 2007 and
September 30, 2006.......................................4
Consolidated Statements of Changes in Net Assets
For the six months ended September 30, 2007 (Unaudited)
and year ended March 31, 2007............................5
Consolidated Statements of Cash Flows (Unaudited) For the three and
six months ended September 30, 2007 and
September 30, 2006.......................................6
Portfolio of Investments
September 30, 2007.......................................7
Notes to Consolidated Financial Statements.......................12
ITEM 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations.................18
ITEM 3. Quantitative and Qualitative Disclosure About
Market Risk.........................................20
ITEM 4. Controls and Procedures.................................20
PART II. OTHER INFORMATION
ITEM 1 Legal Proceedings........................................21
ITEM 1A. Risk Factors...............................................21
ITEM 4. Submission of Matters to a Vote of Security Holders.....21
ITEM 6. Exhibits and Reports on Form 8-K........................22
Signatures ...................................................................23
(1) As described in Note 2, the financial statements for fiscal year 2007 have
been restated.
PART I. FINANCIAL INFORMATION
Item 1. Consolidated Financial Statements
CAPITAL SOUTHWEST CORPORATION AND SUBSIDIARIES
Consolidated Statements of Financial Condition
----------------------------------------------
Assets September 30, 2007 March 31, 2007
------------- -------------
(Unaudited) as restated
Investments at market or fair value
Companies more than 25% owned
(Cost: September 30, 2007 - $28,758,246
March 31, 2007 - $28,632,356) $ 389,987,981 $ 526,993,983
Companies 5% to 25% owned
(Cost: September 30, 2007 - $19,962,243,
March 31, 2007 - $18,798,896) 82,329,351 76,398,002
Companies less than 5% owned
(Cost: September 30, 2007 - $31,982,402,
March 31, 2007 - $24,211,045) 96,917,751 77,763,048
------------- -------------
Total investments
(Cost: September 30, 2007- $80,702,891,
March 31, 2007 - $71,642,297) 569,235,083 681,155,033
Cash and cash equivalents 31,871,482 38,844,203
Receivables 102,956 337,892
Other assets 9,379,527 9,170,185
------------- -------------
Totals $ 610,589,048 $ 729,507,313
============= =============
Liabilities and Shareholders' Equity
Other liabilities $ 1,341,573 $ 1,457,847
Deferred income taxes 2,374,777 2,317,777
------------- -------------
Total liabilities 3,716,350 3,775,624
------------- -------------
Shareholders' equity
Common stock, $1 par value: authorized,
5,000,000 shares; issued, 4,326,516 shares
at September 30, 2007 and 4,323,416 shares
at March 31, 2007 4,326,516 4,323,416
Additional capital 116,689,936 116,373,960
Undistributed net investment income 6,728,945 5,655,020
Undistributed net realized loss on investments (2,371,590) (3,100,142)
Unrealized appreciation of investments 488,532,193 609,512,737
Treasury stock - at cost (437,365 shares) (7,033,302) (7,033,302)
------------- -------------
Net assets at market or fair value, equivalent
to $156.04 per share at September 30, 2007 on the 3,889,151 shares
outstanding and $186.75 per share at March 31, 2007 on the 3,886,051
shares outstanding 606,872,698 725,731,689
------------- -------------
Totals $ 610,589,048 $ 729,507,313
============= =============
(See Notes to Consolidated Financial Statements)
3
CAPITAL SOUTHWEST CORPORATION
AND SUBSIDIARIES
Consolidated Statements of Operations
-------------------------------------
(Unaudited)
Three Months Ended Six Months Ended
September 30 September 30
------------------------------ ------------------------------
2007 2006 2007 2006
------------- ------------- ------------- -------------
as restated as restated
Investment income:
Interest $ 679,442 $ 933,678 $ 1,244,129 $ 1,139,530
Dividends 801,467 757,935 1,164,894 1,540,501
Management and directors' fees 226,200 179,950 451,400 378,400
------------- ------------- ------------- -------------
1,707,109 1,871,563 2,860,423 3,058,431
------------- ------------- ------------- -------------
Operating expenses:
Salaries 291,085 320,334 565,221 663,799
Net pension benefit (127,434) (43,284) (163,671) (72,471)
Other operating expenses 288,194 230,737 553,158 451,965
------------- ------------- ------------- -------------
451,845 507,787 954,708 1,043,293
------------- ------------- ------------- -------------
Income before interest expense and
income taxes 1,255,264 1,363,776 1,905,715 2,015,138
Interest expense -- 178,222 -- 325,204
------------- ------------- ------------- -------------
Income before income taxes 1,255,264 1,185,554 1,905,715 1,689,934
Income tax expense 44,400 15,200 54,160 28,024
------------- ------------- ------------- -------------
Net investment income $ 1,210,864 $ 1,170,354 $ 1,851,555 $ 1,661,910
============= ============= ============= =============
Proceeds from disposition of investments $ 402,777 $ 10,045,064 $ 728,552 $ 10,442,080
Cost of investments sold -- 826,317 -- 826,317
------------- ------------- ------------- -------------
Net realized gain on investments 402,777 9,218,747 728,552 9,615,763
------------- ------------- ------------- -------------
Net decrease in unrealized
appreciation of investments (138,128,989) (2,931,221) (120,980,544) (8,148,701)
------------- ------------- ------------- -------------
Net realized and unrealized gain (loss)
on investments $(137,726,212) $ 6,287,526 $(120,251,992) $ 1,467,062
============= ============= ============= =============
Increase (decrease) in net assets
from operations $(136,515,348) $ 7,457,880 $(118,400,437) $ 3,128,972
============= ============= ============= =============
(See Notes to Consolidated Financial Statements)
4
CAPITAL SOUTHWEST CORPORATION
AND SUBSIDIARIES
Consolidated Statements of Changes in Net Assets
------------------------------------------------
Six Months Ended Year Ended
September 30, 2007 March 31, 2007
------------- -------------
(Unaudited) as restated
Operations
Net investment income $ 1,851,555 $ 4,233,340
Net realized gain on investments 728,552 14,966,296
Net increase (decrease) in unrealized
appreciation of investments (120,980,544) 147,681,609
------------- -------------
Increase (decrease) in net assets from operations (118,400,437) 166,881,245
Distributions from:
Undistributed net investment income (777,630) (2,323,150)
Capital share transactions
Exercise of employee stock options 231,390 1,794,850
Adjustment to initially apply FASB No. 158,
net of tax -- 1,173,751
Stock option expense 87,686 169,003
------------- -------------
Increase (decrease) in net assets (118,858,991) 167,695,699
Net assets, beginning of period as restated 725,731,689 558,035,990
------------- -------------
Net assets, end of period $ 606,872,698 $ 725,731,689
============= =============
(See Notes to Consolidated Financial Statements)
5
CAPITAL SOUTHWEST CORPORATION
AND SUBSIDIARIES
Consolidated Statements of Cash Flows
-------------------------------------
(Unaudited)
Three Months Ended Six Months Ended
September 30 September 30
------------ ------------
2007 2006 2007 2006
------------- ------------- ------------- -------------
as restated as restated
Cash flows from operating activities
Increase (decrease) in net assets from
operations $(136,515,348) $ 7,457,880 $(118,400,437) $ 3,128,972
Adjustments to reconcile increase in net
assets from operations to net cash
provided by operating activities:
Proceeds from disposition of investments 402,777 10,045,064 728,552 10,442,080
Purchases of securities (1,163,347) (370,230) (9,215,094) (370,230)
Maturities of securities 150,000 482,491 154,500 884,936
Depreciation and amortization 6,272 4,022 10,681 7,887
Net pension benefit (127,434) (43,284) (163,671) (72,471)
Realized gain on investments (402,777) (9,218,747) (728,552) (9,615,763)
Net decrease in unrealized appreciation
of investments 138,128,989 2,931,221 120,980,544 8,148,701
Stock option expense 44,100 77,711 87,686 81,831
Increase (decrease) in receivables 50,016 (31,415) 234,936 (47,285)
(Increase) decrease in other assets (23,679) 1,955 (30,408) (17,988)
Increase (decrease) in other liabilities 43,779 21,727 (75,384) (84,856)
Decrease in accrued pension cost (30,266) (36,568) (66,834) (71,035)
Increase in deferred income taxes 44,400 15,200 57,000 25,400
------------- ------------- ------------- -------------
Net cash provided by (used in) operating
activities 607,482 11,337,027 (6,426,481) 12,440,179
------------- ------------- ------------- -------------
Cash flows from financing activities
Decrease in notes payable to bank -- (150,000,000) -- --
Distributions from undistributed net
investment income -- -- (777,630) (772,050)
Proceeds from exercise of employee
stock options -- -- 231,390 1,097,500
------------- ------------- ------------- -------------
Net cash provided by (used in) financing
activities -- (150,000,000) (546,240) 325,450
------------- ------------- ------------- -------------
Net increase (decrease) in cash and cash
equivalents 607,482 (138,662,973) (6,972,721) 12,765,629
Cash and cash equivalents at beginning
of period 31,264,000 162,932,468 38,844,203 11,503,866
------------- ------------- ------------- -------------
Cash and cash equivalents at end of period $ 31,871,482 $ 24,269,495 $ 31,871,482 $ 24,269,495
============= ============= ============= =============
Supplemental disclosure of cash flow information:
Cash paid during the period for:
Interest $ -- $ 201,441 $ -- $ 325,204
Income taxes $ -- $ -- $ -- $ 20,000
(See Notes to Consolidated Financial Statements)
6
Portfolio of Investments - September 30, 2007
Company Investment (a) Cost Value (b)
- ------------------------------------------------------------------------------------------------------------------------------------
+AT&T INC. ++20,770 shares common stock (acquired 3-9-99) $ 12 $ 878,779
San Antonio, Texas
Global leader in local, long
distance, Internet and
transaction-based voice
and data services.
+ALAMO GROUP INC. 2,830,300 shares common stock 2,190,937 48,115,000
Sequin, Texas (acquired 4-1-73 thru 5-25-07)
Tractor-mounted mowing and
mobile excavation equipment
for governmental, industrial
and agricultural markets;
street-sweeping equipment
for municipalities.
ALL COMPONENTS, INC. 8.25% subordinated note due 2012 (acquired 6-27-07) 6,000,000 6,000,000
Addison, Texas 150,000 shares Series A convertible preferred stock,
Electronics contract manu- convertible into 600,000 shares of common stock
facturing; distribution at $0.25 per share (acquired 9-16-94) 150,000 6,600,000
and production of memory Warrant to purchase 350,000 shares of common stock
and other components for at $11.00 per share, expiring 2017 (acquired 6-27-07) - -
computer manufacturers, --------- ---------
retailers and value-added 6,150,000 12,600,000
resellers.
+ALLTEL CORPORATION ++8,880 shares common stock (acquired 7-1-98) 88,699 618,758
Little Rock, Arkansas
Owner and operator of the
nation's largest wireless
network.
+ATLANTIC CAPITAL BANCSHARES, INC. 300,000 shares common stock (acquired 4-10-07) 3,000,000 3,000,000
Atlanta, Georgia
Holding company of Atlantic
Capital Bank a full service
commercial bank.
BALCO, INC. 445,000 shares common stock and 60,920 shares
Wichita, Kansas Class B non-voting common stock 624,920 4,500,000
Specialty architectural (acquired 10-25-83 and 5-30-02)
products used in the
construction and remodeling
of commercial and insti-
tutional buildings.
BOXX TECHNOLOGIES, INC. 3,125,354 shares Series B convertible preferred
Austin, Texas stock, convertible into 3,125,354 shares of
Workstations for computer common stock at $0.50 per share
graphics imaging and design. (acquired 8-20-99 thru 8-8-01) 1,500,000 2
CMI HOLDING COMPANY, INC. 10% convertible subordinate note, due 2009 (acquired 7-2-07) 1,913,347 1,913,347
Richardson, Texas 2,327,658 shares Series A convertible preferred stock,
Owns Chase Medical, which convertible into 2,327,658 shares of common stock
develops and sells devices at $1.72 per share (acquired 8-21-02 and 6-4-03) 4,000,000 2,000,000
used in cardiac surgery to Warrants to purchase 109,012 shares of common stock
relieve congestive heart at $1.72 per share, expiring 2012 (acquired 4-16-04) - -
failure; develops and Warrants to purchase 431,982 shares of Series A-1
supports cardiac imaging convertible preferred stock at $1.72 per share
systems. expiring 2012 (acquired 7-2-07) - -
--------- ---------
5,913,347 3,913,347
7
Company Investment (a) Cost Value (b)
- ------------------------------------------------------------------------------------------------------------------------------------
+COMCAST CORPORATION ++64,656 shares common stock (acquired 11-18-02) $ 21 $ 1,562,089
Philadelphia, Pennsylvania
Leading provider of cable,
entertainment and communi-
cations products and
services.
DENNIS TOOL COMPANY 20,725 shares 5% convertible preferred stock,
Houston, Texas convertible into 20,725 shares of common stock
Polycrystalline diamond at $48.25 per share (acquired 8-10-98) 999,981 999,981
compacts (PDCs) used in oil 140,137 shares common stock (acquired 3-7-94 and 8-10-98) 2,329,963 2,000,000
field drill bits and in --------- ---------
mining and industrial 3,329,944 2,999,981
applications.
+DISCOVERY HOLDING COMPANY ++70,501 shares Series A common stock (acquired 7-21-05) 20,262 2,031,134
Englewood, Colorado
Provider of creative
content, media management
and network services
worldwide.
+EMBARQ CORPORATION ++4,500 shares common stock (acquired 5-17-06) 46,532 250,200
Overland Park, Kansas
Local exchange carrier that
provides voice and data
services, including
high-speed Internet.
+ENCORE WIRE CORPORATION 4,086,750 shares common stock (acquired 7-16-92 thru 10-7-98) 5,800,000 75,605,000
McKinney, Texas
Electric wire and cable for
residential and commercial
use.
EXTREME INTERNATIONAL, INC. 39,359.18 shares Series C convertible preferred
Sugar Land, Texas stock, convertible into 157,436.72 shares of common
Owns Bill Young Productions, stock at $25.00 per share (acquired 9-30-03) 2,625,000 8,391,000
Texas Video and Post, and 3,750 shares 8% Series A convertible preferred stock,
Extreme Communications, convertible into 15,000 shares of common stock at
which produce radio and $25.00 per share (acquired 9-30-03) 375,000 800,000
television commercials and Warrants to purchase 13,035 shares of common stock
corporate communications at $25.00 per share, expiring 2008 (acquired 8-11-98
videos. thru 9-30-03) - 375,000
--------- ---------
3,000,000 9,566,000
+FMC CORPORATION ++6,430 shares common stock (acquired 6-6-86) 66,726 668,977
Philadelphia, Pennsylvania
Chemicals for agricultural,
industrial and consumer
markets.
+FMC TECHNOLOGIES, INC. ++11,057 shares common stock (acquired 1-2-02) 57,051 1,275,093
Houston, Texas
Equipment and systems for
the energy, food processing
and air transportation
industries.
+HEELYS, INC. 9,317,310 shares common stock (acquired 5-26-00) 102,490 55,904,000
Carrollton, Texas
Heelys stealth skate shoes,
equipment and apparel sold
through sporting goods
chains, department stores
and footwear retailers.
8
Company Investment (a) Cost Value (b)
- ------------------------------------------------------------------------------------------------------------------------------------
HIC-STAR CORPORATION 10% subordinated note due 2007 (acquired 10-19-04 and
Dallas, Texas 1-13-05) $ 352,646 $ -
Holding company previously 12% subordinated notes due 2008 (acquired 3-25-05 thru
engaged in mortgage banking 2-27-06) 717,523 1
operations, which have now Warrants to purchase 463,162 shares of Series A common
been sold. stock at $1.00 per share, expiring 2014 (acquired
3-31-04 thru 1-13-05) - -
--------- ---------
1,070,169 1
+HOLOGIC, INC. ++316,410 shares common stock (acquired 8-27-99) 220,000 19,282,025
Bedford, Massachusetts
Medical instruments
including bone densi-
tometers, mammography
devices and digital
radiography systems.
+KIMBERLY-CLARK CORPORATION ++77,180 shares common stock (acquired 12-18-97) 2,358,518 5,422,667
Dallas, Texas
Manufacturer of tissue,
personal care and health
care products.
+LIBERTY GLOBAL, INC. ++42,463 shares Series A common stock (acquired 6-15-05) 106,553 1,741,832
Englewood, Colorado ++42,463 shares Series C common stock (acquired 9-6-05) 100,870 1,639,496
Owns interests in broadband, --------- ---------
distribution and content 207,423 3,381,328
companies.
+LIBERTY MEDIA CORPORATION ++35,250 shares of Liberty Capital Series A common stock
Englewood, Colorado (acquired 5-9-06) 51,829 4,400,258
Holding company owning ++176,252 shares of Liberty Interactive Series A common stock
interests in electronic (acquired 5-9-06) 66,424 3,384,038
retailing, media, communi- --------- ---------
cations and entertainment 118,253 7,784,296
businesses.
LIFEMARK GROUP 1,449,026 shares common stock (acquired 7-16-69) 4,510,400 44,000,000
Hayward, California
Cemeteries, mausoleums and
mortuaries located in
northern California.
MEDIA RECOVERY, INC. 800,000 shares Series A convertible preferred stock,
Graham, Texas convertible into 800,000 shares of common stock at
Computer datacenter and $1.00 per share (acquired 11-4-97) 800,000 6,000,000
office automation supplies 4,000,000 shares common stock (acquired 11-4-97) 4,615,000 30,000,000
and accessories; impact, --------- ---------
tilt monitoring and 5,415,000 36,000,000
temperature sensing devices
to detect mishandled
shipments; dunnage for
protecting shipments.
PALLETONE, INC. 12.3% senior subordinated notes due 2012 (acquired 9-25-06) 1,553,150 2,000,000
Bartow, Florida 150,000 shares common stock (acquired 10-18-01) 150,000 750,000
Manufacturer of wooden Warrant to purchase 15,294 shares of common stock at
pallets and pressure-treated $1.00 per share, expiring 2011 (acquired 2-17-06) 45,746 61,000
lumber. --------- ---------
1,748,896 2,811,000
+PALM HARBOR HOMES, INC. 7,855,121 shares common stock (acquired 1-3-85 thru 7-31-95) 10,931,955 62,841,000
Dallas, Texas
Integrated manufacturing,
retailing, financing and
insuring of manufactured
housing and modular homes.
9
Company Investment (a) Cost Value (b)
- ------------------------------------------------------------------------------------------------------------------------------------
+PETSMART, INC. ++300,000 shares common stock (acquired 6-1-95) $ 1,318,771 $ 9,567,000
Phoenix, Arizona
Retail chain of more than
928 stores selling pet
foods, supplies and
services.
THE RECTORSEAL CORPORATION 27,907 shares common stock (acquired 1-5-73 and 3-31-73) 52,600 108,850,000
Houston, Texas
Specialty chemicals for
plumbing, HVAC, electrical,
construction, industrial,
oil field and automotive
applications; smoke contain-
ment systems for building
fires; also owns 20% of The
Whitmore Manufacturing
Company.
+SPRINT NEXTEL CORPORATION ++90,000 shares common stock (acquired 6-20-84) 457,113 1,710,000
Reston, Virginia
Diversified telecom-
munications company.
TCI HOLDINGS, INC. 21 shares 12% Series C cumulative compounding preferred
Denver, Colorado stock (acquired 1-30-90) - 677,250
Cable television systems and
microwave relay systems.
+TEXAS CAPITAL BANCSHARES, INC. ++489,656 shares common stock (acquired 5-1-00) 3,550,006 10,630,432
Dallas, Texas
Regional bank holding
company with banking
operations in six Texas
cities.
VIA HOLDINGS, INC. 9,118 shares Series B preferred stock (acquired 9-19-05) 4,559,000 2
Sparks, Nevada
Designer, manufacturer and
distributor of high-quality
office seating.
WELLOGIX, INC. 4,540,883 shares Series A-1 convertible participating
Houston, Texas preferred stock, convertible into 4,540,883 shares
Developer and supporter of of common stock at $1.1011 per share (acquired
software used by the oil and 8-19-05 thru 6-15-07) 5,000,000 2
gas industry to control
drilling and maintenance
expenses.
THE WHITMORE MANUFACTURING
COMPANY 80 shares common stock (acquired 8-31-79) 1,600,000 26,600,000
Rockwall, Texas
Specialized mining, railroad
and industrial lubricants;
coatings for automobiles and
primary metals; fluid
contamination control
devices.
+WINDSTREAM CORPORATION ++9,181 shares common stock (acquired 7-17-06) 19,656 129,636
Little Rock, Arkansas
Provider of voice, broadband
and entertainment
services.
10
Company Investment (a) Cost Value (b)
- ------------------------------------------------------------------------------------------------------------------------------------
MISCELLANEOUS - BankCap Partners Fund I, L.P. - 6.0% limited
partnership interest (acquired 7-14-06 thru 4-3-07) $ 2,371,476 $ 2,371,476
- Diamond State Ventures, L.P. - 1.9% limited
partnership interest (acquired 10-12-99 thru 8-26-05) 146,000 146,000
- 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
- Humac Company - 1,041,000 shares common stock
(acquired 1-31-75 and 12-31-75) - 178,000
- PharmaFab, Inc. - contingent payment agreement
(acquired 2-15-07) 2 2
- 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) 950,000 1
- Sterling Group Partners I, L.P. - 1.7% limited
partnership interest (acquired 4-20-01 thru 1-24-05) 1,064,042 2,400,000
- ------------------------------------------------------------------------------------------------------------------------------------
TOTAL INVESTMENTS $ 80,702,891 $569,235,083
============= ============
- ------------------------------------------------------------------------------------------------------------------------------------
+Publicly-owned company ++ Unrestricted securities as defined in Note (a)
Notes to Portfolio of Investments
---------------------------------
(a) 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 September 30, 2007, restricted securities represented
approximately 88.5% of the value of the consolidated investment portfolio.
(b) 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.
11
CAPITAL SOUTHWEST CORPORATION
AND SUBSIDIARIES
Notes to Consolidated Financial Statements
------------------------------------------
(Unaudited)
1. Basis of Presentation
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.
The financial statements included herein have been prepared in accordance
with accounting principles generally accepted in the United States for interim
financial information and the instructions to Form 10-Q and Article 6 of
Regulation S-X. The financial statements should be read in conjunction with the
consolidated financial statements and notes thereto included in our Form 10-K/A
for the year ended March 31, 2007. Certain information and footnotes normally
included in financial statements prepared in accordance with accounting
principles generally accepted in the United States have been condensed or
omitted, although we believe that the disclosures are adequate for a fair
presentation. The information reflects all adjustments (consisting of normal
recurring adjustments) which are, in the opinion of management, necessary for a
fair presentation of the results of operations for the interim periods.
2. Restatement of Consolidated Financial Statements
Capital Southwest Corporation (the "Company") has filed an amendment to its
Annual Report on Form 10-K for the year ended March 31, 2007, to amend and
restate its consolidated financial statements and selected per share data and
ratios for each of the fiscals years ended March 31, 2007, 2006 and 2005 and our
selected per share data and ratios for the years ended March 31, 2004 and 2003.
In addition, we have filed an amendment to our Quarterly Report on Form 10-Q for
the quarter ended June 30, 2007.
After reviewing the accounting treatment for deferred taxes on unrealized
appreciation of investments, the Company has determined its long-standing policy
of recording deferred taxes on unrealized appreciation of investments was not in
conformity with generally accepted accounting principles and its previously
issued financial statements required restatement. The effect of the restatement
on the consolidated statement of financial condition as of March 31, 2007; the
consolidated statement of operations and consolidated statement of cash flows
for the three months and six months ended September 30, 2006; the consolidated
statement of changes in net assets for the six months ended September 30, 2006
and year ended March 31, 2007 is as follows and shown in tables below:
(A) A Regulated Investment Company (RIC) is required to record
deferred taxes when it is probable the RIC will not qualify under
Subchapter M of the Internal Revenue Code for a period longer that one
year. Historically, management believed it was probable the Company would
not maintain its qualifying status as a RIC in future years and recorded a
deferred tax liability on the unrealized appreciation of investments.
However, upon further analysis, the Company determined it was only
reasonably possible, but not probable, the Company would not maintain its
qualifying status as a RIC. Thus the deferred tax liability consistently
recorded and disclosed should not have been recognized.
(B) The Company historically has accrued income taxes payable on its
investment gains as they have been incurred, as it has been the Company's
practice to retain its investment gains. However, RICs are required to
accrue federal income taxes on investment gains that are retained only on
the last day of the tax year. The Company incorrectly recorded the tax
impact of its investment gains in periods other than the last day of its
tax year, December 31. Therefore, the income taxes payable recorded at
times other than the tax year end should not have been recognized.
(C) The Company incorrectly classified its' return of capital
contributions cumulatively as "undistributed net realized gains on
investments." RICs are required to classify return of capital contributions
as "additional capital" in the period in which tax basis amounts become
permanent; and reflect undistributed amounts remaining since its' previous
tax year end adjusted for temporary tax basis differences as "undistributed
net realized gains on investments."
12
Notes to Consolidated Financial Statements
(continued)
The restatement will eliminate the accrual for deferred taxes on unrealized
appreciation of investments, and income taxes payable and related tax
carryforwards on realized gains, increasing the net asset value per share and
net assets from operations for the periods restated; and reclassify return of
capital contributions to "additional capital."
As of March 31, 2007
----------------------------
Previously
Reported (3) As Restated (2)
Consolidated Statement of Financial Condition ------------ ------------
- ------------------------------------------------------
Total assets 729,507,313 729,507,313
============ ============
Income taxes payable 231,274 -- (B)
Deferred income tax 213,474,680 2,317,777 (A)(B)
------------ ------------
Total liabilities 215,163,801 3,775,624
------------ ------------
Additional capital 11,221,601 116,373,960 (C)
Undistributed net realized gains (losses) 102,766,040 (3,100,142) (B)(C)
Net unrealized appreciation of investments 397,410,737 609,512,737 (A)
Net assets at market or fair value 514,343,512 725,731,689
------------ ------------
Total liabilities and shareholders equity
729,507,313 729,507,313
============ ============
Six Months Ended September 30,
2006
----------------------------
Previously
Consolidated Statement of Operations Reported (1) As Restated (2)
- ------------------------------------------------------ ------------ ------------
Net investment income 1,661,910 1,661,910
============ ============
Net realized gain on investments 6,243,744 9,615,763 (B)
Net decrease in unrealized appreciation of investments (5,142,701) (8,148,701) (A)
------------ ------------
Net realized and unrealized gain on investments 1,101,043 1,467,062
------------ ------------
Increase in net assets from operations 2,762,953 3,128,972
============ ============
Three Months Ended September 30,
2006
----------------------------
Previously
Consolidated Statement of Operations Reported (1) As Restated (2)
- ------------------------------------------------------ ------------ ------------
Net investment income
1,170,354 1,170,354
============ ============
Net realized gain on investments
5,985,684 9,218,747 (B)
Net decrease in unrealized appreciation of investments (2,120,220) (2,931,221) (A)
------------ ------------
Net realized and unrealized gain on investments 3,865,463 6,287,526
------------ ------------
Increase in net assets from operations
5,035,817 7,457,880
============ ============
13
Notes to Consolidated Financial Statements
(continued)
Year Ended March 31, 2007
----------------------------
Previously
Consolidated Statement of Changes in Net Assets Reported (3) As Restated (2)
- ------------------------------------------------------ ------------ ------------
Net investment income
4,233,340 4,233,340
Net realized gain on investments 16,334,000 14,966,296 (B)
Net increase on unrealized appreciation before distributions 96,343,609 147,681,609 (A)
------------ ------------
Increase in net assets from operations before distributions 116,910,949 166,881,245
Undistributed net investment income (2,323,150) (2,323,150)
Net realized gains deemed
distributed to shareholders -- (11,417,283) (C)
Allocated increase in share value
for deemed distribution -- 11,417,283 (C)
Employee stock options exercised 1,794,850 1,794,850
Stock option expense 1,173,751 1,173,751
Adjustment to initially apply FASB Statement No. 158, net of tax 169,003 169,003
------------ ------------
Increase in net assets 117,725,403 167,695,699
Net assets, beginning of year 396,618,109 558,035,990
------------ ------------
Net assets, end of year 514,343,512 725,731,689
============ ============
Net asset value, per share $ 132.36 $ 186.75
============ ============
Six Months Ended
September 30, 2006
----------------------------
Previously
Consolidated Statement of Changes in Net Assets Reported (1) As Restated (2)
- ------------------------------------------------------ ------------ ------------
Net investment income 1,661,910 1,661,910
Net realized gain on investments 6,243,744 9,615,763 (B)
Net decrease on unrealized appreciation before distributions (5,142,701) (8,148,701) (A)
------------ ------------
Increase in net assets from operations before distributions 2,762,953 3,128,972
Undistributed net investment income (772,050) (772,050)
Employee stock options exercised 1,097,500 1,097,500
Stock option expense 81,831 81,831
------------ ------------
Increase in net assets 3,170,234 3,536,253
Net assets, beginning of year 396,618,109 558,035,990
------------ ------------
Net assets, end of year 399,788,343 561,572,243
============ ============
Net asset value, per share $ 103.15 $ 144.89
============ ============
14
Notes to Consolidated Financial Statements
(continued)
Six Months Ended
September 30, 2006
----------------------------
Previously
Consolidated Statement of CashFlow Reported (1) As Restated (2)
- ------------------------------------------------------ ------------ ------------
Net cash provided by operating activities 12,440,179 12,440,179
Net cash provided by financing activities 325,450 325,450
------------ ------------
Net increase in cash and cash equivalents
12,765,629 12,765,629
============ ============
Three Months Ended
September 30, 2006
----------------------------
Previously
Consolidated Statement of CashFlow Reported (1) As Restated (2)
- ------------------------------------------------------ ------------ ------------
Net cash provided by operating activities 11,337,027 11,337,027
Net cash used in financing activities (150,000,000) (150,000,000)
------------ ------------
Net decrease in cash and cash equivalents (138,662,973) (138,662,973)
============ ============
(1) As presented in the Company's original Form 10-Q for the quarter ended
September 30, 2006
(2) Adjusted to reflect the restatement described above.
(3) As presented in the Company's original Form 10-K for the fiscal year ended
March 31, 2007
(A),(B) and (C) are described in detail above.
3. Stock-Based Compensation
In December 2004, the Financial Accounting Standards Board (FASB) issued
SFAS No. 123 (revised 2004), Share-Based Payment (SFAS 123R), which revised 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.
Effective April 1, 2006, we adopted SFAS 123R using the modified
prospective transition method. We recognize compensation cost over the
straight-line method 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 fair value of stock options are determined on the
date of grant using the Black-Scholes pricing model and are expensed over the
vesting period of the related stock options. Accordingly, for the quarter and
six months ended September 30, 2007, we recognized compensation expense of
$44,100 and $87,686, respectively.
As of September 30, 2007, the total remaining unrecognized compensation
cost related to non-vested stock options was $1,971,812, which will be amortized
over the weighted-average service period of approximately 6.4 years.
4. Employee Stock Option Plan
On July 19, 1999, shareholders approved the 1999 Stock Option ("Plan"),
which provides for the granting of stock options to employees and officers and
authorizes the issuance of common stock upon exercise of such options for up to
140,000 shares. All options are granted at or above market price, 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 September 30, 2007, there were 37,500 shares available for grant under
the Plan. The per share weighted-average fair value of the stock options granted
on May 15, 2006 was $31.276 per option 15
15
Notes to Consolidated Financial Statements
(continued)
using the Black-Scholes pricing model with the following assumptions: expected
dividend yield of .64%, risk-free interest rate of 5.08%, expected volatility of
21.1%, and expected life of 7 years. The per share weighted-average fair value
of the stock options granted on July 17, 2006 was $33.045 per option using the
Black-Scholes pricing model with the following assumptions: expected dividend
yield of .61%, risk-free interest rate of 5.04%, expected volatility of 21.2%,
and expected life of 7 years. The per share weighted-average fair value of the
stock options granted on July 16, 2007 was $41.777 per option using the
Black-Scholes pricing model with the following assuptions: expected dividend
yield of .39%, risk-free interest rate of 4.95%, expected volatility of 19.9%,
and expected life of 5 years.
The following summarizes activity in the stock option plan since March 31,
2007:
Number Weighted-Average
of shares Exercise Price
Balance at March 31, 2007 52,500 $ 86.184
Granted 25,000 152.980
Exercised (3,100) 74.642
Canceled (4,000) 93.490
--------- ---------
Balance at September 30, 2007 70,400 109.998
========= ========
At September 30, 2007, the range of exercise prices and weighted-average
remaining contractual life of outstanding options was $65.00 to $152.98 and 6.41
years, respectively. The total intrinsic value of options exercised during the
six months ended September 30, 2007 was $75,129 with the exercise prices ranging
from $65.00 to $93.49 per share. A total of 3,100 new shares were issued for the
$231,390 cash received from option exercises for the six months ended September
30, 2007.
At September 30, 2007, the number of options exercisable was 9,930 and the
weighted-average exercise price of those options was $79.01.
5. Summary of Per Share Information
Three Months Ended Six Months Ended
September 30 September 30
--------------------- ---------------------
2007 2006 2007 2006
---------- ---------- ---------- ----------
as restated as restated
Investment income $ .44 $ .48 $ .74 $ .79
Operating expenses (.12) (.13) (.25) (.27)
Interest expense -- (.04) -- (.08)
Income taxes (.01) (.01) (.01) (.01)
---------- ---------- ---------- ----------
Net investment income .31 .30 .48 .43
Distributions from undistributed
net investment income -- -- (.20) (.20)
Net realized gain on investments .10 2.38 .19 2.48
Net decrease in unrealized appreciation
of investments after (35.52) (.76) (31.11) (2.10)
Exercise of employee stock options * -- -- (.09) (.29)
Stock option expense .01 .02 .02 .02
---------- ---------- ---------- ----------
Increase (decrease) in net asset value (35.10) 1.94 (30.71) .33
Net asset value:
Beginning of period 191.13 142.95 186.75 144.56
---------- ---------- ---------- ----------
End of period $ 156.04 $ 144.89 $ 156.04 $ 144.89
========== ========== ========== ==========
Shares outstanding at end of period
(000s omitted) 3,889 3,875 3,889 3,875
* Net decrease is due to the exercise of employee stock options at prices less
than beginning of period net asset value.
16
Notes to Consolidated Financial Statements
(continued)
6. Subsequent Events
In July 2007, William R. Thomas, retired from role as President and Chief
Executive Officer, but has continued in capacity as Chairman of the Board. Gary
L Martin was named President and Chief Executive Officer.
In August 2007, Susan K. Hodgson resigned from her position as
Secretary-Treasurer and Chief Financial Officer. Tracy L. Morris was hired in
September 2007, as Controller and Chief Financial Officer.
As described in Part II. Item 1. Legal Proceedings; on August 27, 2007 a
lawsuit was filed against, Capital Southwest Corporation, Capital Southwest
Venture Corporation, Heelys, Inc., and its Chief Executive Officer, Chief
Financial Officer and directors who signed its registration statement with the
SEC in connection with its December 7, 2006 initial public offering ("IPO") and
its underwriters for the IPO. Four similar suits were filed in September and
October 2007.
On November 15, 2007, the Company received a Staff Determination Letter
from NASDAQ, stating that we were delinquent in our SEC filings for the quarter
ended September 30, 2007 and in violation of NASDAQ rules. The letter instructed
us to file for an appeal for the determination or trading of the Company's stock
would be suspended. On November 20, 2007, the Company requested a written
hearing with NASDAQ. The hearing date is set for January 10, 2008.
7. Recent Accounting Pronouncements
The State of Texas recently passed House Bill 3 (HB3), which revises the
existing franchise tax system to create a new tax on virtually all Texas
businesses. Starting in the fiscal year 2007, HB3 changes the franchise tax
base, lowers the tax rate and extends coverage to active businesses receiving
state law liability protection. We have been subject to an immaterial amount of
Texas franchise taxes and expect the HB3 to have some affect, but have not
determined the extent of this impact.
In May 2005, the FASB issued Statement of Financial Accounting Standards
No. 154, "Accounting Changes and Error Corrections--a replacement of APB Opinion
No. 20 and FASB Statement No. 3" ("SFAS 154"). This Statement replaces APB
Opinion No. 20, "Accounting Changes," and FASB Statement No. 3, "Reporting
Accounting Changes in Interim Financial Statements." SFAS 154 requires
retrospective application to prior periods' financial statements for changes in
accounting principle, unless it is impracticable to determine either the
period-specific effects or the cumulative effect of the change. SFAS 154 also
requires that a change in depreciation, amortization, or depletion method for
long-lived, non-financial assets be accounted for as a change in accounting
estimate effected by a change in accounting principle. SFAS 154 is effective for
accounting changes and corrections of errors made in fiscal years beginning
after December 15, 2005. The impact of this standard, if any, will depend upon
accounting changes or errors that may occur in future periods. The Company
adopted SFAS 154 effective December 31, 2005. Prior to the quarter ended
September 30, 2007, SFAS 154 did not have any impact on the company's financial
statements.
In September 2006, the FASB issued Statement of Financial Accounting
Standard No. 157, "Fair Value Measurements" (SFAS 157). The standard defines
fair value, outlines a framework for measuring fair value, and details the
required disclosures about fair value measurements. The standard is effective
for years beginning after November 15, 2007; therefore, we will adopt SFAS 157
effective April 1, 2008. We are evaluating the impact of SFAS 157.
In February 2007, the FASB issued SFAS No. 159, "The Fair Value Option for
Financial Assets and Financial Liabilities" (SFAS 159). SFAS 159 permits
entities to choose to measure many financial instruments and certain other items
at fair value and establishes presentation and disclosure requirements designed
to facilitate comparisons between entities that choose different measurement
attributes for similar types of assets and liabilities. SFAS 159 is effective
for us beginning April 1, 2008. The impact, if any, from the adoption of SFAS
159 has not been determined.
17
Notes to Consolidated Financial Statements
(continued)
In February 2007, the FASB issued SFAS No. 159, "The Fair Value Option for
Financial Assets and Financial Liabilities" (SFAS 159). SFAS 159 permits
entities to choose to measure many financial instruments and certain other items
at fair value and establishes presentation and disclosure requirements designed
to facilitate comparisons between entities that choose different measurement
attributes for similar types of assets and liabilities. SFAS 159 is effective
for us beginning April 1, 2008. The impact, if any, from the adoption of SFAS
159 has not been determined.
Net asset value at September 30, 2007 was $606,872,698, equivalent to
$156.04 per share. Assuming reinvestment of all dividends and tax credits on
retained long-term capital gains, less deferred taxes on unrealized appreciation
on investments in prior periods, the September 30, 2007 net asset value reflects
an increase of 10.6% during the past twelve months.
September 30, September 30,
2007 2006
---- ----
Net assets $606,872,698 $561,572,243
Shares outstanding 3,889,151 3,875,751
Net assets per share $156.04 $144.89
Item 2. Managements Discussion and Analysis of Financial Condition and Results
of Operations
Results of Operations
The composite measure of our financial performance in the Consolidated
Statements of Operations is captioned "Increase (decrease) in net assets from
operations" and consists of three elements. The first is "Net investment
income", which is the difference between our income from interest, dividends and
fees and our combined operating and interest expenses, net of applicable income
taxes. The second element is "Net realized gain on investments", which is the
difference between the proceeds received from disposition of portfolio
securities and their stated cost. The third element is the "Net increase
(decrease) in unrealized appreciation of investments", which is the net change
in the market or fair value of our investment portfolio, compared with stated
cost. It should be noted that the "Net realized gain on investments" and "Net
increase (decrease) 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
Interest income of $1,244,129 in the six months ended September 30, 2007
increased from $1,139,530 in the year-ago period due to an increase in excess
cash and interest rates. During the six months ended September 30, 2007 and
2006, we recorded dividend income from the following sources:
Six Months Ended
September 30
------------
2007 2006
---- ----
Alamo Group Inc. $ 339,096 $ 338,556
Dennis Tool Company 37,499 49,999
Encore Wire Corporation 163,470
Kimberly-Clark Corporation 81,811 75,636
Lifemark Group 150,000 300,000
PalletOne, Inc. 0 89,842
PETsMart, Inc. 18,000 18,000
The RectorSeal Corporation 240,000 480,000
TCI Holdings, Inc. 40,635 40,635
The Whitmore Manufacturing Company 60,000 120,000
Other 34,383 27,833
------------- -------------
$1,164,894 $1,540,501
============= =============
18
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations (continued)
Net Increase (Decrease) in Unrealized Appreciation of Investments
Set forth in the following table are the significant increases and
decreases in unrealized appreciation by portfolio company:
Three Months Ended Six Months Ended
September 30 September 30
------------ ------------
2007 2006 2007 2006
---- ---- ---- ----
Encore Wire Corporation $ -- $ -- $ 6,130,000 $ 8,174,000
Heelys, Inc. (130,442,000) 30,000,000 (139,760,000) 30,000,000
Media Recovery, Inc. (9,000,000) -- (9,000,000) --
Palm Harbor Homes, Inc. (7,855,000) (15,710,000) (7,855,000) (23,565,000)
The RectorSeal Corporation -- -- 10,850,000 --
During the six months ended September 30, 2007, the value of our investment
in Encore Wire Corporation was increased by $6,130,000 due to the company's
ability to cope with an increasingly volatile wire and cable market. The value
of our investment in The RectorSeal Corporation was increased by $10,850,000 due
to increased sales and earnings at the company derived largely from growing
demand for the smoke containment systems manufactured by its Smoke Guard
subsidiary.
Offsetting the gains at Encore and RectorSeal during the six months ended
September 30, 2007, was a $139,760,000 decline in the value of Heelys, Inc.,
which experienced significantly slower growth and an extreme decline in market
price during the past quarter; a $7,855,000 decline in the value of Palm Harbor
Homes, Inc. due to the deterioration of the manufactured housing market; and a
$9,000,000 decline in the value of Media Recovery, Inc. due to reduced sales and
earnings at the company.
Portfolio Investments
During the quarter ended September 30, 2007, we made additional investments
of $1,050,000 in an existing portfolio company.
We have agreed, subject to certain conditions, to invest up to $4,846,947
in four portfolio companies.
Financial Liquidity and Capital Resources
At September 30, 2007, we had cash and cash equivalents of approximately
$31.9 million. Pursuant to Small Business Administration (SBA) regulations, cash
and cash equivalents of $3.8 million held by Capital Southwest Venture
Corporation (CSVC) may not be transferred or advanced to us 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 $16.4 million. 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, we
have elected to retain all gains realized during the past 39 years. Retention of
future gains is viewed as an important source of funds to sustain our investment
activity. Approximately $65.2 million of our investment portfolio is represented
by unrestricted publicly-traded securities, and represent a source of liquidity.
Funds to be used by us for operating or investment purposes may be
transferred in the form of dividends, management fees or loans from Lifemark
Group, The RectorSeal Corporation and The Whitmore Manufacturing Company,
wholly-owned portfolio companies, to the extent of their available cash reserves
and borrowing capacities.
19
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations (continued)
Management believes that our cash and cash equivalents and cash available
from other sources described above are adequate to meet our expected
requirements. Consistent with our long-term strategy, the disposition of
investments from time to time may also be an important source of funds for
future investment activities.
Item 3. Quantitative and Qualitative Disclosure About Market Risk
We are subject to financial market risks, including changes in marketable
equity security prices. We do not use derivative financial instruments to
mitigate any of these risks.
Our investment performance is a function of our portfolio companies'
profitability, which may be affected by economic cycles, competitive forces,
foreign currency fluctuations and production costs including labor rates, raw
material prices and certain commodity prices. Most of the companies in our
investment portfolio do not hedge their exposure to raw material and commodity
price fluctuations. However, the portfolio company with the greatest exposure to
foreign currency fluctuations generally hedges its exposure. All of these
factors may have an adverse effect on the value of our investments on our net
asset value.
Our investment in portfolio securities includes fixed-rate debt securities
which totaled $9,913,348 at September 30, 2007, equivalent to 1.7% of the value
of our total investments. Generally these debt securities are below investment
grade and have relatively high fixed rates of interest; therefore, minor changes
in market yields of publicly-traded debt securities have little or no effect on
the values of debt securities in our portfolio and no effect on interest income.
Our investments in debt securities are generally held to maturity and their fair
values are determined on the basis of the terms of the debt security and the
financial condition of the issuer.
A portion of our investment portfolio consists of debt and equity
securities of private companies. We anticipate little or no effect on the values
of these investments from modest changes in public market equity valuations.
Should significant changes in market valuations of comparable publicly-owned
companies occur, there may be a corresponding effect on valuations of private
companies, which would affect the value and the amount and timing of proceeds
eventually realized from these investments. A portion of our investment
portfolio also consists of restricted common stocks of publicly-owned companies.
The fair values of these restricted securities are influenced by the nature of
applicable resale restrictions, the underlying earnings and financial condition
of the issuers of such restricted securities and the market valuations of
comparable publicly-owned companies. A portion of our investment portfolio also
consists of unrestricted, freely marketable common stocks of publicly-owned
companies. These freely marketable investments, which are valued at the public
market price, are directly exposed to equity price risks, in that a change in an
issuer's public market equity price would result in an identical change in the
fair value of our investment in such security.
Item 4. Controls and Procedures
An evaluation was performed under the supervision and with the
participation of our Management, including the President and Controller, of the
effectiveness of the design and operation of our disclosure controls and
procedures (as defined in Rules 13a-15 and 15d-15 of the Securities Exchange Act
of 1934). Based on that evaluation, the President and Controller concluded that
our disclosure controls and procedures were not effective due to a material
weakness in the Company's internal control over financial reporting ("ICFR")
disclosed in "Item 9A. Controls and Procedures" of the Company's Annual Report
on Form 10-K/A, for the fiscal year ended March 31, 2007. The following material
weakness is the basis for our conclusion:
20
Item 4. Controls and Procedures
(continued)
o We did not maintain an adequate process to assess and determine the
probability of the Company maintaining its qualifying status as a RIC
subject to subchapter M of the IRC over the next twelve months at any given
quarter.
To address this material weakness, Management will add a formal evaluation
to consider whether it is probable the company will not qualify as a RIC subject
to Subchapter M of the IRC over the next 12 months at any given quarter.
Additionally, the Company will review its investment gains quarterly and
calculate the tax impact on those gains it will retain, however, they will only
record the tax liability at the last day of the tax year. Management will also
determine, based on materiality, any footnote disclosure that may be required
during the interim periods. Furthermore, Management will review and assess
temporary and permanent differences for reclassification to "additional capital"
at each tax year end. When considered necessary by Management, an independent
attorney or accountant with requisite knowledge of investment company taxation
will be consulted in order to provide necessary guidance. Accordingly,
Management believes that the financial statements included in this report fairly
represent in all material respects the Company's financial position, results of
operations and cash flows for the periods presented. There were no changes in
the Company's internal control over financial reporting that have materially
affected, or are reasonably likely to materially affect our ICFR during the
fiscal quarter ended September 30, 2007.
PART II. OTHER INFORMATION
Item 1. Legal Proceedings
We are currently the subject of certain legal actions. In our judgment,
none of the lawsuits currently pending against us, either individually or in the
aggregate, is likely to have a material adverse effect on our business, results
of operations, or financial position.
We, Capital Southwest Corporation and Capital Southwest Venture
Corporation, have been named in a lawsuit filed on August 27, 2007 in the United
States District Court of the Northern District of Texas, Dallas Division,
against Heelys, Inc and its Chief Executive Officer, Chief Financial Officer and
the directors who signed its registration statement with the Securities and
Exchange Commission in connection with its December 7, 2006 initial public
offering ("IPO"), and its underwriters for the IPO. The complaint alleges
violations of Sections 11 and 15 of the Securities Act of 1933 and the
plaintiffs are seeking compensatory damages in an unspecified amount, as well as
reasonable costs and expenses incurred in the action, including counsel fees and
expert fees.
Four similar suits were also filed in September and October 2007 in the
United States District Court of the Northern District of Texas making
substantially similar allegations under Sections 11, 12 and 15 of the Securities
Act of 1933, and seeking substantially similar damages. These lawsuits have been
transferred to a single judge, and we expect that all the cases will be
consolidated into a single action, with a consolidated complaint filed shortly
thereafter.
We believe that the plaintiffs' claims are without merit, we deny the
allegations in the complaints, and we intend to vigorously defend the lawsuits.
Item 1A. Risk Factors
There have been no material changes to our risk factors as disclosed in
Item 1A, "Risk Factors", in our Annual Report on Form 10-K/A for the fiscal
year ended March 31, 2007.
21
Item 4. Submission of Matters to a Vote of Security Holders
Our Annual Meeting of Stockholders was held on July 16, 2007, with the following
results of elections and approval:
Votes Cast
-----------------------------------------
Against/ Abstentions/
For Withheld Non-Votes
--- -------- ---------
a. The following Directors were elected to serve
until the next Annual Meeting of Stockholders:
Donald W. Burton 3,390,519 25,241 473,391
Graeme W. Henderson 3,388,577 27,183 473,391
Samuel B. Ligon 3,390,069 25,691 473,391
Gary L. Martin 3,386,898 28,862 473,391
William R. Thomas 3,384,051 31,709 473,391
John H. Wilson 3,335,121 80,639 473,391
Votes Cast
-----------------------------------------
Against/ Abstentions/
For Withheld Non-Votes
--- -------- ---------
b. Grant Thornton LLP was approved as our
independent registered accounting firm
for the 2008 fiscal year. 3,412,395 516 476,240
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits
Exhibit 31.1- Certification of President 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.
Exhibit 31.2- Certification of Controller required by Rule
13a-14(a) or Rule 15d-14(a) of the Exchange Act, filed herewith.
Exhibit 32.1- Certification of President 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 32.2- Certification of Controller 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.
(b) Reports on Form 8-K We filed the following Current Reports on Forms 8-K
with the SEC during the quarter ended September 30, 2007:
Current report on Form 8-K filed with the SEC on July 18, 2007
relating to the resignation of Susan K. Hodgson as
Secretary-Treasurer (Chief Financial Officer), effective August
6, 2007; and naming Jeffrey G. Peterson as Secretary of the
Corporation.
Current report on Form 8-K filed with the SEC on September 24,
2007 relating to the arrival of Tracy Morris as Controller
serving as the Chief Financial Officer of the Corporation.
22
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
CAPITAL SOUTHWEST CORPORATION
Date: January 9, 2008 By: /s/ Gary L. Martin
-------------------- ----------------------------------
Gary L. Martin, President
(chief executive officer)
Date: January 9, 2008 By: /s/ Tracy L. Morris
-------------------- ----------------------------------
Tracy L. Morris, Controller
(chief financial/accounting)
Exhibit 31.1
CERTIFICATIONS
I, Gary L. Martin, President of Capital Southwest Corporation, certify that:
1. I have reviewed this quarterly report on Form 10-Q 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: January 9, 2008 By: /s/ Gary L. Martin
--------------- -------------------------
Gary L. Martin, President
Exhibit 31.2
CERTIFICATIONS
I, Tracy L. Morris, Controller of Capital Southwest Corporation, certify that:
1. I have reviewed this quarterly report on Form 10-Q 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: January 9, 2008 By: /s/ Tracy L. Morris
--------------- --------------------------
Tracy L. Morris, Controller
Exhibit 32.1
Certification of President and Chief Executive Officer
Pursuant to Section 1350 of Chapter 63 of Title 18 of the United States Code
I, Gary L. Martin, President of the Board of Capital Southwest Corporation,
certify that, to my
knowledge:
1. the Form 10-Q, filed with the Securities and Exchange Commission on January
9, 2008 ("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: January 9, 2008 By: /s/ Gary L. Martin
--------------- ------------------------------------
Gary L. Martin, President
Exhibit 32.2
Certification of Controller
Pursuant to Section 1350 of Chapter 63 of Title 18 of the United States Code
I, Tracy L. Morris, Controller of Capital Southwest Corporation, certify
that, to my knowledge:
1. the Form 10-Q, filed with the Securities and Exchange Commission on January
9, 2008 ("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: January 9 , 2008 By: /s/ Tracy L. Morris
--------------- ------------------------------
Tracy L. Morris, Controller