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 December 31, 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 31, 2008
TABLE OF CONTENTS
Page No.
--------
PART I. FINANCIAL INFORMATION
ITEM 1. Consolidated Financial Statements (1)
Consolidated Statements of Financial Condition
December 31, 2007 (Unaudited) and March 31, 2007.........3
Consolidated Statements of Operations (Unaudited) For the three
and nine months ended December 31, 2007 and
December 31, 2006........................................4
Consolidated Statements of Changes in Net Assets
For the nine months ended December 31, 2007 (Unaudited)
and year ended March 31, 2007............................5
Consolidated Statements of Cash Flows (Unaudited) For the three
and nine months ended December 31, 2007 and
December 31, 2006........................................6
Consolidated Statement of Investments
December 31, 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....................................21
PART II. OTHER INFORMATION
ITEM 1 Legal Proceedings........................................22
ITEM 1A. Risk Factors...............................................22
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 December 31, 2007 March 31, 2007
------------- -------------
(Unaudited) as restated
Investments at market or fair value
Companies more than 25% owned
(Cost: December 31, 2007 - $28,758,246
March 31, 2007 - $28,632,356) $ 362,231,558 $ 526,993,983
Companies 5% to 25% owned
(Cost: December 31, 2007 - $20,412,243,
March 31, 2007 - $18,798,896) 48,765,256 76,398,002
Companies less than 5% owned
(Cost: December 31, 2007 - $31,190,721,
March 31, 2007 - $24,211,045) 93,097,989 77,763,048
------------- -------------
Total investments
(Cost: December 31, 2007- $80,361,210,
March 31, 2007 - $71,642,297) 504,094,803 681,155,033
Cash and cash equivalents 31,949,168 38,844,203
Receivables 258,171 337,892
Other assets 9,477,698 9,170,185
------------- -------------
Totals $ 545,779,840 $ 729,507,313
============= =============
Liabilities and Shareholders' Equity
Other liabilities $ 1,452,545 $ 1,457,847
Deferred income taxes 2,403,277 2,317,777
------------- -------------
Total liabilities 3,855,822 3,775,624
------------- -------------
Shareholders' equity
Common stock, $1 par value: authorized,
5,000,000 shares; issued, 4,326,516 shares
at December 31, 2007 and 4,323,416 shares
at March 31, 2007 4,326,516 4,323,416
Additional capital 116,777,926 116,373,960
Undistributed net investment income 6,979,403 5,655,020
Undistributed net realized loss on investments (2,860,118) (3,100,142)
Unrealized appreciation of investments 423,733,593 609,512,737
Treasury stock - at cost (437,365 shares) (7,033,302) (7,033,302)
------------- -------------
Net assets at market or fair value, equivalent
to $139.34 per share at December 31, 2007
on the 3,889,151 shares outstanding and $186.75
per share at March 31, 2007 on the 3,886,051
shares outstanding 541,924,018 725,731,689
------------- -------------
Totals $ 545,779,840 $ 729,507,313
============= =============
(See Notes to Consolidated Financial Statements)
3
CAPITAL SOUTHWEST CORPORATION
AND SUBSIDIARIES
Consolidated Statements of Operations
-------------------------------------
(Unaudited)
Three Months Ended Nine Months Ended
December 31 December 31
------------------------------ ------------------------------
2007 2006 2007 2006
------------- ------------- ------------- -------------
as restated as restated
Investment income:
Interest $ 552,950 $ 484,888 $ 1,797,079 $ 1,624,418
Dividends 1,838,757 1,626,702 3,003,651 3,167,203
Management and directors' fees 222,449 163,750 673,849 542,150
------------- ------------- ------------- -------------
2,614,156 2,275,340 5,474,579 5,333,771
------------- ------------- ------------- -------------
Operating expenses:
Salaries 380,247 310,127 945,468 973,926
Net pension benefit (81,837) (36,237) (245,508) (108,708)
Other operating expenses 481,128 238,504 1,034,286 690,469
------------- ------------- ------------- -------------
779,538 512,394 1,734,246 1,555,687
------------- ------------- ------------- -------------
Income before interest expense and
income taxes 1,834,618 1,762,946 3,740,333 3,778,084
Interest expense -- 133,749 -- 458,953
------------- ------------- ------------- -------------
Income before income taxes 1,834,618 1,629,197 3,740,333 3,319,131
Income tax expense 28,500 12,700 82,660 40,724
------------- ------------- ------------- -------------
Net investment income $ 1,806,118 $ 1,616,497 $ 3,657,673 $ 3,278,407
============= ============= ============= =============
Proceeds from disposition of investments $ 670,339 $ 31,578,052 $ 1,398,891 $ 42,020,132
Cost of investments sold 1,158,868 12,046,678 1,158,868 12,872,995
------------- ------------- ------------- -------------
Net realized gain (loss) on investments
before taxes (488,528) 19,531,374 240,024 29,147,137
Income tax expense -- 11,080,699 -- 11,080,699
------------- ------------- ------------- -------------
Net realized gain (loss) on investments (488,528) 8,450,675 240,024 18,066,438
Net increase (decrease) in unrealized
appreciation of investments (64,798,599) 132,210,244 (185,779,143) 124,061,543
------------- ------------- ------------- -------------
Net realized and unrealized gain (loss)
on investments $ (65,287,127) $ 140,660,919 $(185,539,119) $ 142,127,981
============= ============= ============= =============
Increase (decrease) in net assets
from operations $ (63,481,009) $ 142,277,416 $(181,881,446) $ 145,406,388
============= ============= ============= =============
(See Notes to Consolidated Financial Statements)
4
CAPITAL SOUTHWEST CORPORATION
AND SUBSIDIARIES
Consolidated Statements of Changes in Net Assets
------------------------------------------------
Nine Months Ended Year Ended
December 31, 2007 March 31, 2007
------------- -------------
(Unaudited) as restated
Operations
Net investment income $ 3,657,673 $ 4,233,340
Net realized gain on investments 240,024 14,966,296
Net increase (decrease) in unrealized
appreciation of investments (185,779,143) 147,681,609
------------- -------------
Increase (decrease) in net assets from operations (181,881,446) 166,881,245
Distributions from:
Undistributed net investment income (2,333,291) (2,323,150)
Net realized gains deemed distributed to shareholders -- (11,417,283)
Capital share transactions
Allocated increase in share value for deemed
distribution -- 11,417,283
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 175,676 169,003
------------- -------------
Increase (decrease) in net assets (183,807,671) 167,695,699
Net assets, beginning of period as restated 725,731,689 558,035,990
------------- -------------
Net assets, end of period $ 541,924,018 $ 725,731,689
============= =============
(See Notes to Consolidated Financial Statements)
5
CAPITAL SOUTHWEST CORPORATION
AND SUBSIDIARIES
Consolidated Statements of Cash Flows
-------------------------------------
(Unaudited)
Three Months Ended Nine Months Ended
December 31 December 31
----------- -----------
2007 2006 2007 2006
------------- ------------- ------------- -------------
as restated as restated
Cash flows from operating activities
Increase (decrease) in net assets from
operations $ (63,481,009) $ 142,277,416 $(181,881,446) $ 145,406,388
Adjustments to reconcile increase in net
assets from operations to net cash
provided by (used in ) operating activities:
Proceeds from disposition of investments 670,339 31,578,052 1,398,891 42,020,132
Purchases of securities (817,186) (4,500) (10,032,280) (374,730)
Maturities of securities -- -- 154,500 884,936
Depreciation and amortization 8,089 4,426 18,770 12,313
Net pension benefit (81,837) (36,237) (245,508) (108,708)
Realized (gain) loss on investments after
income taxes 488,528 (8,450,675) (240,024) (18,066,438)
Net (increase) decrease in unrealized
appreciation of investments 64,798,599 (132,210,244) 185,779,143 (124,061,543)
Stock option expense 87,989 43,586 175,676 125,417
(Increase) decrease in receivables (155,215) (105,087) 79,720 (152,372)
(Increase) decrease in other assets (11,451) 3,391 (41,859) (14,597)
Increase (decrease) in other liabilities 132,468 38,330 57,084 (46,526)
Decrease in accrued pension cost (34,467) (36,567) (101,301) (107,602)
Increase in deferred income taxes 28,500 12,700 85,500 38,100
------------- ------------- ------------- -------------
Net cash provided by (used in) operating
activities 1,633,347 33,114,591 (4,793,134) 45,554,770
------------- ------------- ------------- -------------
Cash flows from financing activities
Decrease in notes payable to bank -- -- -- --
Distributions from undistributed net
investment income (1,555,661) (1,551,100) (2,333,291) (2,323,150)
Proceeds from exercise of employee
stock options -- 697,350 231,390 1,794,850
------------- ------------- ------------- -------------
Net cash used in financing activities (1,555,661) (853,750) (2,101,901) (528,300)
------------- ------------- ------------- -------------
Net increase (decrease) in cash and cash
equivalents 77,686 32,260,841 (6,895,035) 45,026,470
Cash and cash equivalents at beginning
of period 31,871,482 24,269,495 38,844,203 11,503,866
------------- ------------- ------------- -------------
Cash and cash equivalents at end of period $ 31,949,168 $ 56,530,336 $ 31,949,168 $ 56,530,336
============= ============= ============= =============
Supplemental disclosure of cash flow information:
Cash paid during the period for:
Interest $ -- $ 133,749 $ -- $ 458,953
Income taxes $ -- $ -- $ -- $ 20,000
(See Notes to Consolidated Financial Statements)
6
CAPITAL SOUTHWEST CORPORATION
AND SUBSIDIARIES
Consolidated Statement of Investments
-------------------------------------
December 31, 2007
Company Investment (a) Cost Value (b)
- ------------------------------------------------------------------------------------------------------------------------------------
+AT&T INC. ++20,770 shares common stock (acquired 3-9-99) $ 12 $ 863,201
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 38,209,050
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
Austin, 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.
+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) 2,363,347 1,000,000
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
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) - -
--------- ---------
6,363,347 1,000,002
7
CAPITAL SOUTHWEST CORPORATION
AND SUBSIDIARIES
Consolidated Statement of Investments
-------------------------------------
December 31, 2007
(continued)
Company Investment (a) Cost Value (b)
- ------------------------------------------------------------------------------------------------------------------------------------
+COMCAST CORPORATION ++64,656 shares common stock (acquired 11-18-02) $ 21 $ 1,180,619
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 1,770,280
Englewood, Colorado
Provider of creative
content, media management
and network services
worldwide.
+EMBARQ CORPORATION ++4,500 shares common stock (acquired 5-17-06) 46,532 222,885
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 44,954,250
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 $29.00 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 $29.00 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 $29.00 per share, expiring 2008 (acquired 8-11-98
videos. thru 9-30-03) - 375,000
--------- ---------
3,000,000 9,566,000
+FMC CORPORATION ++12,860 shares common stock (acquired 6-6-86 and 9-13-07) 66,726 701,513
Philadelphia, Pennsylvania
Chemicals for agricultural,
industrial and consumer
markets.
+FMC TECHNOLOGIES, INC. ++22,114 shares common stock (acquired 1-2-02 and 8-31-07) 57,051 1,253,864
Houston, Texas
Equipment and systems for
the energy, food processing
and air transportation
industries.
8
CAPITAL SOUTHWEST CORPORATION
AND SUBSIDIARIES
Consolidated Statement of Investments
-------------------------------------
December 31, 2007
(continued)
Company Investment (a) Cost Value (b)
- ------------------------------------------------------------------------------------------------------------------------------------
+HEELYS, INC. 9,317,310 shares common stock (acquired 5-26-00) 102,490 37,269,240
Carrollton, Texas
Heelys stealth skate shoes,
equipment and apparel sold
through sporting goods
chains, department stores
and footwear retailers.
+HOLOGIC, INC. ++316,410 shares common stock (acquired 8-27-99) 220,000 21,712,054
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 5,351,661
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 1,664,125
Englewood, Colorado ++42,463 shares Series C common stock (acquired 9-6-05) 100,870 1,552,023
Owns interests in broadband, --------- ---------
distribution and content 207,423 3,216,148
companies.
+LIBERTY MEDIA CORPORATION ++35,250 shares of Liberty Capital Series A common stock
Englewood, Colorado (acquired 5-9-06) 51,829 4,106,273
Holding company owning ++176,252 shares of Liberty Interactive Series A common stock
interests in electronic (acquired 5-9-06) 66,424 3,362,888
retailing, media, communi- --------- ---------
cations and entertainment 118,253 7,469,161
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,
Dallas, 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 51,058,287
Dallas, Texas
Integrated manufacturing,
retailing, financing and
insuring of manufactured
housing and modular homes.
9
CAPITAL SOUTHWEST CORPORATION
AND SUBSIDIARIES
Consolidated Statement of Investments
-------------------------------------
December 31, 2007
(continued)
Company Investment (a) Cost Value (b)
- ------------------------------------------------------------------------------------------------------------------------------------
+PETSMART, INC. ++300,000 shares common stock (acquired 6-1-95) $ 1,318,771 $ 7,056,000
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) 52,600 120,000,000
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 1,181,700
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 8,906,843
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 1,118 shares Series C preferred stock (acquired 11-01-07) 281,523 281,523
Designer, manufacturer and --------- -------
distributor of high-quality 4,840,523 281,525
office seating.
WELLOGIX, INC. 4,664,627 shares Series A-1 convertible participating
Houston, Texas preferred stock, convertible into 4,664,627 shares
Developer and supporter of of common stock at $1.1011 per share (acquired
software used by the oil and 8-19-05 thru 12-15-07) 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 28,000,000
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) 19,656 119,537
Little Rock, Arkansas
Provider of voice, broadband
and entertainment
services.
10
CAPITAL SOUTHWEST CORPORATION
AND SUBSIDIARIES
Consolidated Statement of Investments
-------------------------------------
December 31, 2007
(continued)
Company Investment (a) Cost Value (b)
- ------------------------------------------------------------------------------------------------------------------------------------
MISCELLANEOUS - BankCap Partners Fund I, L.P. - 6.0% limited
partnership interest (acquired 7-14-06 thru 12-21-07) $ 2,457,140 $ 2,457,140
- 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) - 195,000
- 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 $ 80,361,210 $504,094,803
============= ============
- ------------------------------------------------------------------------------------------------------------------------------------
+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 December 31, 2007, restricted securities represented
approximately 87.9% 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") 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 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 realized
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 conditions as of March 31, 2007; the
consolidated statement of operations and consolidated statement of cash flows
for the three months and nine months ended December 31, 2006; the consolidated
statement of changes in net assets for the nine months ended December 31, 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 than 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
12
Notes to Consolidated Financial Statements
(continued)
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 contributuions 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 "undistsributed net
realized gains on investment."
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; reclassify return of
capital contributions to "additional capital."
As of March 31, 2007
--------------------
Previously
Consolidated Statement of Financial Condition Reported (3) As Restated (2)
- --------------------------------------------- ----------- -----------
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 11,221,601 116,343,960 (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
=========== ============
Nine Months Ended December 31, 2006
-----------------------------------
Previously
Consolidated Statement of Operations Reported (1) As Restated (2)
- ------------------------------------ ----------- -----------
Net investment income 3,278,407 3,278,407
Net realized gain on investments 29,147,137 29,147,137 (B)
Income tax expense 10,098,046 11,080,699
----------- -----------
Net realized gain on investments 19,049,091 18,066,438
Increase in unrealized appreciation of investments 124,061,543 124,061,543 (A)
Increase in deferred income taxes on appreciation
of investments 43,017,000 --
----------- -----------
Net increase in unrealized appreciation of investments 81,044,543 124,061,543
Net realized and unrealized gain on investments 100,093,634 142,127,981
----------- -----------
Increase in net assets from operations 103,372,041 145,406,388
=========== ===========
Three Months Ended December 31, 2006
------------------------------------
Previously
Consolidated Statement of Operations Reported (1) As Restated (2)
- ------------------------------------ ----------- -----------
Net investment income 1,616,497 1,616,497
Net realized gain on investments 12,805,347 8,450,675 (B)
Net decrease in unrealized appreciation of investments 86,187,244 132,210,244 (A)
----------- -----------
Net realized and unrealized gain on investments 98,992,591 140,660,919
----------- -----------
Increase in net assets from operations 100,609,088 142,277,416
=========== ===========
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
============ ============
Nine Months Ended December 31, 2006
-----------------------------------
Previously
Consolidated Statement of Changes in Net Assets Reported (1) As Restated (2)
- ----------------------------------------------- ------------ ------------
Net investment income 3,278,407 3,278,407
Net realized gain on investments 19,049,091 18,066,438 (B)
Net increase in unrealized appreciation of investments 81,044,543 124,061,543 (A)
------------ ------------
Increase in net assets from operations 103,372,041 145,406,388
Distributions from undistributed net investment income (2,323,150) (2,323,150)
Capital share transactions
Exercise of employee stock options 1,794,850 1,794,850
Adjustment to initially apply FASB No. 158, net of tax -- --
Stock option expense 125,417 125,417
------------ ------------
Increase in net assets 102,969,158 145,003,505
Net assets, beginning of year 396,618,109 558,035,990
------------ ------------
Net assets, end of year 499,587,267 703,039,495
============ ============
Net asset value, per share $ 128.56 $ 180.91
============ ============
Nine Months Ended December 31, 2006
-----------------------------------
Previously
Consolidated Statement of Cash Flow Reported (1) As Restated (2)
- ----------------------------------- ------------ ------------
Net cash provided by operating activities 45,554,770 45,554,770
----------- -----------
Net cash used in financing activities (528,300) (528,300)
----------- -----------
Net increase in cash and cash equivalents 45,026,470 45,026,470
=========== ===========
14
Notes to Consolidated Financial Statements
(continued)
Three Months Ended December 31, 2006
Previously
Consolidated Statement of Cash Flow Reported (1) As Restated (2)
- ----------------------------------- ----------- -----------
Net cash provided by operating activities 33,114,591 33,114,591
Net cash used in financing activities (853,750) (853,750)
----------- -----------
Net decrease in cash and cash equivalents 32,260,841 32,260,841
=========== ===========
- ------------------
(1) As presented in the Company's original Form 10-Q for the quarter ended
December 31, 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. Income Taxes
For the tax years ended December 31, 2007 and 2006, Capital Southwest
Corporation ("CSC") and Capital Southwest Venture Corporation ("CSVC") qualified
to be taxed as RICs. We intend to meet the applicable qualifications to be taxed
as a RIC in future years; management feels it is probable that we will maintain
our RIC status for a period longer than one year. However, either company's
ability to meet certain portfolio diversification requirements of RICs in future
years may not be controllable by such company.
As permitted by the Internal Revenue Code, a RIC can designate dividends
paid in the subsequent tax year as dividends of the current year ordinary
taxable income and long-term capital gains if those dividends are both declared
by the extended due date of the RIC's federal income tax return and paid to
shareholders by the last day of the subsequent tax year. For the tax years ended
December 31, 2007 and 2006 we declared and paid dividends in the amounts of
$2,333,291 and $2,323,150, respectively.
Additionally, we are also subject to a nondeductible federal excise tax of
4% if we do not distribute at least 98% of our investment company ordinary
taxable income during our tax year. For the tax years ended December 31, 2007
and 2006 we distributed 100% of our investment company ordinary taxable income.
As a result we have made no provision for income taxes on ordinary taxable
income for the tax years ended December 31, 2007 and 2006.
For the tax year ended December 31, 2007, we have an estimated net
long-term capital loss of $961,655 for tax purposes and $860,118 for book
purposes, which will be carried forward and offset by future net long-term
capital gains. For the tax year ended December 31, 2006, we had net long-term
capital gains of $31,659,140 for tax purposes and $31,932,775 for book purposes,
which we elected to retain and treat as a deemed distribution to our
shareholders. In order to make the election to retain capital gains, we incurred
and paid a federal tax on behalf of our shareholders of $11,080,699 for the tax
year ended December 31, 2006.
CSMC, a wholly owned subsidiary of CSC, is not a RIC and is required to pay
taxes at the current corporate rate. The Company sponsors a qualified defined
benefit pension plan which covers its employees and employees of certain of its
wholly owned portfolio companies. Deferred taxes related to the qualified
defined pension plan are recorded as incurred.
15
Notes to Consolidated Financial Statements
(continued)
4. 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
nine months ended December 31, 2007, we recognized compensation expense of
$87,988 and $175,676, respectively.
As of December 31, 2007, the total remaining unrecognized compensation cost
related to non-vested stock options was $1,883,824, which will be amortized over
the weighted-average service period of approximately 6.2 years.
5. 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 December 31, 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 $31.28 per option 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 $33.05 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 $41.78 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 $ 86.18
Granted 25,000 152.98
Exercised (3,100) 74.64
Canceled (4,000) 93.49
------- -------
Balance at December 31, 2007 70,400 $109.99
======= =======
16
Notes to Consolidated Financial Statements
(continued)
At December 31, 2007, the range of exercise prices and weighted-average
remaining contractual life of outstanding options was $65.00 to $152.98 and 6.16
years, respectively. The total intrinsic value of options exercised during the
nine months ended December 31, 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 nine months ended December
31, 2007.
At December 31, 2007, the number of options exercisable was 9,930 and the
weighted-average exercise price of those options was $79.01.
6. Summary of Per Share Information
Three Months Ended Nine Months Ended
December 31 December 31
----------- -----------
2007 2006 2007 2006
--------- --------- --------- ---------
as restated as restated
Investment income $ .67 $ .59 $ 1.41 $ 1.37
Operating expenses (.20) (.13) (.46) (.40)
Interest expense -- (.04) -- (.12)
Income taxes (.01) -- (.01) (.01)
--------- --------- --------- ---------
Net investment income .46 .42 .94 .84
Distributions from undistributed
net investment income (.40) (.40) (.60) (.60)
Net realized gains deemed distributed to
shareholders -- (2.94) -- (2.94)
Net realized gain on investments (.12) 2.17 .06 4.66
Net increase (decrease) in unrealized
appreciation of investments (16.66) 34.02 (47.77) 31.92
Allocated increase in share value for
deemed distributions -- 2.94 -- 2.94
Exercise of employee stock options * -- (.20) (.09) (.50)
Stock option expense .02 .01 .05 .03
--------- --------- --------- ---------
Increase (decrease) in net asset value (16.70) 36.02 (47.41) 36.35
Net asset value:
Beginning of period 156.04 144.89 186.75 144.56
--------- --------- --------- ---------
End of period $139.34 $180.91 $139.34 $180.91
========= ========= ========= =========
Shares outstanding at end of period
(000s omitted) 3,889 3,886 3,889 3,886
* Net decrease is due to the exercise of employee stock options at prices
less than beginning of period net asset value.
7. Subsequent Events
On January 9, 2008, the Company filed its Form 10-Q for the quarter ended
September 30, 2007 with the Securities and Exchange Commission and NASDAQ.
Additionally, the Company filed its restated Form 10-K/A for the year ended
March 31, 2007 and Form 10-Q/A for the quarter ended June 30, 2007 with the
Securities and Exchange Commission as explained in Note 2 "Restatement."
On January 10, 2008, the Company received a "moot" letter from NASDAQ
informing it that its filing delinquency had been cured. Accordingly, the
Company is in compliance with Rule 4310(c) (14).
17
Notes to Consolidated Financial Statements
(continued)
8. Recent Accounting Pronouncements
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. We are evaluating the impact of SFAS 159. The
impact, if any, from the adoption of SFAS 159 has not been determined.
Net asset value at December 31, 2007 was $541,924,018, equivalent to
$139.34 per share. Assuming reinvestment of all dividends and tax credits on
retained long-term capital gains, the December 31, 2007 net asset value reflects
a decrease of 22.63% during the past twelve months.
December 31, December 31,
2007 2006
---- ----
as restated
Net assets $541,924,018 $703,039,495
Shares outstanding 3,889,151 3,886,051
Net assets per share $139.34 $180.91
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 (loss) 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 (loss)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 "unrealized" to
"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 $1,797,079 for the nine months ended December 31, 2007
increased from $1,624,418 for nine months ended December 31, 2006, due to an
increase in excess cash and interest rates. During the nine months ended
December 31, 2007 and 2006, we recorded dividend income from the following
sources:
18
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations (continued)
Nine Months Ended
December 31
-----------
2007 2006
---- ----
Alamo Group Inc. $ 508,914 $ 507,834
Balco, Inc. 224,400 --
Dennis Tool Company 49,999 62,499
Encore Wire Corporation 245,205 --
Kimberly-Clark Corporation 122,716 113,455
Lifemark Group 571,333 450,000
PalletOne, Inc. -- 89,842
PETsMart, Inc. 27,000 27,000
The RectorSeal Corporation 914,133 1,629,947
TCI Holdings, Inc. 60,953 60,953
The Whitmore Manufacturing Company 228,533 180,000
Other 50,465 45,673
----------- -----------
$ 3,003,651 $ 3,167,203
=========== ===========
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 Nine Months Ended
December 31 December 31
----------- -----------
2007 2006 2007 2006
---- ---- ---- ----
Alamo Group, Inc. $ (9,905,950) $ -- $ (9,878,840) $ --
Encore Wire Corporation (30,650,750) (28,608,000) (24,520,750) (20,434,000)
Heelys, Inc. (18,634,760) 135,681,510 (158,394,760) 165,681,510
Palm Harbor Homes, Inc. (11,782,713) (3,928,000) (19,637,713) (27,493,000)
The RectorSeal Corporation 11,150,000 10,500,000 22,000,000 10,500,000
During the nine months ended December 31, 2007, the value of our investment
in The RectorSeal Corporation was increased by $22,000,000 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 gain at RectorSeal during the nine months ended December 31,
2007, was a $158,394,760 decline in the value of Heelys, Inc., which experienced
significantly slower growth and an extreme decline in market price during the
past quarter; a $24,520,750 decline in the value of Encore Wire Corporation due
to reduced demand attributable to the residential slowdown and declining margins
needed to be competitive; a $19,637,713 decline in the value of Palm Harbor
Homes, Inc. due to the deterioration of the manufactured housing market; and a
$9,878,840 decline in the value of Alamo Group, Inc. due to inventory shortages
that are back logged and excessive startup expenses for the manufacturing of its
sweeper line.
Portfolio Investments
During the quarter ended December 31, 2007, we made additional investments
of $817,186 in an existing portfolio company.
We have agreed, subject to certain conditions, to invest up to $6,029,760
in three portfolio companies.
19
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations (continued)
Financial Liquidity and Capital Resources
At December 31, 2007, we had cash and cash equivalents of approximately
$31.9 million. Pursuant to Small Business Administration (SBA) regulations, cash
and cash equivalents of $4.6 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 $61.0 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.
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 $9,000,000 at December 31, 2007, equivalent to 1.8% 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.
20
Item 3. Quantitative and Qualitative Disclosure About Market Risk
(continued)
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:
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 December 31, 2007.
21
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.
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
No reports on Form 8-K have been filed during the quarter for which
this report is filed.
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
/s/ Gary L. Martin
Date: February 8, 2008 By:
-------------------------- ------------------------------
Gary L. Martin, President
(chief executive officer)
/s/ Tracy L. Morris
Date: February 8, 2008 By:
-------------------------- ------------------------------
Tracy L. Morris, Controller
(chief financial/accounting)
23
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: February 8, 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: February 8, 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
February 8, 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: February 8, 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
February 8, 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: February 8, 2008 By: /s/ Tracy L. Morris
---------------- -----------------------------
Tracy L. Morris, Controller