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, 2008
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 Exchange 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.
3,741,638 shares of Common Stock, $1 par value, as of October 31, 2008
TABLE OF CONTENTS
Page No.
--------
PART I. FINANCIAL INFORMATION
ITEM 1. Consolidated Financial Statements
Consolidated Statements of Financial Condition
September 30, 2008 (Unaudited) and March 31, 2008..............3
Consolidated Statements of Operations (Unaudited)
For the three and six months ended September 30, 2008 and
September 30, 2007.............................................4
Consolidated Statements of Changes in Net Assets
For the six months ended September 30, 2008 (Unaudited) and
year ended March 31, 2008......................................5
Consolidated Statements of Cash Flows (Unaudited) For the three and
six months ended September 30, 2008 and
September 30, 2007.............................................6
Portfolio of Investments
September 30, 2008.............................................7
Notes to Consolidated Financial Statements.............................14
ITEM 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations.....................19
ITEM 3. Quantitative and Qualitative Disclosure About
Market Risk.............................................21
ITEM 4. Controls and Procedures.....................................21
PART II. OTHER INFORMATION
ITEM 1 Legal Proceedings............................................22
ITEM 1A. Risk Factors...................................................22
ITEM 4. Submission of Matters to Vote of Security Holders...........22
ITEM 6. Exhibits ...................................................23
Signatures ...................................................................24
PART I. FINANCIAL INFORMATION
- -------------------------------
Item 1. Consolidated Financial Statements
CAPITAL SOUTHWEST CORPORATION AND SUBSIDIARIES
Consolidated Statements of Financial Condition
----------------------------------------------
September 30, March 31,
2008 2008
------------- -------------
(Unaudited)
Assets
Investments at market or fair value
Companies more than 25% owned
(Cost: September 30, 2008 - $28,908,246
March 31, 2008 - $28,758,246) $387,275,539 $410,026,178
Companies 5% to 25% owned
(Cost: September 30, 2008 - $20,412,243,
March 31, 2008 - $20,412,243) 57,671,133 54,895,381
Companies less than 5% owned
(Cost: September 30, 2008 - $35,762,756,
March 31, 2008 - $31,856,977) 75,452,373 82,648,943
------------- -------------
Total investments
(Cost: September 30, 2008- $85,083,245,
March 31, 2008 - $81,027,466) 520,399,045 547,570,502
Cash and cash equivalents 9,400,652 31,327,758
Receivables 623,338 156,322
Other assets 7,820,058 7,630,486
------------- -------------
Totals $538,243,093 $586,685,068
============= =============
Liabilities and Shareholders' Equity
Other liabilities $ 2,323,461 $ 1,187,796
Deferred income taxes 1,841,358 1,797,058
------------- -------------
Total liabilities 4,164,819 2,984,854
------------- -------------
Shareholders' equity
Common stock, $1 par value: authorized,
5,000,000 shares; issued, 4,326,516 shares
at September 30, 2008 and March 31, 2008 4,326,516 4,326,516
Additional capital 115,907,746 115,687,153
Undistributed net investment income 5,373,019 7,036,929
Undistributed net realized loss on investments (2,908,159) (2,860,118)
Unrealized appreciation of investments 435,315,800 466,543,036
Treasury stock - at cost 584,878 shares at September
30, 2008 and 437,365 shares at March 31, 2008 (23,936,648) (7,033,302)
------------- -------------
Net assets at market or fair value, equivalent
to $142.74 per share at September 30, 2008 on the
3,741,638 shares outstanding and $150.09
per share at March 31, 2008 on the 3,889,151
shares outstanding 534,078,274 583,700,214
------------- -------------
Totals $538,243,093 $586,685,068
============= =============
The accompanying Notes are an integral part of these
Consolidated Financial Statements
3
CAPITAL SOUTHWEST CORPORATION
AND SUBSIDIARIES
Consolidated Statements of Operations
-------------------------------------
(Unaudited)
Three Months Ended Six Months Ended
September 30 September 30
----------------------------- ------------------------------
2008 2007 2008 2007
---- ---- ---- ----
Investment income:
Interest $ 327,171 $ 679,442 $ 677,023 $ 1,244,129
Dividends 677,999 801,467 1,335,479 1,164,894
Management and directors' fees 311,108 226,200 542,108 451,400
------------- ------------- ------------- -------------
1,316,278 1,707,109 2,554,610 2,860,423
------------- ------------- ------------- -------------
Operating expenses:
Salaries 439,480 291,085 777,919 565,221
Net pension benefit (44,779) (127,434) (126,617) (163,671)
Other operating expenses 435,192 288,194 804,437 553,158
------------- ------------- ------------- -------------
829,893 451,845 1,455,739 954,708
------------- ------------- ------------- -------------
Income before income taxes 486,385 1,255,264 1,098,871 1,905,715
Income tax expense 57,343 44,400 84,630 54,160
------------- ------------- ------------- -------------
Net investment income $ 429,042 $ 1,210,864 $ 1,014,241 $ 1,851,555
============= ============= ============= =============
Proceeds from disposition of investments $ -- $ 402,777 $ -- $ 728,552
Cost of investments sold 48,041 -- 48,041 --
------------- ------------- ------------- -------------
Net realized gain (loss) on investments (48,041) 402,777 (48,041) 728,552
------------- ------------- ------------- -------------
Net decrease in unrealized
appreciation of investments (30,970,122) (138,128,989) (31,227,236) (120,980,544)
------------- ------------- ------------- -------------
Net realized and unrealized loss
on investments $(31,018,163) $(137,726,212) $(31,275,277) $(120,251,992)
============= ============= ============= =============
Decrease in net assets from operations $(30,589,121) $(136,515,348) $(30,261,036) $(118,400,437)
============= ============= ============= =============
The accompanying Notes are an integral part of these
Consolidated Financial Statements
4
CAPITAL SOUTHWEST CORPORATION
AND SUBSIDIARIES
Consolidated Statements of Changes in Net Assets
------------------------------------------------
Six Months Ended Year Ended
September 30, 2008 March 31, 2008
------------------ --------------
(Unaudited)
Operations
Net investment income $ 1,014,241 $ 3,715,200
Net realized gain (loss) on investments (48,041) 240,024
Net decrease in unrealized appreciation
of investments (31,227,236) (142,969,698)
------------- -------------
Decrease in net assets from operations (30,261,036) (139,014,474)
Distributions from:
Undistributed net investment income (2,678,152) (2,333,291)
Capital share transactions:
Exercise of employee stock options -- 231,390
Change in pension plan funded status -- (1,178,764)
Stock option expense 220,594 263,664
Treasury stock (16,903,346) --
------------- -------------
Decrease in net assets (49,621,940) (142,031,475)
Net assets, beginning of period 583,700,214 725,731,689
------------- -------------
Net assets, end of period $534,078,274 $ 583,700,214
============= =============
The accompanying Notes are an integral part of these
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
------------------------------ ------------------------------
2008 2007 2008 2007
---- ---- ---- ----
Cash flows from operating activities
Decrease in net assets from
operations $(30,589,121) $(136,515,348) $(30,261,036) $(118,400,437)
Adjustments to reconcile increase in net
assets from operations to net cash
provided by operating activities:
Proceeds from disposition of investments -- 402,777 -- 728,552
Purchases of securities (3,994,279) (1,163,347) (4,103,820) (9,215,094)
Maturities of securities -- 150,000 -- 154,500
Depreciation and amortization 10,638 6,272 19,907 10,681
Net pension benefit (44,780) (127,434) (126,617) (163,671)
Realized (gain) loss on investments before
income taxes 48,041 (402,777) 48,041 (728,552)
Net decrease in unrealized appreciation
of investments 30,970,122 138,128,989 31,227,236 120,980,544
Stock option expense 132,605 44,100 220,594 87,686
(Increase) decrease in receivables (442,880) 50,016 (467,016) 234,936
Increase in other assets (26,325) (23,679) (23,747) (30,408)
Increase (decrease) in other liabilities (497,383) 43,779 22,992 (75,384)
Decrease in accrued pension cost (34,467) (30,266) (68,934) (66,834)
Increase in deferred income taxes 15,800 44,400 44,300 57,000
------------- ------------- ------------- -------------
Net cash provided by (used in) operating
activities (4,452,029) 607,482 (3,468,100) (6,426,481)
------------- ------------- ------------- -------------
Cash flows from financing activities
Distributions from undistributed net
investment income -- -- (1,555,660) (777,630)
Proceeds from exercise of employee
stock options -- -- -- 231,390
Purchase of treasury stock (16,178,867) -- (16,903,346) --
------------- ------------- ------------- -------------
Net cash used in financing activities (16,178,867) -- (18,459,006) (546,240)
------------- ------------- ------------- -------------
Net increase (decrease) in cash and cash
equivalents (20,630,896) 607,482 (21,927,106) (6,972,721)
Cash and cash equivalents at beginning
of period 30,031,548 31,264,000 31,327,758 38,844,203
------------- ------------- ------------- -------------
Cash and cash equivalents at end of period $ 9,400,652 $ 31,871,482 $ 9,400,652 $ 31,871,482
============= ============= ============= =============
Supplemental disclosure of cash flow information:
Cash paid during the period for:
Interest $ -- $ -- $ -- $ --
Income taxes $ -- $ -- $ -- $ --
The accompanying Notes are an integral part of these
Consolidated Financial Statements
6
CAPITAL SOUTHWEST CORPORATION
AND SUBSIDIARIES
Consolidated Statement of Investments
-------------------------------------
September 30, 2008
Company Investment (a) Cost Value (b)
- ------------------------------------------------------------------------------------------------------------------------------------
+AT&T INC. ++20,770 shares common stock (acquired 3-9-99) $ 12 $ 579,898
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
Seguin, Texas (acquired 4-1-73 thru 5-25-07) 2,190,937 33,963,600
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 5,400,000
Austin, Texas 150,000 shares Series A Convertible Preferred Stock,
Electronics contract manufacturing; convertible into 600,000 shares of common stock
distribution and production of memory at $0.25 per share (acquired 9-16-94) 150,000 --
and other components for computer Warrants to purchase 350,000 shares of common stock
manufacturers, retailers and value-added at $11.00 per share, expiring 2017 (acquired 6-27-07) -- --
resellers. ---------- ----------
6,150,000 5,400,000
+ASCENT MEDIA CORPORATION ++3,525 shares Series A common stock (acquired 9-26-08) -- 86,045
Santa Monica, California
Provider of content production,
management and distribution services
for television and film industries.
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
Specialty architectural products used in (acquired 10-25-83 and 5-30-02) 624,920 6,000,000
the construction and remodeling of
commercial and institutional buildings.
BOXX TECHNOLOGIES, INC. 3,125,354 shares Series B Convertible Preferred Stock,
Austin, Texas convertible into 3,125,354 shares of common stock
Workstations for computer graphic at $0.50 per share (acquired 8-20-99 thru 8-8-01) 1,500,000 2
imaging and design.
7
CAPITAL SOUTHWEST CORPORATION
AND SUBSIDIARIES
Consolidated Statement of Investments
-------------------------------------
September 30, 2008
(continued)
Company Investment (a) Cost Value (b)
- ------------------------------------------------------------------------------------------------------------------------------------
CMI HOLDING COMPANY, INC. 10% convertible subordinated note, due 2009,
Richardson, Texas (acquired 7-2-07 thru 10-9-07) $ 2,363,347 $ 1,000,000
Owns Chase Medical, which develops 2,327,658 shares Series A Convertible Preferred Stock,
and sells devices used in cardiac surgery convertible into 2,327,658 shares of common stock
to relieve congestive heart failure; develops at $1.72 per share (acquired 8-21-02 and 6-4-03) 4,000,000 2
and supports cardiac imaging systems. Warrants to purchase 109,012 shares of common stock
at $1.72 per share, expiring 2012 (acquired 4-7-04) -- --
Warrant to purchase 431,982 shares of Series A-1
Convertible Preferred Stock at $1.72 per share,
expiring 2017 (acquired 7-2-07) -- --
---------- ----------
6,363,347 1,000,002
CINATRA CLEAN TECHNOLOGIES,
INC, 10% subordinated secured promissory note 2,743,000 2,743,000
Houston, Texas (acquired 7-14-08)
Cleans above ground oil storage tanks 533,300 shares Series A Convertible Preferred
with a patented, automated system. Stock, convertible into 533,300 shares common 533,300 533,300
stock at $1.00 per share(acquired 7-14-08) ---------- ----------
3,276,300 3,276,300
+COMCAST CORPORATION ++64,656 shares common stock (acquired 11-18-02) 21 1,269,197
Philadelphia, Pennsylvania
Leading provider of cable, entertainment
and communications 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 compacts (PDCs) at $48.25 per share (acquired 8-10-98) 999,981 999,981
used in oil field drill bits and in mining 140,137 shares common stock (acquired 3-7-94
and industrial applications. and 8-10-98) 2,329,963 3,200,000
---------- ----------
3,329,944 4,199,981
+DISCOVERY COMMUNICATIONS, INC. ++35,250 shares Series A common stock (acquired 9-26-08) 10,131 502,313
Silver Spring, MD ++35,250 shares Series A common stock (acquired 9-26-08) 10,131 488,918
Provider of creative content, media -------- --------
management and network services 20,262 991,231
worldwide.
+EMBARQ CORPORATION ++4,500 shares common stock (acquired 5-17-06) 46,532 182,475
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
McKinney, Texas thru 10-7-98) 5,800,000 55,171,125
Electric wire and cable for residential
and commercial use.
8
CAPITAL SOUTHWEST CORPORATION
AND SUBSIDIARIES
Consolidated Statement of Investments
-------------------------------------
September 30, 2008
(continued)
Company Investment (a) Cost Value (b)
- ------------------------------------------------------------------------------------------------------------------------------------
EXTREME INTERNATIONAL, INC. 11,797.5 shares Series A common stock
Sugar Land, Texas (acquired 9-26-08) $ 294,938 $ 526,000
Owns Bill Young Productions, Texas 39,359.18 shares Series C Convertible Preferred Stock,
Video and Post, and Extreme Communi- convertible into 157,436.72 shares of common stock
cations, which produce radio and television at $25.00 per share (acquired 9-30-03) 2,625,000 7,026,000
commercials and corporate communica- 3,750 shares 8% Series A Convertible Preferred Stock,
tions videos. convertible into 15,000 shares of common stock at
$25.00 per share (acquired 9-30-03) 375,000 669,000
Warrants to purchase 1,237.50 shares of common stock at
$25.00 per share, expiring 2008 (acquired 1-15-02) -- 28,000
---------- ----------
3,294,938 8,249,000
+FMC CORPORATION ++12,860 shares common stock (acquired 6-6-86
Philadelphia, Pennsylvania and 9-13-07) 66,727 660,875
Chemicals for agricultural, industrial
and consumer markets.
+FMC TECHNOLOGIES, INC. ++22,114 shares common stock (acquired 1-2-02
Houston, Texas and 8-31-07) 57,051 1,029,407
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 34,939,913
Carrollton, Texas
Heelys stealth skate shoes, equipment
and apparel sold through sporting goods
chains, department stores and footwear
retailers.
+HOLOGIC, INC. ++632,820 shares common stock (acquired 8-27-99) 220,000 12,143,816
Bedford, Massachusetts
Medical instruments including bone
densitometers, mammography devices
and digital radiography systems.
+JOHNBEAN TECHNOLOGIES CORP ++4,776 shares common stock (acquired 7-31-08) -- 60,464
Chicago, Illinois
Global technology solutions provider
to high-value segments of the food
processing and air transportation
industry.
+KIMBERLY-CLARK CORPORATION ++77,180 shares common stock (acquired 12-18-97) 2,358,518 5,004,351
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 1,285,355
Englewood, Colorado ++42,463 shares Series C common stock (acquired 9-6-05) 100,870 1,192,786
Owns interests in broadband, distribution ---------- ----------
and content companies. 207,423 2,478,141
9
CAPITAL SOUTHWEST CORPORATION
AND SUBSIDIARIES
Consolidated Statement of Investments
-------------------------------------
September 30, 2008
(continued)
Company Investment (a) Cost Value (b)
- ------------------------------------------------------------------------------------------------------------------------------------
+LIBERTY MEDIA CORPORATION ++35,250 shares of Liberty Capital Series A common
Englewood, Colorado stock (acquired 5-9-06) $ 7,833 $ 470,588
Holding company owning interests in ++176,252 shares of Liberty Interactive Series A
electronic retailing, media, communica- common stock (acquired 5-9-06) 66,423 2,275,413
tions and entertainment businesses. ++141,000 shares of Liberty Entertainment Series A
common stock (acquired 3-3-08) 43,996 3,513,720
---------- ----------
118,252 6,259,721
LIFEMARK GROUP 1,449,026 shares common stock (acquired 7-16-69) 4,510,400 71,000,000
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 office automation $1.00 per share (acquired 11-4-97) 800,000 5,333,000
supplies and accessories; impact, tilt 4,000,002 shares common stock (acquired 11-4-97) 4,615,000 26,667,000
monitoring and temperature sensing ---------- ----------
devices to detect mishandling shipments; 5,415,000 32,000,000
dunnage for protecting shipments.
PALLETONE, INC. 12.3% senior subordinated notes due 2012
Bartow, Florida (acquired 9-25-06) 1,553,150 1,500,000
Manufacturer of wooden pallets and 150,000 shares common stock (acquired 10-18-01) 150,000 2
pressure-treated lumber. Warrant to purchase 15,294 shares of common stock at
$1.00 per share, expiring 2011 (acquired 2-17-06) 45,746 --
---------- ----------
1,748,896 1,500,002
+PALM HARBOR HOMES, INC. 7,855,121 shares common stock (acquired 1-3-85
Dallas, Texas thru 7-31-95) 10,931,955 35,348,045
Integrated manufacturing, retailing,
financing and insuring of manufactured
housing and modular homes.
+PETSMART, INC. ++300,000 shares common stock (acquired 6-1-95) 1,318,771 7,410,000
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
Houston, Texas and 3-31-73) 52,600 131,500,000
Specialty chemicals for plumbing, HVAC,
electrical, construction, industrial,
oil field and automotive applications;
smoke containment systems for building
fires; also owns 20% of The Whitmore
Manuacturing Company.
+SPRINT NEXTEL CORPORATION ++90,000 shares common stock (acquired 6-20-84) 457,113 549,000
Reston, Virginia
Diversified telecommunications company.
10
CAPITAL SOUTHWEST CORPORATION
AND SUBSIDIARIES
Consolidated Statement of Investments
-------------------------------------
September 30, 2008
(continued)
Company Investment (a) Cost Value (b)
- ------------------------------------------------------------------------------------------------------------------------------------
TCI HOLDINGS, INC. 21 shares 12% Series C Cumulative Compounding Preferred
Denver, Colarodo 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 9,969,396
Dallas, Texas
Regional bank holding company with
banking operations in six Texas cities.
VIA HOLDINGS, INC. 9,118 shares Series B Preferred Stock
Sparks, Nevada (acquired 9-19-05) 4,559,000 2
Designer, manufacturer and distributor 1,118 shares Series C Preferred Stock
of high-quality office seating. (acquired 11-01-07) 281,523 2
---------- ----------
4,840,523 4
WELLOGIX, INC. 4,788,371 shares Series A-1 Convertible Participating
Houston, Texas Preferred Stock, convertible into 4,788,371 shares
Developer and supporter of software of common stock at $1.0441 per share
used by the oil and gas industry to (acquired 8-19-05 thru 6-15-08) 5,000,000 2
control drilling and maintenance
expenses.
THE WHITMORE MANUFACTURING
COMPANY 80 shares common stock (acquired 8-31-79) 1,600,000 38,000,000
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) 19,656 100,440
Little Rock, Arkansas
Provider of voice, broadband and
entertainment services.
MISCELLANEOUS - Ballast Point Ventures II, L.P. - 2.6% limited
partnership interest(acquired 8-4-08) 225,000 225,000
- BankCap Partners Fund I, L.P. - 6.0% limited
partnership interest (acquired 7-14-06 thru 6-23-08) 2,566,681 2,566,681
- CapitalSouth Partners Fund III, L.P. - 2.8% limited
partnership interest (acquired 1-22-08) 701,256 701,256
- Diamond State Ventures, L.P. - 1.9% limited partnership
interest (acquired 10-12-99 thru 8-26-05) 111,000 111,000
- Discovery Alliance, LLC - 90.0% limited liability
company (acquired 9-12-08) 150,000 150,000
- 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) -- 174,000
- 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 1,506,817
- ------------------------------------------------------------------------------------------------------------------------------------
TOTAL INVESTMENTS $85,083,245 $520,399,045
=========== ============
- ------------------------------------------------------------------------------------------------------------------------------------
+Publicly-owned company ++Unrestricted securities as defined in Note (a)
11
Notes to Consolidated Statement of Investments
----------------------------------------------
(a) Definitions
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 restriction on resale and are not
freely marketable. At September 30, 2008, restricted securities represented
approximately 90.6% of the value of the consolidated investment portfolio.
(b) Investment Valuation Policy
Our investments are carried at fair value in accordance with the Investment
Company Act of 1940 (the "1940 Act") and SFAS No. 157, Fair Value Measurements
("SFAS No. 157"). In accordance with the 1940 Act, unrestricted minority-owned
publicly traded securities, for which the market quotations are readily
available, are valued at the closing sale price for the NYSE listed securities
and the lower of the closing bid price or the last sale price for NASDAQ
securities on the valuation date; and restricted publicly traded securities and
other privately held securities are valued as determined in good faith by our
Board of Directors.
We adopted SFAS No. 157 on April 1, 2008 (see footnote 1 in "Notes to
Consolidated Financial Statements," page 13). SFAS No. 157 provides a framework
for measuring the fair value of assets and liabilities. SFAS No. 157 also
provides guidance regarding a fair value hierarchy, which prioritizes
information used to measure fair value and the effect of fair value measurements
on earnings and provides for enhanced disclosures determined by the level within
the hierarchy of information used for valuation. SFAS No. 157 applies whenever
other standards require (or permit) assets or liabilities to be measured at fair
value but does not expand the use of fair value in any new circumstances.
SFAS No. 157 defines fair value in terms of the price that would be
received upon the sale of an asset or paid to transfer a liability in an orderly
transaction between market participants at the measurement date (the "exit
price") and excludes transaction costs. Under SFAS No. 157, the fair value
measurement also assumes that the transaction to sell an asset occurs in the
principal market for the asset or, in the absence of a principal market, the
most advantageous market for the asset. The principal market is the market in
which the reporting entity would sell or transfer the asset with the greatest
volume and level of activity for the asset. In determining the principal market
for an asset or liability under SFAS No. 157, it is assumed that the reporting
entity has access to the market as of the measurement date.
(c) Valuation Methodologies
Debt Securities are generally valued on the basis of the price the security
would command in order to provide a yield-to-maturity equivalent to the present
yield of comparable debt instruments of similar quality.
Partnership Interests and Common Equity including unrestricted marketable
securities, which are valued at the closing sale price for the NYSE listed
securities and the lower of the closing bid price or the last sale price for
NASDAQ securities on the valuation date; and restricted marketable securities
for which there is a public market, are valued at the closing sale price for the
NYSE listed securities and the lower of the closing bid price or the last sale
price for NASDAQ securities on the valuation date adjusted in good faith by our
Board of Directors if they deem a discount or premium would be likely or
obtainable upon a sale or transfer of our interest, for those without a
principal market, the Board of Directors considers 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; protective put
analysis based on the Black-Scholes option pricing model, 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
12
Notes to Consolidated Statement of Investments
(continued)
regard to the restrictive feature and adjusts for any diminution in value
resulting from restrictions on resale.
Preferred Equity is valued on the basis of the price (bond value) the
security would carry in the absence of the conversion feature plus the value
allocable to the conversion feature (conversion value).
Equity Warrants are valued on the basis of accepted formulas derived from
empirical studies which define the market value of a warrant in relation to the
market price of its common stock. These formulas measure the "option value" of a
warrant as well as its "exercise value" (the amount, if any, by which the value
of the stock exceeds the exercise price of the warrant). In applying such
formulas, the market price of the stock is usually discounted to reflect the
fact that the stock is restricted and the calculated value of the warrant itself
may be discounted (if deemed appropriate) to reflect its restrictive nature.
Generally, the option value is excluded if the formula indicates (i) the warrant
expires within six months, (ii) the market price of the stock (discounted) is
less than one-half of the exercise price of the warrant, or (iii) the market
price of the stock (discounted) is more than two times the amount of the
exercise price of the warrant.
13
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 ("GAAP") 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
for the year ended March 31, 2008. 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.
Fair Value Measurements. The Company adopted SFAS No. 157, Fair Value
Measurements ("SFAS 157"), on April 1, 2008. SFAS 157 (1) creates a single
definition of fair value, (2) establishes a framework for measuring fair value,
and (3) expands disclosure requirements about items measured at fair value. The
Statement applies to both items recognized and reported at fair value in the
financial statements and items disclosed at fair value in the notes to the
financial statements. The Statement does not change existing accounting rules
governing what can or what must be recognized and reported at fair value in the
Company's financial statements, or disclosed at fair value in the Company's
notes to the financial statements. Additionally, SFAS 157 does not eliminate
practicability exceptions that exist in accounting pronouncements amended by
this Statement when measuring fair value. As a result, the Company will not be
required to recognize any new assets or liabilities at fair value.
Prior to SFAS 157, certain measurements of fair value were based on the
price that would be paid to acquire an asset, or received to assume a liability
(an entry price). SFAS 157 clarifies the definition of fair value as the price
that would be received from the sale of an asset, or paid to transfer a
liability, in an orderly transaction between market participants at the
measurement date (that is, an exit price). The exit price is based on the amount
that the holder of the asset or liability would receive or need to pay in an
actual transaction (or in a hypothetical transaction if an actual transaction
does not exist) at the measurement date. In some circumstances, the entry and
exit price may be the same; however, they are conceptually different.
Fair value is generally determined based on quoted market prices in the
active markets for identical assets or liabilities. If quoted market prices are
not available, the Company uses valuation techniques that place greater reliance
on observable inputs and less reliance on unobservable inputs. In measuring fair
value, the Company may make adjustments for risks and uncertainties, if a market
participant would include such an adjustment in its pricing.
2. Investments
We fair value our investments in accordance with GAAP as determined in good
faith by our Board of Directors. When available, we base the fair value of our
investments on directly observable market prices or on market data derived for
14
Notes to Consolidated Financial Statements
(continued)
comparable assets. For all other investments, inputs used to measure fair value
reflect management's best estimate of assumptions that would be used by market
participants in pricing the investments in a hypothetical transaction.
The levels of fair value inputs used to measure our investments are
characterized in accordance with the fair value hierarchy established by SFAS
No. 157, Fair Value Measurements ("SFAS 157"). Where inputs for an asset or
liability fall in more than one level in the fair value hierarchy, the
investment is classified in its entirety based on the lowest level input that is
significant to that investment's fair value measurement. We use judgment and
consider factors specific to the investment in determining the significance of
an input to a fair value measurement. The three levels of the fair value
hierarchy and investments that fall into each of the levels are described below:
o Level 1: Level 1 inputs are unadjusted quoted prices in active markets
that are accessible at the measurement date for identical,
unrestricted assets or liabilities. We use Level 1 inputs for publicly
traded unrestricted securities for which we do not have a controlling
interest. Such investments are valued at the closing price for listed
securities and at the lower of the closing bid price or the closing
sale price for over-the-counter (NASDAQ) securities on the valuation
date.
o Level 2: Level 2 inputs are inputs other than the quoted prices
included within Level 1 that are observable for the asset or
liability, either directly or indirectly. We did not value any of our
investments using level 2 inputs as of September 30, 2008.
o Level 3: Level 3 inputs are unobservable and cannot be corroborated by
observable market data. We use Level 3 inputs for measuring the fair
value of substantially all of our investments. See "Notes to Portfolio
of Investments" (c) on page 12 for the investment policy used to
determine the fair value of these investments.
The following fair value hierarchy table sets forth our investment
portfolio by level as of September 30, 2008 (in millions):
Level 1 Level 2 Level 3 Total
------- ------- ------- -------
Debt $ -- $ -- $ 10.6 $ 10.6
Partnership Interests -- -- 9.9 9.9
Preferred Equity -- -- 14.6 14.6
Common Equity 48.8 -- 436.5 485.3
Equity Warrants -- -- -- --
------- ------- ------- -------
Total Investments $48.8 $ -- $471.6 $520.4
======= ======= ======= =======
The following table sets forth a summary of changes in the fair value of
investment assets and liabilities measured using Level 3 inputs during the
quarter ended September 30, 2008 (in millions):
Purchases,
Sales,
Beginning Unrealized Issuance & Ending
Balance gain (loss) Settlement Balances
------- ----------- ---------- --------
Debt $ 9.0 $( 1.1) $ 2.7 $ 10.6
Partnership Interests 9.2 0.4 0.4 9.9
Preferred Equity 20.5 (6.4) 0.5 14.6
Common Equity 459.8 (23.9) 0.6 436.5
Equity Warrants 0.3 -- (0.3) --
------ ------ ------ ------
Total Investments $498.7 $(31.0) $ 3.9 $471.6
====== ====== ====== ======
15
Notes to Consolidated Financial Statements
(continued)
The following table sets forth a summary of changes in the fair value of
investment assets and liabilities measured using Level 3 inputs during the six
months ended September 30, 2008 (in millions):
Purchases,
Sales,
Beginning Unrealized Issuance & Ending
Balance gain (loss) Settlement Balances
------- ----------- ---------- --------
Debt $ 9.0 $ (1.1) $ 2.7 $ 10.6
Partnership Interests 9.1 0.4 0.4 9.9
Preferred Equity 20.4 (6.3) 0.5 14.6
Common Equity 456.0 (20.2) 0.7 436.5
Equity Warrants 0.4 (0.1) (0.3) --
------ ------ ------ ------
Total Investments $494.8 $(27.3) $ 4.1 $471.6
====== ====== ====== ======
3. Stock-Based Compensation
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, 2008, we recognized compensation expense of
$132,605 and $220,594, respectively.
As of September 30, 2008, the total remaining unrecognized compensation
cost related to non-vested stock options was $2,645,978, which will be amortized
over the weighted-average service period of approximately 5.2 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 of
the Company 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, 2008, there were no shares available for grant under the
Plan. The following table summarizes the price per option at grant date using
the Black-Scholes pricing model:
Black-Scholes Pricing Model Assumptions
-----------------------------------------------------------
Weighted Expected Risk-Free Expected
Average Dividend Interest Expected Life
Date of Issuance Fair Value Yield Rate Volatility (in years)
----------------------- ------------ ------------ ----------- ------------ ------------
May 15, 2006 $ 31.28 0.64% 5.08% 21.1% 7
July 17, 2006 $ 33.05 0.61% 5.04% 21.2% 7
July 16, 2007 $ 41.78 0.39% 4.95% 19.9% 5
July 21, 2008 $ 27.35 0.67% 3.41% 20.2% 5
July 30, 2008 $ 29.93 0.62% 3.36% 20.2% 5
16
Notes to Consolidated Financial Statements
(continued)
The following table summarizes activity in the Plan as of September 30,
2008:
Number Weighted-Average
of shares Exercise Price
--------- --------------
Balance at March 31, 2008 70,400 $109.99
Granted 37,500 $123.72
Exercised -- --
Canceled -- --
------- -------
Balance at September 30, 2008 107,900 $114.78
======= =======
At September 30, 2008, the range of exercise prices and weighted-average
remaining contractual life of outstanding options was $65.00 to $152.98 and 5.2
years, respectively. No options were exercised during the six months ended
September 30, 2008.
At September 30, 2008, the number of options exercisable was 21,445 and the
weighted-average exercise price of those options was $97.00.
5. Summary of Per Share Information
Three Months Ended Six Months Ended
September 30 September 30
----------------- -----------------
2008 2007 2008 2007
---- ---- ---- ----
Investment income $ .35 $ .44 $ .68 $ .74
Operating expenses (.22) (.12) (.39) (.25)
Interest expense -- -- -- --
Income taxes (.02) (.01) (.02) (.01)
------- ------- ------- -------
Net investment income .11 .31 .27 .48
Distributions from undistributed
net investment income (.30) -- (.72) (.20)
Net realized gain (loss) on investments (.01) .10 (.01) .19
Net decrease in unrealized appreciation
of investments (8.28) (35.52) (8.35) (31.11)
Treasury stock repurchase * 1.33 -- 1.40 --
Exercise of employee stock options ** -- -- -- (.09)
Stock option expense 0.4 .01 .06 .02
------- ------- ------- -------
Decrease in net asset value (7.11) (35.10) (7.35) (30.71)
Net asset value:
Beginning of period 149.85 191.13 150.09 186.75
------- ------- ------- -------
End of period $142.74 $156.04 $142.74 $156.04
======= ======= ======= =======
Shares outstanding at end of period
(000s omitted) 3,742 3,889 3,742 3,889
* Net increase is due to purchases of Common Stock at prices less than beginning
period net asset value.
** Net decrease is due to the exercise of employee stock options at prices less
than beginning of period net asset value.
6. Share Repurchase Plan
On June 12, 2008, the Company announced that its Board of Directors
authorized a share repurchase plan, which allows for the repurchase of up to 10
percent (or 388,915 shares) of its Common Stock at prices not above the lower of
the net asset value per share of its Common Stock, or
17
Notes to Consolidated Financial Statements
(continued)
prices prevailing in the over-the-counter market at the time of such purchases.
The Company anticipates that share purchases will be made from time to time,
depending upon market conditions. Shares may be purchased on the open market,
including block repurchases, or through privately negotiated transactions. The
Company does not intend to purchase any shares from its directors, officers or
other affiliates. The repurchase program does not obligate the Company to
acquire any specific number of shares and may be discontinued at any time. The
Company intends to fund the purchases with available cash and/or the sale of
marketable securities readily available for sale. The repurchase program is
expected to be in effect through December 10, 2008, or until the approved number
of shares has been repurchased. During the quarter ended September 30, 2008, the
Company purchased a total of 141,028 shares of its Common Stock on the open
market for $16,178,867 at an average price of $114.72 per share, which brings
the total shares of its Common Stock purchased on the open market since
announcing its plan to 147,513 shares for $16,903,346 at an average price of
$114.59 per share.
7. 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 financial statements issued for fiscal years beginning after November 15,
2007, and interim periods within those fiscal years. The Company has adopted
this statement on a prospective basis beginning in the quarter ended June 30,
2008. Adoption of this statement did not have a material effect on the Company's
consolidated financial statements for the period ended June 30, 2008. However,
the impact on its consolidated financial statements for the periods subsequent
to the period of adoption cannot be determined at this time as it will be
influenced by the estimates of fair value for those periods, the number and
amount of investments the Company originates, acquires or exits, and the effect
of any additional guidance or any changes in the interpretation of this
statement.
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 did not elect the fair value option
provisions upon adoption of SFAS 159 on April 1, 2008.
In February 2008, the FASB issued FASB Staff Position ("FSP") SFAS 157-2,
"Effective Date of FASB Statement No. 157" (FSP 157-2), which defers the
effective date of SFAS 157 to fiscal years beginning after November 15, 2008,
and interim periods within those fiscal years, for all nonfinancial assets and
nonfinancial liabilities, except for items that are recognized or disclosed at
fair value in the financial statements on a recurring basis (at least annually).
We are currently evaluating the impact of our adoption of FSP 157-2 effective
April 1, 2009 on our consolidated financial statements.
In October 2008, the FASB issued Staff Position 157-3, "Determining the
Fair Value of a Financial Asset in a Market That Is Not Active" ("FSP 157-3"),
which clarifies the application of SFAS 157 in an inactive market and provides
an illustrative example to demonstrate how the fair value of a financial asset
is determined when the market for that financial asset is not active. The
guidance provided by FSP 157-3 is consistent with Capital Southwest's approach
to valuing financial assets for which there are no active markets.
18
Item 2. Managements Discussion and Analysis of Financial Condition and Results
of Operations
Net asset value at September 30, 2008 was $534,078,274, equivalent to
$142.74 per share. Assuming reinvestment of all dividends and tax credits on
retained long-term capital gains, the September 30, 2008 net asset value
reflects a decrease of 7.91% during the past twelve months.
September 30, September 30,
2008 2007
---- ----
Net assets $534,078,274 $606,872,698
Shares outstanding 3,741,638 3,889,151
Net assets per share $142.74 $156.04
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 $677,023 for the six months ended September 30, 2008
decreased from $1,244,125 in the year-ago period due to a decrease in excess
cash and interest rates. During the six months ended September 30, 2008 and
2007, we recorded dividend income from the following sources:
Six Months Ended
September
---------
2008 2007
---- ----
Alamo Group Inc. $ 339,636 $ 339,096
Dennis Tool Company 25,000 37,499
Encore Wire Corporation 163,470 163,470
Kimberly-Clark Corporation 89,529 81,811
Lifemark Group 0 150,000
PETsMart, Inc. 18,000 18,000
The RectorSeal Corporation 480,000 240,000
TCI Holdings, Inc. 40,635 40,635
The Whitmore Manufacturing Company 120,000 60,000
Other 59,209 34,383
---------- ----------
$1,335,479 $1,164,894
========== ==========
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:
19
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations (continued)
Three Months Ended Six Months Ended
September 30 September 30
------------ ------------
2008 2007 2008 2007
---- ---- ---- ----
Alamo Group Inc. $(11,321,200) $ -- $(11,321,200) $ 27,110
All Components, Inc. (7,200,000) 5,600,000 (7,200,000) 5,600,000
Encore Wire Corporation (10,216,875) -- 4,086,750 6,130,000
Heelys, Inc. -- (130,442,000) -- (139,760,000)
Media Recovery, Inc. (5,500,000) (9,000,000) (5,500,000) (9,000,000)
Palm Harbor Homes, Inc. -- (7,855,000) 3,927,561 (7,855,000)
The RectorSeal Corporation 2,300,000 -- (12,700,000) 10,850,000
During the six months ended September 30, 2008, the value of our
investments in The RectorSeal Corporation decreased by $12,700,000, All
Components, Inc. decreased $7,200,000 and Media Recovery, Inc decreased
$5,500,000, due to decreases in their respective sales resulting from slowdowns
in segments of their businesses. Additionally, our investment in Alamo Group
Inc. decreased $11,321,200 due primarily to the decrease in their stock price at
September 30, 2008.
Offsetting the loss at The RectorSeal Corporation, All Components, Inc.,
Media Recovery, Inc. and Alamo Group Inc. during the six months ended September
30, 2008, was a $4,086,750 increase in the value of Encore Wire Corporation and
a $3,927,561 increase in the value of Palm Harbor Homes, Inc. due to increases
in their respective stock prices.
Portfolio Investments
During the quarter ended September 30, 2008, we made investments of
$3,651,300 in three new portfolio companies and an investment of $294,938 in an
existing portfolio company.
We have agreed, subject to certain conditions, to invest up to $12,578,419
in six portfolio companies.
Financial Liquidity and Capital Resources
At September 30, 2008, we had cash and cash equivalents of approximately
$9.4 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 $17.0 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 $48.8 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.
20
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 $10,643,000 at September 30, 2008, equivalent to 2.0% 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 stock 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 stock 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
As of the end of the period covered by this report, an evaluation was
performed under the supervision and with the participation of our management,
including the President and Chairman of the Board and Chief Financial Officer,
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 Chairman of the Board and
Chief Financial Officer concluded that our disclosure controls and procedures
are effective to ensure that the information required to be disclosed is
recorded, processed, summarized and reported within the time periods specified
in the Securities and Exchange Commission's rules and forms, and is accumulated
and communicated to management, including the President and Chairman of the
Board and Chief Financial Officer, as appropriate, to allow timely decisions
regarding such required disclosure.
During the fiscal quarter ended September 30, 2008, there were no changes
to the internal controls over financial reporting that have materially affected,
or are reasonably likely to materially affect our internal controls over
financial reporting.
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.
Similar suits were also filed in 2007 and 2008 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.
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
Deterioration in economic conditions could impair our portfolio companies,
as a result, could reduce valuations and adversely affect our financial
condition.
Changes in national and local economic conditions could have a negative
impact on our business. Many of the companies in which we have made or will make
investments may be susceptible to economic slowdowns or recessions. An economic
slowdown may affect the ability of a company to operate profitably, acquire
other companies, or engage in a liquidity event such as a sale.
Our business of making private equity investments also may be affected by
current and future market conditions. As a result, the pace of our investment
activity may slow. In addition, significant changes in the capital markets could
have a negative effect on the valuations of our investments. This could an
adverse affect on our net asset value.
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 for the fiscal year
ended March 31, 2008.
Item 4. Submission of Matters to a Vote of Security Holders
Our Annual Meeting of Stockholders was held on July 21, 2008, 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 2,831,910 592,506 464,735
Graeme W. Henderson 2,720,798 703,618 464,735
Samuel B. Ligon 2,734,283 690,133 464,735
Gary L. Martin 2,811,850 612,566 464,735
William R. Thomas 2,691,304 733,112 464,735
John H. Wilson 2,722,722 701,694 464,735
22
Item 4. Submission of Matters to a Vote of Security Holders
(continued)
Votes Cast
-------------------------------------------
Against/ Abstentions/
For Withheld Non-Votes
------- -------- ---------
b. Grant Thornton LLP was approved as our
independent registered accounting firm
for the 2009 fiscal year. 2,797,197 627,219 464,735
Item 6. Exhibits
(a) Exhibits
Exhibit 31.1- Certification of President and Chairman of the
Board required by Rule 13a-14(a) or Rule 15d-14(a) of the
Securities Exchange Act of 1934, as amended (the "Exchange Act"),
filed herewith.
Exhibit 31.2- Certification of Chief Financial Officer required
by Rule 13a-14(a) or Rule 15d-14(a) of the Exchange Act, filed
herewith.
Exhibit 32.1- Certification of President and Chairman of the
Board required by Rule 13a-14(b) or Rule 15d-14(b) of the
Exchange Act and Section 1350 of Chapter 63 of Title 18 of the
United States Code, furnished herewith.
Exhibit 32.2- Certification of Chief Financial Officer 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.
23
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: November 7, 2008 By:
--------------------- -------------------------------------------
Gary L. Martin, President
and Chairman of the Board
/s/ Tracy L. Morris
Date: November 7, 2008 By:
--------------------- ------------------------------------------
Tracy L. Morris, Chief Financial Officer
24
Exhibit 31.1
CERTIFICATIONS
I, Gary L. Martin, President and Chairman of the Board 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: November 7, 2008 By: /s/ Gary L. Martin
---------------- -------------------------
Gary L. Martin, President
and Chairman of the Board
Exhibit 31.2
CERTIFICATIONS
I, Tracy L. Morris, Chief Financial Officer 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: November 7, 2008 By: /s/ Tracy L. Morris
---------------- --------------------------------------
Tracy L. Morris, Chief Financial Officer
Exhibit 32.1
Certification of President and Chairman of the Board
Pursuant to Section 1350 of Chapter 63 of Title 18 of the United States Code
I, Gary L. Martin, President and Chairman 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
November 7, 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: November 7, 2008 By: /s/ Gary L. Martin
---------------- -------------------------
Gary L. Martin, President
and Chairman of the Board
Exhibit 32.2
Certification of Chief Financial Officer
Pursuant to Section 1350 of Chapter 63 of Title 18 of the United States Code
I, Tracy L. Morris, Chief Financial Officer of Capital Southwest
Corporation, certify that, to my knowledge:
1. the Form 10-Q, filed with the Securities and Exchange Commission on
November 7, 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: November 7, 2008 By: /s/ Tracy L. Morris
---------------- ----------------------------------------
Tracy L. Morris, Chief Financial Officer