Capital Southwest (CSWC) 10-Q 2011 Q3 Quarterly report

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, 2010

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 or organization)	(I.R.S. Employer 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 has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such filings).  Yes  ___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,” “large accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check One):

Large accelerated filer  ____	Accelerated filer   X	Non-accelerated filer ____
Smaller reporting company ____

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.

3,753,038 shares of Common Stock, $1 par value, as of January 31, 2011

TABLE OF CONTENTS

	Page No.
PART I. FINANCIAL INFORMATION
ITEM 1. Consolidated Financial Statements
Consolidated Statements of Assets and Liabilities
December 31, 2010 (Unaudited) and March 31, 2010	3
Consolidated Statements of Operations (Unaudited)
For the nine months ended December 31, 2010 and
December 31, 2009	4
Consolidated Statements of Changes in Net Assets (Unaudited)
For the nine months ended December 31, 2010 and
December 31, 2009	5
Consolidated Statements of Cash Flows (Unaudited)
For the nine months ended December 31, 2010 and
December 31, 2009	6
Consolidated Schedules of Investments (Unaudited)
December 31, 2010 and March 31, 2010	7
Notes to Consolidated Financial Statements	17
ITEM 2. Management’s Discussion and Analysis of Financial
Condition and Results of Operations	26
ITEM 3. Quantitative and Qualitative Disclosure About
Market Risk	29
ITEM 4. Controls and Procedures	29
PART II. OTHER INFORMATION
ITEM 1 Legal Proceedings	30
ITEM 1A. Risk Factors	30
ITEM 6. Exhibits	31
Signatures	32

2

PART I.  FINANCIAL INFORMATION

Item 1.             Consolidated Financial Statements

CAPITAL SOUTHWEST CORPORATION AND SUBSIDIARIES

Consolidated Statements of Assets and Liabilities

	December 31, 2010			March 31, 2010
Assets	(Unaudited)
Investments at market or fair value
Companies more than 25% owned
(Cost: December 31, 2010 - $25,521,521,
March 31, 2010 - $26,178,302)	$	295,201,592		$	330,147,325
Companies 5% to 25% owned
(Cost: December 31, 2010 - $23,561,278,
March 31, 2010 - $21,562,243)		86,380,732			73,589,142
Companies less than 5% owned
(Cost: December 31, 2010 - $52,591,363,
March 31, 2010 - $52,282,449)		77,466,430			74,206,590
Total investments
(Cost: December 31, 2010 - $101,674,162,
March 31, 2010 - $100,022,994)		459,048,754			477,943,057
Cash and cash equivalents		73,547,621			4,093,508
Receivables
Dividends and interest		1,697,287			1,012,782
Affiliates		307,403			864,943
Pension assets		7,345,910			7,068,957
Other assets		159,613			191,338
Total assets	$	542,106,588		$	491,174,585
Liabilities
Other liabilities	$	352,388		$	1,070,540
Pension liability		1,141,410			1,082,941
Income taxes payable		24,577,557			–
Deferred income taxes		2,172,018			2,095,518
Total liabilities		28,243,373			4,248,999
Net Assets
Common stock, $1 par value: authorized, 5,000,000 shares; issued, 4,337,916 shares at December 31, 2010 and 4,326,516 at March 31, 2010		4,337,916			4,326,516
Additional capital		173,749,236			126,554,546
Undistributed net investment income		2,338,119			2,061,109
Unrealized appreciation of investments		357,374,592			377,920,063
Treasury stock - at cost on 584,878 shares		(23,936,648	)		(23,936,648	)
Total net assets		513,863,215			486,925,586
Total liabilities and net assets	$	542,106,588		$	491,174,585
Net asset value per share(on the 3,753,038 shares outstanding at December 31, 2010 and on the 3,741,638 shares outstanding at March 31, 2010)	$	136.92		$	130.14

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						Nine Months Ended
	December 31						December 31
	2010			2009			2010			2009
Investment income:
Interest	$	327,492		$	260,822		$	1,077,803		$	773,076
Dividends		1,899,156			2,019,208			4,860,400			3,216,810
Management and directors' fees		135,255			264,389			554,055			1,014,010
		2,361,903			2,544,419			6,492,258			5,003,896
Operating expenses:
Salaries		770,939			605,729			2,101,716			1,557,061
Net pension benefit		(72,828	)		(92,277	)		(218,484	)		(276,831	)
Professional fees		203,547			140,420			616,523			401,022
Other operating expenses		134,831			157,289			647,858			519,317
		1,109,318			811,161			3,147,613			2,200,569
Income before income taxes		1,252,585			1,733,258			3,344,645			2,803,327
Income tax expense		25,500			25,183			74,012			82,617
Net investment income	$	1,227,085		$	1,708,075		$	3,270,633		$	2,720,710
Proceeds from disposition of investments		(4,219,231	)		156,926			74,836,330		$	5,126,865
Cost of investments sold		–			156,926			4,510,400			3,486,870
Realized gain (loss) on investmentsbefore income tax		(4,219,231	)		–			70,325,930			1,639,995
Income tax expense		24,577,557			814,503			24,577,557			814,503
Net realized gain (loss) on investments		(28,796,788	)		(814,503	)		45,748,373			825,492
Net increase (decrease) in unrealized appreciation of investments		21,837,200			3,157,460			(20,545,471	)		40,419,753
Net realized and unrealized gain (loss) on investments	$	(6,959,588	)	$	2,342,957		$	25,202,902		$	41,245,245
Increase (decrease) in net assets from operations	$	(5,732,503	)	$	4,051,032		$	28,473,535		$	43,965,955

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

(Unaudited)

	Nine Months			Nine Months
	Ended			Ended
	December 31, 2010			December 31, 2009
Operations:
Net investment income	$	3,270,633		$	2,720,710
Net realized gain on investments		45,748,373			825,492
Net increase (decrease) in unrealized
appreciation of investments		(20,545,471	)		40,419,753
Increase in net assets from operations		28,473,535			43,965,955
Distributions from:
Undistributed net investment income		(2,993,623	)		(2,993,310	)
Net realized gains deemed distributed
to shareholders		(45,748,373	)		(868,114	)
Capital share transactions:
Allocated increase in share value for
deemed distribution		45,748,373			868,114
Change in pension plan funded status		–			(263,416	)
Exercise of employee stock options		745,200			–
Stock option expense		712,517			473,703
Increase in net assets		26,937,629			41,182,932
Net assets, beginning of period		486,925,586			415,262,991
Net assets, end of period	$	513,863,215		$	456,445,923

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						Nine Months Ended
	December 31						December 31
	2010			2009			2010			2009
Cash flows from operating activities
Increase (decrease) in net assets from operations	$	(5,732,503	)	$	4,051,032		$	28,473,535		$	43,965,955
Adjustments to reconcile increase (decrease)  in net assets from operations to net cash provided by (used in) operating activities:
Net proceeds from disposition of investments		(4,219,231	)		156,926			71,132,711			5,126,865
Proceeds from repayment of loans		4,273,097			–			4,407,434			3,000,000
Purchases of securities		(2,831,624	)		(753,000	)		(6,865,383	)		(16,121,588	)
Depreciation and amortization		6,734			6,516			19,568			21,414
Net pension benefit		(72,828	)		(92,277	)		(218,484	)		(276,831	)
Realized (gain) loss on investments      before income tax		4,219,231			–			(70,325,930	)		(1,639,994	)
Taxes payable on behalf of shareholders      on deemed distribution		24,577,557			814,503			24,577,557			814,503
Net (increase) decrease in unrealized
appreciation of investments		(21,837,200	)		(3,157,460	)		20,545,471			(40,419,753	)
Stock option expense		244,650			190,652			712,517			473,703
Increase in dividend and interest receivable		(1,433,821	)		(1,881,293	)		(684,505	)		(2,115,111	)
(Increase) decrease in receivables from affiliates		(18,058	)		158,528			557,540			(605,539	)
(Increase) decrease in other assets		7,050			(4,093	)		12,157			22,760
Increase (decrease) in other liabilities		84,544			(64,281	)		(718,152	)		633,825
Increase in deferred income taxes		25,500			32,400			76,500			97,200
Net cash provided by (used in) operating activities		(2,706,902	)		(541,845	)		71,702,536			(7,022,591	)
Cash flows from financing activities
Distributions from undistributed net
investment income		(1,496,968	)		(1,496,655	)		(2,993,623	)		(2,993,310	)
Proceeds from exercise of employee stock options		693,823			–			745,200			–
Net cash used in financing activities		(803,145	)		(1,496,655	)		(2,248,423	)		(2,993,310	)
Net increase (decrease) in cash and cash
equivalents		(3,510,047	)		(2,038,500	)		69,454,113			(10,015,901	)
Cash and cash equivalents at beginning
of period		77,057,668			6,744,329			4,093,508			14,721,730
Cash and cash equivalents at end of period	$	73,547,621		$	4,705,829		$	73,547,621		$	4,705,829
Supplemental disclosure of cash flow information:
Cash paid during the period for:
Interest	$	–		$	–		$	–		$	–
Income taxes	$	–		$	–		$	–		$	–

Non-Cash transaction:

In June 2010, the Company transferred certain tracts of Real Estate from Lifemark Group to their newly formed CapStar Holdings Corporation, wholly-owned by the Company.  This transaction had the following non-cash effect on the Company’s Consolidated Statement of Assets and Liabilities:

Total Investments $ – $ – $ 3,703,619 $ –

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

6

CAPITAL SOUTHWEST CORPORATION

AND SUBSIDIARIES

Consolidated Schedule of Investments

December 31, 2010

(Unaudited)

Company	Equity (a)	Investment (b)	Cost	Value (c)
¥†ALAMO GROUP INC.	22.0%	2,830,300 shares common stock (acquired 4-1-73
Seguin, Texas		thru 5-25-07)	$  2,190,937	$  59,011,755
Tractor-mounted mowing and mobile excavation
equipment for governmental, industrial and agricultural
markets; street-sweeping equipment for municipalities.
ALL COMPONENTS, INC.	80.4%	8.25%  subordinated note, $2,000,000 principal due
Pflugerville, Texas		2012 (acquired 6-27-07)	2,000,000	2,000,000
Electronics contract manufacturing; distribution and		150,000 shares Series A Convertible Preferred Stock,
production of memory and other components for		convertible into 600,000 shares of common stock
computer manufacturers,retailers and .		at $0.25 per share (acquired 9-16-94)	150,000	4,494,970
value-added resellers		Warrants to purchase 350,000 shares of common stock
		at $11.00 per share, expiring 2017 (acquired 6-27-07)	–	–
			2,150,000	6,494,970
ATLANTIC CAPITAL BANCSHARES, INC.	1.9%	300,000 shares common stock (acquired 4-10-07)	3,000,000	1,575,000
Atlanta, Georgia
Holding company of Atlantic Capital Bank,     a full service commercial bank.
¥ BALCO, INC.	90.9%	445,000 shares common stock and 60,920 shares Class B
Wichita, Kansas		non-voting common stock (acquired 10-25-83 and 5-30-02)	624,920	5,300,000
Specialty architectural products used in the construction
and remodeling of commercial and institutional buildings.
*BOXX TECHNOLOGIES, INC.	15.2%	3,125,354 shares Series B Convertible Preferred Stock,
Austin, Texas		convertible into 3,125,354 shares of common stock at
Workstations for computer graphic imaging and design.		$0.50 per share (acquired 8-20-99 thru 8-8-01)	1,500,000	2
*CMI HOLDING COMPANY, INC.	21.4%	10% convertible promissory note, due 2010 (acquired 9-13-10)	864,035	864,035
Richardson, Texas		10% convertible promissory note, due 2013 (acquired 5-19-10)	600,000	300,000
Owns Chase Medical, which develops and sells devices		10% convertible promissory note, due 2013 (acquired 2-23-10)	650,000	325,000
used in cardiac surgery to relieve congestive heart failure,		3% convertible promissory note, due 2011 (acquired 12-21-10)	535,000	535,000
develops and supports cardiac imaging systems.		1,631,516 shares Series C-1 Convertible Preferred
		Stock, convertible into 1,631,516 shares of common
		stock at $2.15 per share (acquired 7-10-09)	2,863,347	1
		2,327,658 shares Series A Convertible Preferred Stock,
		convertible into 2,327,658 shares of common stock at
		$1.72 per share (acquired 8-21-02 and 6-4-03)	4,000,000	2
		Warrants to purchase 109,012 shares of common stock at
		$1.72 per share, expiring 2012 (acquired 4-7-04)	–	–
		Warrants to purchase 636,151 shares of Series A-1
		Convertible Preferred Stock at $1.72 per share expiring
		2017 and 2019 (acquired 7-2-07 and 6-9-09)	–	–
		Warrant to purchase 90,698 shares of Series D or D-1
		Convertible Preferred Stock at $1.72 per share expiring
		2017 (acquired 2-23-10)	–	–
			9,512,382	2,024,038

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

7

CAPITAL SOUTHWEST CORPORATION

AND SUBSIDIARIES

Consolidated Schedule of Investments

December 31, 2010

(Unaudited)

Company	Equity (a)	Investment (b)	Cost	Value (c)
CINATRA CLEAN TECHNOLOGIES, INC.	68.8%	12% subordinated secured promissory note, due 2012      (acquired 5-19-10 thru 10-20-10)	$  1,001,929	$ 1,001,929
Houston, Texas		10% subordinated secured promissory note, due 2013
Cleans above ground oil storage tanks with a patented,		(acquired 7-14-08 thru 4-28-10)	6,200,700	6,200,700
automated system.		3,033,410 shares Series A Convertible Preferred Stock,
		convertible into 3,033,410 shares of common stock at $1.00
		per share (acquired 7-14-08 thru 11-18-10)	3,033,410	3,033,410
			10,236,039	10,236,039
*†ENCORE WIRE CORPORATION	16.9%	4,086,750 shares common stock (acquired 7-16-92 thru
McKinney, Texas		10-7-98)	5,800,000	82,756,688
Electric wire and cable for residential, commercial and
industrial construction use.
EXTREME INTERNATIONAL, INC.	53.6%	13,035 shares Series A common stock (acquired 9-26-08
Sugar Land, Texas		and 12-18-08)	325,875	757,000
Owns  Bill  Young  Productions, Texas  Video  and  Post, and		39,359.18 shares Series C Convertible Preferred Stock,
Extreme Communications, which produce radio and television		convertible into 157,437.72 shares of common stock at
commercials and corporate communications videos.		$25.00 per share (acquired 9-30-03)	2,625,000	9,143,000
		3,750 shares 8% Series A Convertible Preferred Stock,
		convertible into 15,000 shares of common stock at $25.00
		per share (acquired 9-30-03)	375,000	871,000
			3,325,875	10,771,000
¥†HEELYS, INC.	31.1%	9,317,310 shares common stock (acquired 5-26-00)	102,490	22,268,371
Carrollton, Texas
Heelys stealth skate shoes, equipment and apparel sold
through sporting goods chains,  department stores and
footware retailers.
†HOLOGIC, INC.	<1%	‡632,820 shares common stock (acquired 8-27-99)	220,000	11,909,672
Bedford, Massachusetts
Medical instruments including bone densitometers,
mammography devices and digital radiography systems.
iMEMORIES, INC.	27.6%	10% subordinated secured promissory note, due 2012	875,000	875,000
Scottsdale, AZ		(acquired 9-13-10)
Enables online video and photo sharing and DVD creation		17,391,304 shares Series B Convertible Preferred Stock,
for home movies recorded in analog and new digital format.		convertible into 17,391,304 shares of common stock at
		$0.23 per share (acquired 7-10-09)	4,000,000	4,000,000
		Warrant to purchase 968,750 shares of common stock at $0.12
		per share, expiring 2020 (acquired 9-13-10)	-	-
			4,875,000	4,875,000
KBI BIOPHARMA, INC.	17.1%	7,142,857 shares Series B-2 Convertible Preferred Stock,
Durham, NC		convertible into 7,142,857 shares of common stock at
Provides fully-integrated, outsourced drug development		$0.70 per share (acquired 9-08-09)	5,000,000	5,000,000
and bio-manufacturing services.

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

8

CAPITAL SOUTHWEST CORPORATION

AND SUBSIDIARIES

Consolidated Schedule of Investments

December 31, 2010

(Unaudited)

Company	Equity (a)	Investment (b)	Cost	Value (c)
¥MEDIA RECOVERY, INC.	97.9%	800,000 shares Series A Convertible Preferred Stock,
Dallas, Texas		convertible into 800,000 shares of common stock at
Computer datacenter and office automation supplies and		$1.00 per share (acquired 11-4-97)	$     800,000	$  3,200,000
accessories; impact, tilt monitoring and temperature sensing		4,000,002 shares common stock (acquired 11-4-97)	4,615,000	15,800,000
devices to detect mishandled shipments; dunnage for			5,415,000	19,000,000
protecting shipments.
*PALLETONE, INC.	8.4%	12.3% senior subordinated notes, $2,000,000
Bartow, Florida		principal due 2015 (acquired 9-25-06)	1,553,150	1,600,000
Manufacturer of wooden pallets and pressure-treated		150,000 shares common stock (acquired 10-18-01)	150,000	2
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	1,600,002
¥†PALM HARBOR HOMES, INC.	30.4%	7,855,121 shares common stock (acquired 1-3-85
Dallas, Texas		thru 7-31-95)	10,931,955	2
Integrated manufacturing, retailing, financing and insuring		Warrant to purchase 286,625 shares of common
of manufactured housing and modular homes.		stock at $3.14 per share, expiring 2019 (acquired
		4-24-09)	–	–
			10,931,955	2
¥THE RECTORSEAL CORPORATION	100.0%	27,907 shares common stock (acquired 1-5-73 and 3-31-73)	52,600	133,000,000
Houston, Texas
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 Manufacturing Company.
TCI HOLDINGS, INC.	–	21 shares 12% Series C Cumulative Compounding
Denver, Colorado		Preferred stock (acquired 1-30-90)	–	677,250
Cable television systems and microwave relay systems.
†TEXAS CAPITAL BANCHSARES, INC.	1.6%	‡489,656 shares common stock (acquired 5-1-00)	3,550,006	10,414,983
Dallas, Texas
Regional bank holding company with banking operations
in six Texas cities.

TRAX HOLDINGS, INC.	30.9%	1,061,279 shares Series A Convertible Preferred Stock,
Scottsdale, Arizona		convertibleinto 1,061,279 common stock at $4.71
Provides a comprehensive set of solutions to improve		per share (acquired 12-8-08 and 2-17-09)	5,000,000	6,205,387
the transportation validation, accounting, payment
and information management process.

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

9

CAPITAL SOUTHWEST CORPORATION

AND SUBSIDIARIES

Consolidated Schedule of Investments

December 31, 2010

(Unaudited)

Company	Equity (a)	Investment (b)	Cost	Value (c)
VIA HOLDINGS, INC.	28.1%	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 11-1-07)	281,523	2
Designer, manufacturer and distributor of high-quality			4,840,523	4
office  seating.
*WELLOGIX, INC.	19.3%	4,788,371 shares Series A-1 Convertible Participating
Houston, Texas		Preferred Stock, convertible into 4,788,371 shares
Developer and supporter of software used by the oil and gas		of common stock at $1.0441 per share (acquired
industry.		8-19-05 thru 6-15-08)	5,000,000	2
¥THE WHITMORE	80.0%	80 shares common stock (acquired 8-31-79)	1,600,000	51,800,000
MANUFACTURING COMPANY
Rockwall, Texas
Specialized surface mining, railroad and industrial
lubricants;coatings for automobiles and primary metals;
fluid contamination control devices.
MISCELLANEOUS		– Ballast Point Ventures II, L.P. – 2.2% limited partnership
		interest (acquired 8-4-08 thru 6-18-10)	975,000	975,000
		– BankCap Partners Fund I, L.P. – 5.5% limited partnership
		interest (acquired 7-14-06  thru 12-13-10)	5,646,770	5,126,941
		– CapitalSouth Partners Fund III, L.P. –1.9% limited
		partnership interest (acquired 1-22-08 and 2-12-09)	831,256	790,000
	100.0%	– ¥CapStar Holdings Corporation, – 500 shares common
		stock (acquired 6-10-10)	3,703,619	4,028,994
		– Diamond State Ventures, L.P. – 1.4% limited partnership
		interest (acquired 10-12-99 thru 8-26-05)	76,000	177,494
		– ¥Discovery Alliance, LLC – 90.0% limited liability company
		(acquired 9-12-08 thru 5-14-10)	900,000	635,470
		– Essex Capital Corporation – 10% unsecured promissory
		note due 8-19-10 (acquired 8-16-09)	–	1,000,000
		– First Capital Group of Texas III, L.P. – 3.0% limited
		partnership interest (acquired 12-26-00 thru 8-12-05)	778,895	402,825
	100.0%	– ¥Humac Company – 1,041,000 shares common stock
		(acquired 1-31-75 and 12-31-75)	–	157,000
		– STARTech Seed Fund I – 12.1% limited partnership
		interest (acquired 4-17-98 thru 1-5-00)	178,066	54,399
		– STARTech Seed Fund II – 3.2% limited partnership
		interest (acquired 4-28-00 thru 2-23-05)	843,891	119,621
		– Sterling Group Partners I, L.P. – 1.6% limited partnership
		interest (acquired 4-20-01 thru 1-24-05)	1,064,042	660,845
TOTAL INVESTMENTS			$101,674,162	$459,048,754
†Publicly-owned company   ¥ Control investment   * Affiliated investment  ‡Unrestricted securities as defined in Note (a)

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

10

CAPITAL SOUTHWEST CORPORATION

AND SUBSIDIARIES

Consolidated Schedule of Investments

March 31, 2010

Company	Equity (a)	Investment (b)	Cost	Value (c)
¥†ALAMO GROUP INC.	22.0%	2,830,300 shares common stock (acquired 4-1-73
Seguin, Texas		thru 5-25-07)	$  2,190,937	$  42,454,500
Tractor-mounted mowing and mobile excavation
equipment for governmental, industrial and agricultural
markets; street-sweeping equipment for municipalities.
ALL COMPONENTS, INC.	80.4%	8.25%  subordinated note, $6,000,000 principal due
Pflugerville, Texas		2012 (acquired 6-27-07)	6,000,000	6,454,925
Electronics contract manufacturing; distribution and		150,000 shares Series A Convertible Preferred Stock, con-
production of memory and other components for		vertible into 600,000 shares of common stock at $0.25
computer manufacturers,retailers and		per share (acquired 9-16-94)	150,000	5,821,725
value-added resellers.		Warrants to purchase 350,000 shares of common stock at
		$11.00 per share, expiring 2017 (acquired 6-27-07)	–	–
			6,150,000	12,276,650
ATLANTIC CAPITAL BANCSHARES, INC.	1.9%	300,000 shares common stock (acquired 4-10-07)	3,000,000	3,150,000
Atlanta, Georgia
Holding company of Atlantic Capital Bank,     a full service commercial bank.
¥BALCO, INC.	90.9%	445,000 shares common stock and 60,920 shares Class B
Wichita, Kansas		non-voting common stock (acquired 10-25-83 and 5-30-02)	624,920	8,000,000
Specialty architectural products used in the construction
and remodeling of commercial and institutional buildings.
*BOXX TECHNOLOGIES, INC.	15.2%	3,125,354 shares Series B Convertible Preferred Stock,
Austin, Texas		convertible into 3,125,354 shares of common stock at
Workstations for computer graphic imaging and design.		$0.50 per share (acquired 8-20-99 thru 8-8-01)	1,500,000	2
*CMI HOLDING COMPANY, INC.	22.4%	10% convertible promissory note, due 2013 (acquired 2-23-10)	650,000	1,300,000
Richardson, Texas		1,631,516 shares Series C-1 Convertible Preferred
Owns Chase Medical, which develops and sells devices		Stock, convertible into 1,631,516 shares of common
used in cardiac surgery to relieve congestive heart failure;		stock at $2.15 per share (acquired 7-10-09)	2,863,347	2,857,759
develops and supports cardiac imaging systems.		2,327,658 shares Series A Convertible Preferred Stock,
		convertible into 2,327,658 shares of common stock at
		$1.72 per share (acquired 8-21-02 and 6-4-03)	4,000,000	2
		Warrants to purchase 109,012 shares of common stock at
		$1.72 per share, expiring 2012 (acquired 4-7-04)	–	–
		Warrants to purchase 636,151 shares of Series A-1 Convertible
		Preferred Stock at $1.72 per share expiring 2017 and
		2019 (acquired 7-2-07 and 6-9-09)	–	–
		Warrant to purchase 90,698 shares of Series D or D-1
		Convertible Preferred Stock at $1.72 per share expiring
		2017 (acquired 2-23-10)	–	–
			7,513,347	4,157,761

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

11

CAPITAL SOUTHWEST CORPORATION

AND SUBSIDIARIES

Consolidated Schedule of Investments

March 31, 2010

Company	Equity (a)	Investment (b)	Cost	Value (c)
CINATRA CLEAN	59.2%	10% subordinated secured promissory note, $6,200,000
TECHNOLOGIES, INC.		principal due 2013 (acquired 7-14-08 thru 3-23-10)	$  6,000,300	$   3,815,235
Houston, Texas		1,128,649 shares Series A Convertible Preferred Stock,
Cleans above ground oil storage tanks with a patented,		convertible into 1,128,649 shares of common stock at $1.00
automated system.		per share (acquired 7-14-08 and 11-19-08)	1,128,649	1,128,649
			7,128,949	4,943,884
*†ENCORE WIRE CORPORATION	17.3%	4,086,750 shares common stock (acquired 7-16-92 thru
McKinney, Texas		10-7-98)	5,800,000	67,431,375
Electric wire and cable for residential, commercial and
industrial construction use.
EXTREME INTERNATIONAL, INC.	53.6%	13,035 shares Series A common stock (acquired 9-26-08
Sugar Land, Texas		and 12-18-08)	325,875	600,000
Owns  Bill  Young  Productions, Texas  Video  and  Post, and		39,359.18 shares Series C Convertible Preferred Stock,
Extreme Communications, which produce radio and television		convertible into 157,437.72 shares of common stock at
commercials and corporate communications videos.		$25.00 per share (acquired 9-30-03)	2,625,000	7,236,000
		3,750 shares 8% Series A Convertible Preferred Stock,
		convertible into 15,000 shares of common stock at $25.00
		per share (acquired 9-30-03)	375,000	689,000
			3,325,875	8,525,000
¥†HEELYS, INC.	31.1%	9,317,310 shares common stock (acquired 5-26-00)	102,490	19,845,870
Carrollton, Texas
Heelys stealth skate shoes, equipment and apparel sold
through sporting goods chains,  department stores and
footware retailers.
†HOLOGIC, INC.	<1%	‡632,820 shares common stock (acquired 8-27-99)	220,000	11,726,155
Bedford, Massachusetts
Medical instruments including bone densitometers,
mammography devices and digital radiography systems.
iMEMORIES, INC.	26.2%	17,391,304 shares Series B Convertible Preferred Stock,
Scottsdale, AZ		convertible into 17,391,304 shares of common stock at
Enables online video and photo sharing and DVD creation		$0.23 per share (acquired 7-10-09)	4,000,000	4,000,000
for home movies recorded in analog and new digital format.
KBI BIOPHARMA, INC.	14.8%	7,142,857 shares Series B-2 Convertible Preferred Stock,
Durham, NC		convertible into 7,142,857 shares of common stock at
Provides fully-integrated, outsourced drug development		$0.70 per share (acquired 9-08-09)	5,000,000	5,000,000
and bio-manufacturing services.

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

12

CAPITAL SOUTHWEST CORPORATION

AND SUBSIDIARIES

Consolidated Schedule of Investments

March 31, 2010

Company	Equity (a)	Investment (b)	Cost	Value (c)
¥LIFEMARK GROUP	100.0%	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.	97.5%	800,000 shares Series A Convertible Preferred Stock,
Dallas, Texas		convertible into 800,000 shares of common stock at
Computer datacenter and office automation supplies and		$1.00 per share (acquired 11-4-97)	800,000	2,200,000
sensing devices accessories; impact, tilt monitoring and		4,000,002 shares common stock (acquired 11-4-97)	4,615,000	11,200,000
temperature to detect mishandled shipments; dunnage			5,415,000	13,400,000
for protecting shipments.
*PALLETONE, INC.	8.4%	12.3% senior subordinated notes, $2,000,000
Bartow, Florida		principal due 2012 (acquired 9-25-06)	1,553,150	2,000,000
Manufacturer of wooden pallets and pressure-treated		150,000 shares common stock (acquired 10-18-01)	150,000	2
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	2,000,002
¥†PALM HARBOR HOMES, INC.	30.5%	7,855,121 shares common stock (acquired 1-3-85
Dallas, Texas		thru 7-31-95)	10,931,955	6,833,955
Integrated manufacturing, retailing, financing and insuring		Warrant to purchase 286,625 shares of common
of manufactured housing and modular homes.		stock at $3.14 per share, expiring 2019 (acquired
		4-24-09)	–	–
			10,931,955	6,833,955
¥THE RECTORSEAL CORPORATION	100.0%	27,907 shares common stock (acquired 1-5-73 and 3-31-73)	52,600	120,200,000
Houston, Texas
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 Manufacturing Company.
TCI HOLDINGS, INC.	–	21 shares 12% Series C Cumulative Compounding
Denver, Colorado		Preferred stock (acquired 1-30-90)	–	677,250
Cable television systems and microwave relay systems.
†TEXAS CAPITAL BANCSHARES, INC.	1.6%	‡489,656 shares common stock (acquired 5-1-00)	3,550,006	9,288,774
Dallas, Texas
Regional bank holding company with banking operations
in six Texas cities.

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

13

CAPITAL SOUTHWEST CORPORATION

AND SUBSIDIARIES

Consolidated Schedule of Investments

March 31, 2010

Company	Equity (a)	Investment (b)	Cost	Value (c)
TRAX HOLDINGS, INC.	31.1%	1,061,279 shares Series A Convertible Preferred Stock,
Scottsdale, Arizona		convertibleinto 1,061,279 common stock at $4.71
Provides a comprehensive set of solutions to improve		per share (acquired 12-8-08 and 2-17-09)	$5,000,000	$5,687,669
the transportation validation, accounting, payment
and information management process.
VIA HOLDINGS, INC.	28.1%	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 11-1-07)	281,523	2
Designer, manufacturer and distributor of high-quality			4,840,523	4
office  seating.
*WELLOGIX, INC.	19.6%	4,788,371 shares Series A-1 Convertible Participating
Houston, Texas		Preferred Stock, convertible into 4,788,371 shares
Developer and supporter of software used by the oil and gas		of common stock at $1.0441 per share (acquired
industry.		8-19-05 thru 6-15-08)	5,000,000	2
¥THE WHITMORE MANUFACTURING COMPANY	80.0%	80 shares common stock (acquired 8-31-79)	1,600,000	47,500,000
Rockwall, Texas
Specialized surface mining, railroad and industrial
lubricants;coatings for automobiles and primary metals;
fluid contamination control devices.
MISCELLANEOUS		–Ballast Point Ventures II, L.P. – 2.6% limited partnership
		interest (acquired 8-4-08 thru 11-3-09)	675,000	675,000
		–BankCap Partners Fund I, L.P. – 6.0% limited partnership
		interest (acquired 7-14-06  thru 6-18-09)	5,513,837	5,179,842
		–CapitalSouth Partners Fund III, L.P. – 2.0% limited partnership
		interest (acquired 1-22-08 and 2-12-09)	831,256	831,256
		–Diamond State Ventures, L.P. – 1.8% limited partnership
		interest (acquired 10-12-99 thru 8-26-05)	76,000	186,852
		–¥ Discovery Alliance, LLC – 90.0% limited liability company
		(acquired 9-12-08 thru 3-12-10)	750,000	750,000
		–Essex Capital Corporation – 10% unsecured promissory
		note due 8-19-11 (acquired 8-16-09)	–	1,000,000
		–First Capital Group of Texas III, L.P. – 3.0% limited partnership
		interest (acquired 12-26-00 thru 8-12-05)	778,895	451,208
	100.0%	¥– Humac Company – 1,041,000 shares common stock
		(acquired 1-31-75 and 12-31-75)	–	163,000
		–STARTech Seed Fund I – 12.1% limited partnership
		interest (acquired 4-17-98 thru 1-5-00)	178,066	1
		��STARTech Seed Fund II – 3.2% limited partnership
		interest (acquired 4-28-00 thru 2-23-05)	950,000	1
		–Sterling Group Partners I, L.P. – 1.6% limited partnership
		interest (acquired 4-20-01 thru 1-24-05)	1,064,042	607,044
TOTAL INVESTMENTS			$100,022,994	$477,943,057
†Publicly-owned company   ¥ Control investment   * Affiliated investment  ‡Unrestricted securities as defined in Note (a)

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

14

Notes to Consolidated Schedule of Investments

(Unaudited)

(a)           Equity

The percentages in the “Equity” column express the potential equity interests held by Capital Southwest Corporation and Capital Southwest Venture Corporation (together, the “Company”) in each issuer.  Each percentage represents the amount of the issuer’s common stock the Company owns or can acquire as a percentage of the issuer’s total outstanding common stock, plus stock reserved for all warrants, convertible securities and employee stock options.

(b)           Investments

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, 2010, restricted securities represented approximately 95.1% of the value of the consolidated investment portfolio.

Our investments are carried at fair value in accordance with the Investment Company Act of 1940 (the “1940 Act”) and FASB Accounting Standards Codification™ (ASC) Topic 820, Fair Value Measurements and Disclosures.  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 FASB ASC Topic 820 on April 1, 2008 (see footnote 1 in “Notes to Consolidated Financial Statements,” page 18).  ASC Topic 820 provides a framework for measuring the fair value of assets and liabilities along with 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.  ASC Topic 820 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.

ASC Topic 820 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 ASC Topic 820, 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 ASC, it is assumed that the reporting entity has access to the market as of the measurement date.

(c)           Value

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.  Issuers whose debt securities are judged to be of poor quality and doubtful collectability may instead be valued by assigning percentage discounts commensurate with the quality of such debt securities.  Debt securities may also be valued based on the resulting value from the sale of the business at the estimated fair market value.

15

Notes to Consolidated Schedule of Investments

(continued)

Partnership Interests, Preferred Equity and Common Equity, including unrestricted marketable securities 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 regard to the restrictive feature and adjusts for any diminution in value resulting from restrictions on resale.  Investments in certain entities that calculate net asset value per share (or its equivalent) and for which fair market value is not readily determinable, are valued using the net a sset value per share (or its equivalent, such as member units or ownership interest in partners’ capital to which a proportionate share of net assets is attributed) of the investment.

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.

(d)           Agreements Between Certain Issuers and the Company

Agreements between certain issuers and the Company provide that that issuer will bear substantially all costs in connection with the disposition of common stock, including those costs involved in registration under the Securities Act of 1933, but excluding underwriting discounts and commissions.  These agreements cover common stock owned at December 31, 2010 and common stock which may be acquired thereafter through the exercise of warrants and conversion of debentures and preferred stock.  They apply to restricted securities of all issuers in the investment portfolio of the Company except securities of the following issuers which are not obligated to bear registration costs:  Humac Company and The Whitmore Manufacturing Company.

(e)           Descriptions and Ownership Percentages

The descriptions of the companies and ownership percentages shown in the Consolidated Schedule of Investments were obtained from published reports and other sources believed to be reliable.  Acquisition dates indicated are the dates specific securities were acquired, which may differ from the original investment dates.  Certain securities were received in exchange for or upon conversion or exercise of other securities previously acquired.

16

Notes to Consolidated Financial Statements

(Unaudited)

ORGANIZATION AND BASIS OF PRESENTATION

Organization

Capital Southwest Corporation (“CSC” or the “Company”) was organized as a Texas corporation on April 19, 1961.  Until September 1969, we operated as a licensee under the Small Business Investment Act of 1958.  At that time, we transferred to our wholly-owned subsidiary, Capital Southwest Venture Corporation ("CSVC") certain assets and our license as a small business investment company ("SBIC").  CSVC is a closed-end, non-diversified investment company of the management type registered under the Investment Company Act of 1940 (the “1940 Act”).  Prior to March 30, 1988, we were registered as a closed-end, non-diversified investment company under the 1940 Act.  On that date, we elected to become a business development company subject to the provisi ons of the 1940 Act, as amended by the Small Business Incentive Act of 1980.  Because we wholly own CSVC, the portfolios of both entities are referred to collectively as “our,” “we” and “us.”  Capital Southwest Management Company (“CSMC”), a wholly-owned subsidiary of CSC, is the management company for CSC and CSVC.  CSMC generally incurs all normal operating and administrative expenses, including but not limited to salaries and related benefits, rent, equipment and other administrative costs required for its day-to-day operations.

Our portfolio is a composite of companies in which we have major interests as well as a number of developing companies and marketable securities of established publicly-owned companies.  We make available significant managerial assistance to the companies in which we invest and believe that providing material assistance to such investee companies is critical to their business development activities.  CSMC receives a monthly fixed fee for management services provided to certain of its control portfolio companies.

Basis of Presentation

The consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America (GAAP).  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 GAAP for interim financial information and the instructions to Form10-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,  2010,  as  filed  with  the  Securities  and  Exchange  Commission  (SEC).  Certain information and footnotes normally included in financial statements prepared in accordance with GAAP have been condensed or omitted, although we believe that the disclosures are adequate for a fair presentation.  The information reflects all adjustments (cons isting 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.

Portfolio Investment Classification

We classify our investments in accordance with the requirements of the 1940 Act.  Under the 1940 Act, “Control Investments” are defined as investments in which we own more than 25% of the voting securities or have rights to maintain greater than 50% of the board representation; “Affiliated Investments” are defined as investments in which we own between 5% and 25% of the voting securities; and “Non-Control/Non-Affiliated Investments” are defined as investments that are neither “Control Investments” nor “Affiliated Investments.”

17

Notes to Consolidated Financial Statements

(continued)

SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

1.           Summary of Significant Accounting Policies

The following is a summary of significant accounting policies followed in the preparation of the consolidated financial statements of CSC, CSVC and CSMC.

Fair Value Measurements The Company adopted FASB ASC Topic 820 on April 1, 2008.  ASC Topic 820 (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, ASC Topic 820 does not eliminate practicability exceptions that exist in accounting pronouncements amended by this Statement when measuring fair value.

Prior to ASC Topic 820, 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).  FASB ASC Topic 820 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, we use valuation techniques that place greater reliance on observable inputs and less reliance on unobservable inputs.  Due to the inherent uncertainty in the valuation process, our estimate of fair value may differ materially from the values that would have been used had a ready market for the securities existed.  In addition, changes in the market environment, portfolio company performance and other events may occur over the lives of the investments may cause the gains or losses ultimately realized on these investments to be materially different than the valuations currently assigned.  We determine the fair value of each in dividual investment and recorded changes in fair value as unrealized appreciation or depreciation.

We believe our investments at December 31, 2010 and March 31, 2010 approximate fair value as of those dates based on the market in which we operate and other conditions in existence at those reporting periods.

Investments  Investments are stated at market or fair value determined by our Board of Directors as described in Notes to the Consolidated Schedule of Investments and Note 2 below.  The average cost method is used in determining cost of investments sold.  Investments are recorded on a trade date basis.

Cash and Cash Equivalents  Cash and cash equivalents consist of highly liquid investments with an original maturity of three months or less at the date of purchase.  Cash and cash equivalents are carried at cost, which approximates fair value.

Segment Information  The Company operates and manages its business in a singular segment.  As an investment company, the Company invests in portfolio companies in various industries and geographic areas as presented in the Consolidated Schedule of Investments.

18

Notes to Consolidated Financial Statements

(continued)

Use of Estimates  The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect amounts reported in the financial statements and accompanying notes.  Actual results could differ from those estimates.

Interest and Dividend Income  Interest and dividend income is recorded on an accrual basis to the extent amounts are expected to be collected.  Dividend income is recorded at the ex-dividend date for marketable securities and restricted securities.  In accordance with our valuation policy, accrued interest and dividend income is evaluated periodically for collectability.  When a debt or loan becomes 90 days or more past due, and if we otherwise do not expect the debtor to be able to service all of its debt or other obligations, we will generally establish a reserve against the interest income, thereby placing the loan or debt security’s status on non-accrual basis and cease to recognize interest income on that loan or de bt security until the borrower has demonstrated the ability and intent to pay contractual amounts due.  If a loan or debt security’s status significantly improves regarding ability to service debt or other obligations, it will be restored to accrual basis.

Federal Income Taxes  CSC and CSVC have elected and intend to comply with the requirements of the Internal Revenue Code (IRC) necessary to qualify as regulated investment companies (RICs).  By meeting these requirements, they will not be subject to corporate federal income taxes on ordinary income distributed to shareholders.  In order to comply as a RIC, each company is required to timely distribute to its shareholders at least 90% of investment taxable income, as defined by the IRC, each year.  Taxable income generally differs from net income for financial reporting purposes due to temporary and permanent differences in the recognition of income and expenses.  Taxable income generally excludes net unrealized apprec iation or depreciation, as investment gains and losses are not included in taxable income until they are realized.  The Company’s policy is to retain and pay the 35% corporate tax on realized long-term capital gains.  For investment companies that qualify as RICs under the IRC, federal income taxes payable on security gains that the Company elects to retain are accrued only on the last day of our tax year, December 31.  See Note 3 for further discussion.

CSMC, a wholly owned subsidiary of CSC, is not a RIC and is required to pay taxes at the current corporate rate.

We account for interest and penalties as part of operating expenses.  There were no interest or penalties incurred during the nine months ended December 31, 2010 and 2009.

Deferred Taxes  CSMC sponsors a qualified defined benefit pension plan which covers its employees and employees of certain of its controlled affiliates.  Deferred taxes related to the qualified defined benefit pension plan are recorded as incurred.

Stock-Based Compensation     We account for our stock-based compensation using the fair value method, as prescribed by ASC 718, Compensation – Stock Compensation.  Accordingly, we recognize stock-based 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.  See Note 4 for further discussion.

Defined Pension Benefits and Other Postretirement Plans  We record annual amounts relating to the defined benefit pension plan based on calculations, which include various actuarial assumptions such as discount rates and assumed rates of return depending on the pension plan.  Material changes in pension costs may occur in the future due to changes in the discount rate, changes in the expected long-term rate of return, changes in level of contributions to the plans and other factors.  The funded status is the difference between the fair value of plan assets and the benefit obligation.  We recognize changes in the funded status of postretirement defined benefit plans in the Statement of Assets and Liabilities in the year in whic h the changes occur and measure postretirement defined benefit plan assets and obligations as of the date of the employer’s fiscal year-end.  We presently use March 31 as the measurement date for all of our postretirement defined benefit plans.

19

Notes to Consolidated Financial Statements

(continued)

Concentration of Risk  We place our idle cash in financial institutions, and at times, such balances may be in excess of the federally insured limits. On 11/19/10, the FDIC issued a Final Rule implementing section 343 of the Dodd-Frank Wall Street Reform and Consumer Protection Act  that provides for unlimited insurance coverage of noninterest-bearing transaction accounts beginning December 31, 2010 through December 31, 2012.

Recent Accounting Pronouncements

ASU No. 2010-06, Fair Value Measurements and Disclosures (Topic 820): Improving Disclosures About Fair Value Measurements.  In January 2010, the FASB issued ASU 2010-06 “Improving Disclosures About Fair Value Measurements,” which adds new requirements for disclosures about transfers into and out of Level 1 and 2 and separate disclosures about purchases, sales, issuances and settlements relating to Level 3 measurements.  It also clarifies existing fair value disclosures about the level of disaggregation, inputs and valuation techniques.  ASU 2010-06 is effective for interim and annual reporting periods beginning after December 15, 2009, except for the disclosures about purchases, sales, issuances and settlements in the roll forward of activity in Level 3 fair value measurements.  Those disclosures are effective for fiscal years beginning after December 15, 2010.  Adoption of ASU 2010-06 did not have a significant impact on the Company’s financial statement disclosures.

2.           Investments

We record our investments at fair value as determined in good faith by our Board of Directors in accordance with GAAP.  When available, we base the fair value of our investments on directly observable market prices or on market data derived for 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 ASC Topic 820, “Fair Value Measurements and Disclosures”.  We use judgment and consider factors specific to the investment in determining the significance of an input to a fair value measurement.  While management believes our valuation methodologies are appropriate and consistent with market participants, the use of different methodologies or assumptions to determine the fair value of certain financial instruments could result in a different estimate of fair value at the reporting date.  The three levels of the fair value hierarchy and investments that fall into each of the levels are describe d below:

·   Level 1:  Investments whose values are based on unadjusted quoted prices in active markets for identical assets or liabilities that the Company has the ability to access.  We use Level 1 inputs for publicly traded unrestricted securities.  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.

·   Level 2: Investments whose values are based on observable inputs other than quoted prices included in Level 1 that are observable for the asset or liability, either directly or indirectly.  These inputs may include quoted prices for the identical instrument in non-active markets, quoted prices for similar instruments in active markets and similar data.  We did not value any of our investments using Level 2 inputs as of December 31, 2010.

·   Level 3: Investments whose values are based on prices or valuation techniques that require inputs that are both unobservable and significant to the overall fair value measurement.  These inputs reflect management’s own assumptions about the assumptions a market participant would use in pricing the investment.  We use Level 3 inputs for measuring the fair value of substantially all of our investments.  See “Notes to Consolidated Schedule of Investments” (c) on page 15 for the investment policy used to determine the fair value of these investments.

20

Notes to Consolidated Financial Statements

(continued)

As required by ASC 820, when the inputs used to measure a fair value fall within different levels of the hierarchy, the level within the fair value measurement is categorized based on the lowest level input that is significant to the fair value measurement which may include inputs that are observable (Levels 1 and 2) and unobservable (Level 3).  We conduct reviews of fair value hierarchy on a quarterly basis.  Changes in the observability of valuation inputs may result in a reclassification of certain assets.

The following fair value hierarchy tables set forth our investment portfolio by level as of December 31, 2010 and March 31, 2010 (in millions):

			Fair Value Measurements at 12/31/2010 Using
	Total		Quoted Prices in Active Markets for  Identical Assets (Level 1)		Significant  Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
Debt	$	14.7	$	-	$	-	$	14.7
Partnership Interests		8.9		-		-		8.9
Warrants		-		-		-		-
Preferred Equity		36.6		-		-		36.6
Common Equity		398.8		22.3		-		376.5
Total Investments	$	459.0	$	22.3	$	-	$	436.7

			Fair Value Measurements at 3/31/2010 Using
	Total		Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
Debt	$	14.6	$	-	$	-	$	14.6
Partnership Interests		8.6		-		-		8.6
Preferred Equity		35.3		-		-		35.3
Common Equity		419.4		21.0		-		398.4
Total Investments	$	477.9	$	21.0	$	-	$	456.9

The following table provides a summary of changes in the fair value of investment assets and liabilities measured using Level 3 inputs during the nine months ended December 31, 2010 (in millions):

	Fair Value 3/31/2010		Net Unrealized Appreciation (Depreciation)			Net Changes from Unrealized to Realized		New Investments		Divestitures			Fair Value 12/31/2010
Debt	$	14.6	$	-		$	-	$	4.1	$	(4.0	)	$	14.7
Partnership Interest		8.6		(0.3	)		-		0.6		-			8.9
Warrants		-		-			-		-		-			-
Preferred Equity		35.3		(0.6	)		-		1.9		-			36.6
Common Equity		398.4		(21.1	)		-		3.7		(4.5	)		376.5
Total Investments	$	456.9	$	(22.0	)	$	-	$	10.3	$	(8.5	)	$	436.7

21

Notes to Consolidated Financial Statements

(continued)

The following table provides a summary of changes in the fair value of investment assets and liabilities measured using Level 3 inputs during the three months ended December 31, 2010 (in millions):

	Fair Value 9/30/2010		Net Unrealized Appreciation (Depreciation)			Net Changes  from Unrealized to Realized		New Investments		Divestitures			Fair Value 12/31/2010
Debt	$	18.4	$	(0.4	)	$	-	$	0.7	$	(4.0	)	$	14.7
Partnership Interest		9.2		(0.3	)		-		-		-			8.9
Warrants		4.1		(4.1	)		-		-		-			-
Preferred Equity		40.3		(5.6	)		-		1.9		-			36.6
Common Equity		348.1		28.4			-		-		-			376.5
Total Investments	$	420.1	$	18.0		$	-	$	2.6	$	(4.0	)	$	436.7

The total unrealized gains included in earnings that related to assets still held at report date for the nine month periods ended December 31, 2010 and 2009 were $45,944,129 and $38,208,870, respectively.

3.             Income Taxes

We operate to qualify as a RIC under Subchapter M of the IRC.  In order to qualify as a RIC, we must annually distribute at least 90% of our taxable ordinary income, based on our tax year, to our shareholders in a timely manner.  Ordinary income includes net short-term capital gains but excludes net long-term capital gains.  A RIC is not subject to federal income tax on the portion of its ordinary income and long-term capital gains that are distributed to its shareholders, including “deemed distributions” discussed below.  As permitted by the Code, a RIC can designate dividends paid in the subsequent tax year as dividends of current year ordinary income and net long-term gains if those dividends are both declared by the extended due date of the RIC’s federal income tax ret urn and paid to shareholders by the last day of the subsequent tax year.  We have distributed or intend to distribute sufficient dividends to eliminate taxable income for our completed tax years.  If we fail to satisfy the 90% distribution requirement or otherwise fail to qualify as a RIC in any tax year, we would be subject to tax in such year on all of our taxable income, regardless of whether we made any distributions to our shareholders.  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 before the end of our tax year.  We have a calendar tax year end of December 31.

We have distributed or intend to distribute sufficient dividends to eliminate taxable income for our completed tax years.  If we fail to satisfy the 90% distribution requirement or otherwise fail to qualify as a RIC in any tax year, we would be subject to tax in such year on all of our taxable income, regardless of whether we made any distributions to our shareholders.  For the tax year ended December 31, 2010 and 2009, we declared and paid ordinary dividends in the amount of $2,993,623 and $2,993,310, respectively.

Additionally, we are subject to a nondeductible federal excise tax of 4% if we do not distribute at least 98% of our investment company ordinary taxable income before the end of our tax year.  For the tax years ended December 31, 2010 and 2009, we distributed 100% of our investment company ordinary taxable income.  As a result, we have made no tax provisions for income taxes on ordinary taxable income for the tax years ended December 31, 2010 and 2009.

22

Notes to Consolidated Financial Statements

(continued)

A RIC may elect to retain its long-term capital gains by designating them as “deemed distribution” to its shareholders and paying a federal tax rate of 35% on the long-term capital gains for the benefit of its shareholders.  Shareholders then report their share of the retained capital gains on their income tax returns as if it had been received and report a tax credit for tax paid on their behalf by the RIC.  Shareholders then add the amount of the “deemed distribution” net of such tax, to the basis of their shares.

·   For the tax year ended December 31, 2010, we had net long-term capital gains of $70,221,589 for tax purposes and $70,325,930 for book purposes, which we elected to retain and treat as deemed distributions to our shareholders.  During the quarter ended December 31, 2010 we recorded a $4,217,985 reduction in the gain on sale of Lifemark Group, Inc.  This reduction was the result of a net asset adjustment calculated in accordance with the Stock Purchase Agreement signed on June 10, 2010.

·   In order to make the election to retain capital gains, we incurred federal taxes on behalf of our shareholders in the amount of $24,577,557 for the tax year ended December 31, 2010.  For the tax year ended December 31, 2009, we had net long-term capital gains of $2,327,150 for tax purposes and $1,682,616 for book purposes, which we elected to retain and treat as deemed distributions to our shareholders.  In order to make the election to retain capital gains, we incurred federal taxes on behalf of our shareholders in the amount of $814,502 for the tax year ended December 31, 2009.

For the quarters ended December 31, 2010 and 2009, CSC and 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.

 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.

4.             Employee Stock Option Plans

On July 20, 2009, shareholders approved the Company’s 2009 Stock Incentive Plan (the “2009 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 up to ten years from the date of grant and are generally exercisable on or after the first anniversary of the date of grant in five annual installments.  Options to purchase 38,750 shares at a price of $76.74 (market price at the time of the grant) were granted on October 19, 2009 and remain outstanding, thus leaving a total of 101,250 options available for future grant.  Additionally, options to purchase 20,000 shares at a price of $95.79 (market price at time of the grant) were granted on March 22, 2010.  Options to purchase 15,000 shares at a price of $88.20 were granted on July 19, 2010. All 73,750 shares remain outstanding, thus leaving 66,250 options available for grant under the plan.

The Company previously granted stock options under its 1999 Stock Option Plan (the “1999 Plan”), as approved by shareholders on July 19, 1999.  The 1999 Plan expired on April 19, 2009.  Options previously made under the Company’s 1999 Stock Option Plan and outstanding on July 20, 2009 continue in effect governed by provisions of the 1999 plan.  All options granted under the 1999 Plan were granted at or above market price, generally expire up to 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.

23

Notes to Consolidated Financial Statements

(continued)

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, 2010, we recognized compensation expense of $244,650 and $712,517, respectively.

As of December 31, 2010, the total remaining unrecognized compensation cost related to non-vested stock options was $3,048,554, which will be amortized over the weighted-average service period of approximately 3.6 years.

The following table summarizes the 2009 Plan and the 1999 Plan price per option at grant date using the Black-Scholes pricing model:

		Black-Scholes Pricing Model Assumptions
Date of Issuance	Weighted Average Fair Value	Expected Dividend Yield	Risk- Free  Interest Rate	Expected Volatility	Expected Life        (in years)
2009 Plan
July 19, 2010	$  28.59	0.91%	1.73%	37.5%	5
March 22, 2010	$  32.56	0.84%	2.43%	37.8%	5
October 19, 2009	$  25.36	1.04%	2.36%	37.6%	5
1999 Plan
July 30, 2008	$  29.93	0.62%	3.36%	20.2%	5
July 21, 2008	$  27.35	0.67%	3.41%	20.2%	5
July 16, 2007	$  41.78	0.39%	4.95%	19.9%	5
July 17, 2006	$  33.05	0.61%	5.04%	21.2%	7
May 15, 2006	$  31.28	0.64%	5.08%	21.1%	7

The following table summarizes activity in the 2009 Plan and the 1999 Plan as of December 31, 2010:

	Number			Weighted-Average
	of shares			Exercise Price
2009 Plan
Balance at March 31, 2010		58,750		$	83.23
Granted		15,000			88.20
Exercised		–			–
Canceled		–			–
Balance at December 31, 2010		73,750		$	83.24
1999 Plan
Balance at March 31, 2010		107,900		$	114.78
Granted		–			–
Exercised		(11,400	)		65.37
Canceled		–			–
Balance at December 31, 2010		96,500		$	107.86
Combined Balance at December 31, 2010		170,250		$	104.83

24

Notes to Consolidated Financial Statements

(continued)

At December 31, 2010, the range of exercise prices and weighted-average remaining contractual life of outstanding options was $65.70 to $152.98 and 3.60 years, respectively.  The number of options exercisable under the 2009 Plan and the 1999 Plan, at December 31, 2010, was 54,325 with a weighted-average exercise price of $115.57.  Additionally a total of 10,618 new shares were issued for $693,823 in cash proceeds from options exercised during the quarter ended December 31, 2010 bringing the total number of new shares issued to 11,400 for $745,200 in cash proceeds for the options exercised during the nine months December 31, 2010.

5.         Summary of Per Share Information

	Three Months Ended						Nine Months Ended
	December 31						December 31
	2010			2009			2010			2009
Investment income	$	.63		$	.68		$	1.73		$	1.34
Operating expenses		(.29	)		(.21	)		(.84	)		(.59	)
Interest expense		–			–			–			–
Income taxes		(.01	)		(.01	)		(.02	)		(.02	)
Net investment income		.33			.46			.87			.73
Distributions from undistributed
net investment income		(.40	)		(.40	)		(.80	)		(.80	)
Net realized gain (loss) on investments		(7.67	)		(.22	)		12.19			.22
Net increase (decrease) in unrealized
appreciation of investments		5.82			.84			(5.47	)		10.80
Exercise of employee stock options		(.19	)		–			(.20	)		(.07	)
Stock option expense		.06			.05			.19			.13
Increase (decrease) in net asset value		(2.05	)		.73			6.78			11.01
Net asset value:
Beginning of period		138.99			121.26			130.14			110.98
End of period	$	136.92		$	121.99		$	136.92		$	121.99
Shares outstanding at end of period
(000s omitted)		3,753			3,742			3,753			3,742

6.         Contingencies and Commitments

From time to time the Company may be liable for claims against its portfolio companies.  We do not believe the effects of such claims would have a material impact on our results of operations and financial condition.

The Company has future commitments, subject to specific conditions, to invest up to $11,720,369 in eight portfolio companies.

25

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

Forward-Looking Statements

The information contained herein may contain “forward-looking statements” based on our current expectations, assumptions and estimates about us and our industry.  These forward-looking statements involve risks and uncertainties.  Words such as “believe,” ��anticipate,” “estimate,” “expect,” “intend,” “plan,” “will,” “may,” “might,” “could,” “continue” and other similar expressions identify forward-looking statements.  In addition, any statements that refer to expectations, projections or other characterizations of future events or circumstances are forward-looking statements.  Our actual results could differ materially from those anticipated in the f orward-looking statements as a result of several factors more fully described in “Risk Factors” and elsewhere in this Form 10-Q, and in our Form 10-K for the year ended March 31, 2010, filed with the SEC on May 28, 2010.  The forward-looking statements made in this Form 10-Q related only to events as of the date on which the statements are made.  You should read the following discussion in conjunction with the consolidated financial statements and related footnotes and other financial information included in the Annual Report on Form 10-K for the year ended March 31, 2010.  We undertake no obligation to update publicly any forward-looking statements for any reason, even if new information becomes available or other events occur in the future.

Results of Operations

The composite measure of our financial performance in the Consolidated Statements of Operations is captioned “Increase in net assets from operations” and consists of three elements.  The first is “Net investment income,” which is the difference between our income from interest, dividends and fees and our combined operating and interest expenses, net of applicable income taxes.  The second element is “Net realized gain on investments”, which is the difference between the proceeds received from disposition of portfolio securities and their stated cost.  The third element is the “Net increase (decrease) in unrealized appreciation of investments,” which is the net change in the market or fair value of our investment portfolio, compared with stated cost. 0; It should be noted that the “Net realized gain on investments” and “Net increase (decrease) in unrealized appreciation of investments” are directly related in that when an appreciated portfolio security is sold to realize a gain, a corresponding decrease in net unrealized appreciation occurs by transferring the gain associated with the transaction from “unrealized” to “realized.”  Conversely, when a loss is realized on a depreciated portfolio security, an increase in net unrealized appreciation occurs.

Net asset value at December 31, 2010 was $513,863,215, equivalent to $136.92 per share.  Assuming reinvestment of all dividends and tax credits on retained long-term capital gains, the December 31, 2010 net asset value reflects an increase of 6.1% during the past nine months as well as an increase of 13.2% during the past twelve months.

	December 31, 2010		March 31, 2010		December 31,  2009
Net assets	$	513,863,215	$	486,925,586	$	456,455,923
Shares outstanding		3,753,038		3,741,638		3,741,638
Net assets per share	$	136.92	$	130.14	$	121.99

26

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

(continued)

Net Investment Income

Interest income of $1,077,803 for the Nine months ended December 31, 2010 increased from $773,076 for the nine months ended December 31, 2009 as a result of increased cash balances and interest earned on new debt instruments.  During the nine months ended December 31, 2010 and 2009, we recorded dividend income from the following sources:

	Nine Months Ended December 31,
	2010		2009
Alamo Group Inc.	$	509,454	$	509,454
Balco, Inc.		1,817,503		-
CapitalSouth Partners Fund III		-		20,528
Dennis Tool Company		-		33,333
Encore Wire Corporation		245,205		245,205
The RectorSeal Corporation		1,781,828		1,877,870
TCI Holdings, Inc		60,953		60,953
The Whitmore Manufacturing Company		445,457		469,467
	$	4,860,400	$	3,216,810

Net Realized Gain on Investments

During the nine months ended December 31, 2010, we sold all of our shares of common stock of Lifemark Group to NorthStar Memorial Group LLC generating net cash proceeds of $74,822,145 and $3,703,619 of real estate and assets, which were directly transferred to CapStar Holdings Corporation. In addition, we received $553,668 from escrowed monies held from the sale of Dennis Tool Company in 2009 and capital gains proceeds of $31,933 from STARTech Seed Fund I.  As a result, we incurred federal taxes on behalf of our shareholders in the amount of $24,577,557 for the tax year ended December 31, 2010.  Transfer taxes in the amount of $1,218,855 related to the transfer of real estate were deducted from the realized gain on the Lifemark transaction.

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 December 31,						Nine Months Ended December 31,
	2010			2009			2010			2009
Alamo Group Inc.	$	11,604,230		$	2,830,300		$	16,557,255		$	14,151,500
All Components, Inc.		(10,040,342	)		1,000,000			(1,781,680	)		7,612,999
Balco, Inc.		(700,000	)		–			(2,700,000	)		1,400,000
CMI Holding Company, Inc.		–			–			(4,132,758	)		2,700,759
Encore Wire Corporation		15,325,313			(4,086,750	)		15,325,313			4,086,750
Heelys, Inc.		2,142,981			465,866			2,422,501			4,285,963
Media Recovery, Inc.		2,900,000			1,900,000			5,600,000			(1,100,000	)
Palm Harbor Homes, Inc.		–			(2,984,947	)		(6,833,953	)		(2,984,947	)
The RectorSeal Corporation		(5,100,000	)		5,300,000			12,800,000			2,600,000
The Whitmore Manufacturing Company		2,400,000			–			4,300,000			2,400,000

27

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

(continued)

During the nine months ended December 31, 2010, the value of our investments increased by $21,837,200.  This change in unrealized appreciation of investments includes a $66,489,600 reduction related to the aforementioned sale of Lifemark Group.  Excluding the Lifemark Group unrealized appreciation at March 31, 2010, net unrealized appreciation of investments for the nine months ended December 31, 2010 increased by $45,944,129.  The largest increases in unrealized appreciation are attributable to RectorSeal Corporation, which increased $12,800,000 and The Whitmore Manufacturing Company, which increased $4,300,000 due to improved earnings.  Media Recovery, Inc., which increased $5,600,000 due to earnings improvement and reduced debt,  Encore Wire Corporation, which increased $15,325 ,313, Alamo Group, which increased $16,557,255, and Heelys which increased $2,422,501 due to increases in their respective stock prices.  Offsetting the increases were a $6,833,953 decrease in Palm Harbor Homes, Inc., reflecting depressed market conditions within the housing industry and the company’s outlook; a $4,132,758 decrease in CMI Holding Company due to a decline in the value of the underlying security, a $2,700,000 decrease in Balco, Inc. due to declining earnings and a $1,781,680 decline in All Components, Inc. as a result of earnings and partial payback of its debt to Capital Southwest Corporation.

A description of the investments listed above and other material components of the investment portfolio are included in this report under the caption “Consolidated Schedule of Investments – December 31, 2010 and March 31, 2010.”

Portfolio Investments

During the quarter ended December 31, 2010, we made investments of $2,831,624 in existing portfolio companies.

We have agreed, subject to certain conditions, to invest up to $11,720,369 in eight portfolio companies.

Financial Liquidity and Capital Resources

At December 31, 2010, we had cash and cash equivalents of approximately $73.5 million.  Pursuant to Small Business Administration (SBA) regulations, cash and cash equivalents of $3.2 million held by Capital Southwest Venture Corporation (CSVC) may not be transferred or advanced to us without the consent of the SBA.

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 40 years.  Retention of future gains is viewed as an important source of funds to sustain our investment activity.  Approximately $18.6 million of our investment portfolio is represented by unrestricted publicly-traded securities, and represent a source of liquidity as of December 31, 2010.

Funds to be used by us for operating or investment purposes may be transferred in the form of dividends, management fees or loans from 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.

Application of Critical Accounting Policies and Accounting Estimates

There have been no changes during the quarter December 31, 2010 to the critical accounting policies or the areas that involve the use of significant judgments and estimates we described in our Annual Report on Form 10-K for the fiscal year ended March 31, 2010. 

28

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 and on our net asset value.

Our investment in portfolio securities includes fixed-rate debt securities which totaled $13,701,664 at December 31, 2010, equivalent to 3.2% 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 restri cted 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 Chairman of the Board and President 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 Chairman of the Board and President 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 Chairm an of the Board and President and Chief Financial Officer, as appropriate, to allow timely decisions regarding such required disclosure.

During the fiscal quarter ended December 31, 2010, 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.

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PART II.  OTHER INFORMATION

Item 1. Legal Proceedings

We may, from time to time, be involved in litigation arising out of our operations in the normal course of business or otherwise.  Furthermore, third parties may try to seek to impose liability on us in connection with the activities of our portfolio companies.  We have no current pending legal proceedings to which we are party or to which any of our property is subject.

Item 1A. Risk Factors

There have been no material changes to our risk factors disclosed in Item 1A, “Risk Factors”, in our Annual Report on Form 10-K for the fiscal year ended March 31, 2010.

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Item 6.              Exhibits

(a)   Exhibits

Exhibit 31.1- Certification of Chairman of the Board and 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 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 Chairman of the Board and 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 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.

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SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

		CAPITAL SOUTHWEST CORPORATION
Date:             February 7, 2011	By:
		Gary L. Martin, Chairman of the Board and President

Date:          February 7, 2011	By:	/s/ Tracy L. Morris
		Tracy L. Morris, Chief Financial Officer

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