Exhibit 13.1
Twelve Largest Investments - March 31, 2008
- --------------------------------------------------------------------------------
The RectorSeal Corporation $144,200,000
- --------------------------------------------------------------------------------
The RectorSeal Corporation, Houston, Texas, with facilities in Texas, New
York and Idaho, manufactures specialty chemical products including pipe thread
sealants, firestop sealants, plastic cements and other formulations for
plumbing, HVAC, electrical and industrial applications. The company also makes
special tools for plumbers and systems for containing smoke from building fires.
RectorSeal's subsidiary, Jet-Lube, Inc., with plants in Texas, England and
Canada, produces anti-seize compounds, specialty lubricants and other products
used in industrial and oil field applications. Another subsidiary produces and
sells automotive chemical products. RectorSeal also owns a 20% equity interest
in The Whitmore Manufacturing Company (described on page 9).
During the year ended March 31, 2008, RectorSeal earned $11,264,000 on
revenues of $112,029,000, compared with earnings of $9,676,000 on revenues of
$103,922,000 in the previous year. RectorSeal's earnings do not reflect its 20%
equity in The Whitmore Manufacturing Company.
At March 31, 2008, Capital Southwest owned 100% of RectorSeal's common stock
having a cost of $52,600 and a value of $144,200,000.
- --------------------------------------------------------------------------------
Lifemark Group $71,000,000
- --------------------------------------------------------------------------------
Lifemark Group, Hayward, California, owns and operates cemeteries, funeral
homes, mausoleums and mortuaries. Lifemark's operations, all of which are in
California, include a major cemetery and funeral home in San Mateo, a mausoleum
and an adjacent mortuary in Oakland and cemeteries, mausoleums and mortuaries in
Hayward and Sacramento. The company also owns a funeral home in San Bruno. Its
funeral and cemetery trusts enable Lifemark's clients to make pre-need
arrangements. The company's assets also include excess real estate holdings.
For the fiscal year ended March 31, 2008, Lifemark reported earnings of
$529,000 on revenues of $29,682,000, compared with earnings of $2,239,000 on
revenues of $28,727,000 in the previous year.
At March 31, 2008, Capital Southwest owned 100% of Lifemark Group's common
stock, which had a cost of $4,510,400 and was valued at $71,000,000.
- --------------------------------------------------------------------------------
Encore Wire Corporation $51,084,375
- --------------------------------------------------------------------------------
Encore Wire Corporation, McKinney, Texas, manufactures a broad line of copper
electrical building wire and cable including non-metallic sheathed, underground
feeder and THHN wire and cable as well as armored cable for residential,
commercial and industrial construction. Encore's products are sold through
distributors and building materials retailers.
For the year ended December 31, 2007, Encore reported net income of
$30,796,000 ($1.32 per share) on net sales of $1,184,786,000, compared with net
income of $115,133,000 ($4.86 per share) on net sales of $1,249,330,000 in the
previous year. The March 31, 2008 closing Nasdaq bid price of Encore's common
stock was $18.18 per share.
At March 31, 2008, the $5,800,000 investment in 4,086,750 shares of Encore's
restricted common stock by Capital Southwest and its subsidiary was valued at
$51,084,375 ($12.50 per share), representing a fully-diluted equity interest of
16.9%.
- --------------------------------------------------------------------------------
Alamo Group Inc. $45,284,800
- --------------------------------------------------------------------------------
Alamo Group Inc., Seguin, Texas, is a leading designer, manufacturer and
distributor of heavy-duty, tractor and truck mounted mowing and other vegetation
maintenance equipment, mobile excavators, street-sweeping and snow removal
equipment and replacement parts. Founded in 1969, Alamo Group operates 16
manufacturing facilities and serves governmental, industrial and agricultural
markets in North America, Europe, and Australia.
For the year ended December 31, 2007, Alamo reported net income of
$12,365,000 ($1.24 per share) on net sales of $504,386,000, compared with net
income of $11,488,000 ($1.16 per share) on net sales of $456,494,000 in the
previous year. The March 31, 2008 closing NYSE market price of Alamo's common
stock was $21.27 per share.
At March 31, 2008, the $2,190,937 investment in Alamo by Capital Southwest
and its subsidiary was valued at $45,284,800 ($16.00 per share), consisting of
2,830,300 restricted shares of common stock, representing a fully-diluted equity
interest of 26.2%.
1
- --------------------------------------------------------------------------------
The Whitmore Manufacturing Company $38,000,000
- --------------------------------------------------------------------------------
The Whitmore Manufacturing Company, Rockwall, Texas, manufactures specialty
lubricants for heavy equipment used in surface mining, railroads and other
industries, and produces water-based coatings for the automotive and primary
metals industries. Whitmore's Air Sentry division manufactures fluid
contamination control devices. The company's assets also include several
commercial real estate interests.
During the year ended March 31, 2008, Whitmore reported net income of
$2,879,000 on net sales of $23,148,000, compared with net income of $2,848,000
on net sales of $20,863,000 in the previous year. The company is owned 80% by
Capital Southwest and 20% by Capital Southwest's subsidiary, The RectorSeal
Corporation (described on page 6).
At March 31, 2008, the direct investment in 80% of Whitmore by Capital
Southwest was valued at $38,000,000 and had a cost of $1,600,000.
- --------------------------------------------------------------------------------
Media Recovery, Inc. $37,500,000
- --------------------------------------------------------------------------------
Media Recovery, Inc. (MRI) is a holding company of three operating divisions,
Media Recovery, ShockWatch and Damage Prevention Company. Its Media Recovery
division provides datacenter supplies and services to corporate customers
through its direct sales force. Its ShockWatch division manufactures monitoring
devices used to detect mishandled shipments and devices for monitoring material
handling equipment. Media Recovery's subsidiary, The Damage Prevention Company,
Denver, Colorado, manufactures dunnage products used to prevent damage in
trucking, rail and export container shipments.
During the year ended September 30, 2007, Media Recovery reported net income
of $4,744,000 on net sales of $134,180,000, compared with net income of
$5,164,000 on net sales of $137,040,000 in the previous year.
At March 31, 2008, the $5,415,000 investment in Media Recovery by Capital
Southwest and its subsidiary was valued at $37,500,000, consisting of 800,000
shares of Series A convertible preferred stock and 4,000,000 shares of common
stock, representing a fully-diluted equity interest of 96.9%.
- --------------------------------------------------------------------------------
Heelys, Inc. $34,939,913
- --------------------------------------------------------------------------------
Heelys, Inc., Carrollton, Texas, markets and distributes specialty stealth
skate footwear, equipment and apparel under the brand name Heelys. The company
manufactures its products in China and Korea and distributes them through
domestic and international sporting goods chains, department and lifestyle
stores and specialty footwear retailers.
During the year ended December 31, 2007, Heelys reported net income of
$22,317,000 ($0.79 per share) on net sales of $183,472,000, compared with net
income of $29,174,000 ($1.16 per share) on net sales of $188,208,000 in the
previous year. The March 31, 2008 closing Nasdaq market price of Heely's common
stock was $4.29 per share.
At March 31, 2008, the $102,490 investment in Heelys by Capital Southwest's
subsidiary was valued at $34,939,913 ($3.75 per share), consisting of 9,317,310
restricted shares of common stock, representing a fully-diluted equity interest
of 31.8%.
- --------------------------------------------------------------------------------
Palm Harbor Homes, Inc. $31,420,484
- --------------------------------------------------------------------------------
Palm Harbor Homes, Dallas, Texas, is an integrated manufacturer and retailer
of manufactured and modular housing produced in 12 plants and sold in 29 states
by 87 company-owned retail stores and builder locations and approximately 275
independent dealers, builders and developers.
During the year ended March 31, 2008, Palm Harbor reported a net loss of
$124,262,000 ($5.44 per share) on net sales of $555,096,000, compared with net
loss of $11,565,000 ($0.51 per share) on net sales of $661,247,000 in the
previous year. The March 31, 2008 closing Nasdaq market price of Palm Harbor's
common stock was $5.25 per share.
At March 31, 2008, the $10,931,955 investment in Palm Harbor by Capital
Southwest and its subsidiary was valued at $31,420,484 ($4.00 per share),
consisting of 7,855,121 restricted shares of common stock, representing a
fully-diluted equity interest of 30.5%.
2
- --------------------------------------------------------------------------------
Hologic, Inc. $17,586,068
- --------------------------------------------------------------------------------
Hologic, Inc., Bedford, Massachusetts, is a leading developer, manufacturer
and supplier of bone densitometers, mammography and breast biopsy devices,
direct-to-digital x-ray systems and other x-ray based imaging systems. These
products are generally targeted to address women's healthcare and general
radiographic applications.
For the year ended September 29, 2007, Hologic reported net income of
$94,578,000 ($1.72 per share) on net sales of $738,368,000, compared with net
income of $27,423,000 ($0.56 per share) on net sales of $462,680,000 in the
previous year. The March 31, 2008 closing Nasdaq bid price of Hologic's common
stock was $55.58 per share.
At March 31, 2008, Capital Southwest and its subsidiary owned 316,410
unrestricted shares of common stock, having a cost of $220,000 and a market
value of $17,586,068 ($55.58 per share).
- --------------------------------------------------------------------------------
All Components, Inc. $12,600,000
- --------------------------------------------------------------------------------
All Components, Inc., Austin, Texas, distributes and produces memory and
other electronic components for personal computer manufacturers, retailers,
value-added resellers and other corporate customers. Through its Austin-based
sales and distribution center and its contract manufacturing plants in Austin,
Texas and Boise, Idaho, the company serves over 2,000 customers throughout the
United States.
During the year ended August 31, 2007, All Components reported net income of
$134,000 on net sales of $239,565,000, compared with net income of $968,000 on
net sales of $275,449,000 in the previous year.
At March 31, 2008, the $6,150,000 investment in All Components by Capital
Southwest and its subsidiary was valued at $12,600,000 consisting of an 8.25%
subordinated note valued at its cost of $6,000,000 and 150,000 shares of Series
A Convertible Preferred Stock valued at $6,600,000, representing a 79.9%
fully-diluted equity interest.
- --------------------------------------------------------------------------------
Texas Capital Bancshares, Inc. $8,265,393
- --------------------------------------------------------------------------------
Texas Capital Bancshares, Inc. of Dallas, Texas, formed in 1998, has total
assets of approximately $4.3 billion. With branch banks in Austin, Dallas, Fort
Worth, Houston, Plano and San Antonio, Texas Capital Bancshares conducts its
business through its subsidiary, Texas Capital Bank, N.A., which targets middle
market commercial and wealthy private client customers in Texas.
For the year ended December 31, 2007, Texas Capital reported net income of
$29,422,000 ($1.10 per share), compared with net income of $28,924,000 ($1.09
per share) in the previous year. The March 30, 2008 closing Nasdaq price of
Texas Capital's common stock was $16.88 per share.
At March 31, 2008, Capital Southwest owned 489,656 unrestricted shares of
common stock, having a cost of $3,550,006 and a market value of $8,265,393
($16.88 per share).
- --------------------------------------------------------------------------------
Extreme International, Inc. $7,985,000
- --------------------------------------------------------------------------------
Extreme International, Inc., Sugar Land, Texas, owns Bill Young Productions,
Texas Video and Post, and Extreme Communications, which produce radio and
television commercials and corporate communications videos.
During the year ended September 30, 2007, Extreme reported net income of
$1,688,000 on net sales of $12,470,000, compared with net income of $1,203,000
on net sales of $10,342,000 in the previous year.
At March 31, 2008, Capital Southwest and its subsidiary owned 39,359 shares
of Series C Convertible Preferred Stock, 3,750 shares of 8% Series A Convertible
Preferred Stock and warrants to purchase 13,035 shares of common stock at $25
per share, having a cost of $3,000,000 and a market value of $7,985,000,
representing a fully-diluted equity interest of 53.6%.
3
Portfolio of Investments - March 31, 2008
Company Equity (a) Investment (b) Cost Value (c)
- ------------------------------------------------------------------------------------------------------------------------------------
+AT&T, INC. <1% ++20,770 shares common stock $ 12 $ 795,491
San Antonio, Texas (acquired 3-9-99)
Global leader in local, long distance,
Internet and transaction- based voice
and data services.
- ------------------------------------------------------------------------------------------------------------------------------------
+ALAMO GROUP INC. 26.2% 2,830,300 shares common stock
Seguin, Texas (acquired 4-1-73 thru 5-25-07) 2,190,937 45,284,800
Tractor-mounted mowing and mobile excavation
equipment for governmental, industrial and
agricultural markets; street-sweeping
equipment for municipalities.
- ------------------------------------------------------------------------------------------------------------------------------------
ALL COMPONENTS, INC. 79.9% 8.25% subordinated note due 2012 6,000,000 6,000,000
Austin, Texas (acquired 6-27-07)
Electronics contract manufacturing; distribution 150,000 shares Series A Convertible
and production of memory and other components for Preferred Stock, convertible into
computer manufacturers, retailers and value-added 600,000 shares of common stock at
resellers. $0.25 per share (acquired 9-16-94) 150,000 6,600,000
Warrants to purchase 350,000 shares
of common stock at $11.00 per share,
expiring 2017 (acquired 6-27-07) -- --
--------- ----------
6,150,000 12,600,000
- ------------------------------------------------------------------------------------------------------------------------------------
+ATLANTIC CAPITAL BANCSHARES, INC. 2.0% 300,000 shares common stock
Atlanta, Georgia (acquired 4-10-07) 3,000,000 3,000,000
Holding company of Atlantic Capital Bank
a full service commercial bank.
- ------------------------------------------------------------------------------------------------------------------------------------
BALCO, INC. 88.5% 445,000 shares common stock
Wichita, Kansas and 60,920 shares Class B
Specialty architectural products used non-voting common stock
in the construction and remodeling of (acquired 10-25-83 and 5-30-02) 624,920 4,500,000
commercial and institutional buildings.
- ------------------------------------------------------------------------------------------------------------------------------------
BOXX TECHNOLOGIES, INC. 15.2% 3,125,354 shares Series B Convertible
Austin, Texas Preferred Stock, convertible into
Workstations for computer graphics 3,125,354 shares of common stock
imaging and design. at $0.50 per share (acquired 8-20-99
thru 8-8-01) 1,500,000 2
- ------------------------------------------------------------------------------------------------------------------------------------
CMI HOLDING COMPANY, INC. 15.3% 10% convertible subordinated note,
Richardson, Texas due 2009 (acquired 7-2-07
Owns Chase Medical, which develops and sells thru 10-9-07) 2,363,347 1,000,000
devices used in cardiac surgery to relieve 2,327,658 shares Series A Convertible
congestive heart failure; develops and Preferred Stock, convertible into
supports cardiac imaging systems. 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) -- --
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
- ------------------------------------------------------------------------------------------------------------------------------------
+Publicly-owned company ++Unrestricted securities as defined in Note (b)
4
Company Equity (a) Investment (b) Cost Value (c)
- ------------------------------------------------------------------------------------------------------------------------------------
+COMCAST CORPORATION <1% ++64,656 shares common stock
Philadelphia, Pennsylvania (acquired 11-18-02) $ 21 $ 1,248,508
Leading provider of cable, entertainment
and communications products and services.
- ------------------------------------------------------------------------------------------------------------------------------------
DENNIS TOOL COMPANY 67.4% 20,725 shares 5% convertible preferred
Houston, Texas stock, convertible into 20,725 shares
Polycrystalline diamond compacts of common stock at $48.25 per share
(PDCs) used in oil field drill (acquired 8-10-98) 999,981 999,981
bits and in mining and industrial 140,137 shares common stock
applications. (acquired 3-7-94 and 8-10-98) 2,329,963 2,000,000
--------- ---------
3,329,944 2,999,981
- ------------------------------------------------------------------------------------------------------------------------------------
+DISCOVERY HOLDING COMPANY <1% ++70,501 shares Series A common stock
Englewood, Colorado (acquired 7-21-05) 20,262 1,492,506
Provider of creative content,
media management and network
services worldwide.
- ------------------------------------------------------------------------------------------------------------------------------------
+EMBARQ CORPORATION <1% ++4,500 shares common stock
Overland Park, Kansas (acquired 5-17-06) 46,532 180,450
Local exchange carrier that provides voice
and data services, including high-speed
Internet.
- ------------------------------------------------------------------------------------------------------------------------------------
+ENCORE WIRE CORPORATION 16.9% 4,086,750 shares common stock
McKinney, Texas (acquired 7-16-92 thru 10-7-98) 5,800,000 51,084,375
Electric wire and cable for
residential and commercial use.
- ------------------------------------------------------------------------------------------------------------------------------------
EXTREME INTERNATIONAL, INC. 53.6% 39,359.18 shares Series C Convertible
Sugar Land, Texas Preferred Stock, convertible into
Owns Bill Young Productions, Texas Video 157,436.72 shares of common stock at
and Post, and Extreme Communications, $25.00 per share (acquired 9-30-03) 2,625,000 7,026,000
which produce radio and television 3,750 shares 8% Series A Convertible
commercials and corporate Preferred Stock, convertible into
communications videos. 15,000 shares of common stock at
$25.00 per share (acquired 9-30-03) 375,000 669,000
Warrants to purchase 13,035 shares
of common stock at $25.00 per
share, expiring 2008
(acquired 8-11-98 thru 9-30-03) -- 290,000
--------- ---------
3,000,000 7,985,000
- ------------------------------------------------------------------------------------------------------------------------------------
+FMC CORPORATION <1% ++12,860 shares common stock
Philadelphia, Pennsylvania (acquired 6-6-86 and 9-13-07) 66,726 713,601
Chemicals for agricultural,
industrial and consumer markets.
- ------------------------------------------------------------------------------------------------------------------------------------
+FMC TECHNOLOGIES, INC. <1% ++22,114 shares common stock
Houston, Texas (acquired 1-2-02 and 8-31-07) 57,051 1,258,065
Equipment and systems for the energy,
food processing and air transportation
industries.
- ------------------------------------------------------------------------------------------------------------------------------------
+Publicly-owned company ++Unrestricted securities as defined in Note (b)
5
Company Equity (a) Investment (b) Cost Value (c)
- ------------------------------------------------------------------------------------------------------------------------------------
+HEELYS, INC. 31.8% 9,317,310 shares common stock
Carrollton, Texas (acquired 5-26-00) $ 102,490 $ 34,939,913
Heelys stealth skate shoes, equipment
and apparel sold through sporting goods
chains, department stores and footwear retailers.
- ------------------------------------------------------------------------------------------------------------------------------------
+HOLOGIC, INC. <1% ++316,410 shares common stock
Bedford, Massachusetts (acquired 8-27-99) 220,000 17,586,068
Medical instruments including bone
densitometers, mammography devices
and digital radiography systems.
- ------------------------------------------------------------------------------------------------------------------------------------
+KIMBERLY-CLARK CORPORATION <1% ++77,180 shares common stock
Dallas, Texas (acquired 12-18-97) 2,358,518 4,981,969
Manufacturer of tissue, personal care
and health care products.
- ------------------------------------------------------------------------------------------------------------------------------------
+LIBERTY GLOBAL, INC. <1% ++42,463 shares Series A common stock
Englewood, Colorado (acquired 6-15-05) 106,553 1,446,714
Owns interests in broadband, ++42,463 shares Series C common stock
distribution and content companies. (acquired 9-6-05) 100,870 1,377,500
-------- ---------
207,423 2,824,214
- ------------------------------------------------------------------------------------------------------------------------------------
+LIBERTY MEDIA CORPORATION <1% ++35,250 shares Liberty Capital Series
Englewood, Colorado A common stock (acquired 5-9-06) 7,833 554,130
Holding company owning interests in ++176,252 shares Liberty Interactive
electronic retailing, media, communi- Series A common stock
cations and entertainment businesses. (acquired 5-9-06) 66,424 2,842,945
++141,000 shares Liberty Entertainment
Series A common stock
(acquired 3-3-08) 43,996 3,148,530
-------- ---------
118,253 6,545,605
- ------------------------------------------------------------------------------------------------------------------------------------
LIFEMARK GROUP 100.0% 1,449,026 shares common stock 4,510,400 71,000,000
Hayward, California (acquired 7-16-69)
Cemeteries, mausoleums and mortuaries
located in northern California.
- ------------------------------------------------------------------------------------------------------------------------------------
MEDIA RECOVERY, INC. 96.9% 800,000 shares Series A Convertible
Dallas, Texas Preferred Stock, convertible into
Computer datacenter and office automation 800,000 shares of common stock at
supplies and accessories; impact, tilt $1.00 per share (acquired 11-4-97) 800,000 6,250,000
monitoring and temperature sensing devices 4,000,000 shares common stock
to detect mishandled shipments; dunnage (acquired 11-4-97) 4,615,000 31,250,000
for protecting shipments. --------- ----------
5,415,000 37,500,000
- ------------------------------------------------------------------------------------------------------------------------------------
PALLETONE, INC. 8.4% 12.3% senior subordinated notes due
Bartow, Florida 2012 (acquired 9-25-06) 1,553,150 2,000,000
Manufacturer of wooden pallets 150,000 shares common stock
and pressure-treated lumber. (acquired 10-18-01) 150,000 750,000
Warrant to purchase 15,294 shares of
common stock at $1.00 per share,
expiring 2011 (acquired 2-17-06) 45,746 61,000
--------- ---------
1,748,896 2,811,000
- ------------------------------------------------------------------------------------------------------------------------------------
+Publicly-owned company ++Unrestricted securities as defined in Note (b)
6
Company Equity (a) Investment (b) Cost Value (c)
- ------------------------------------------------------------------------------------------------------------------------------------
+PALM HARBOR HOMES, INC. 30.5% 7,855,121 shares common stock
Dallas, Texas (acquired 1-3-85 thru 7-31-95) $ 10,931,955 $ 31,420,484
Integrated manufacturing, retailing,
financing and insuring of manufactured
housing and modular homes.
- ------------------------------------------------------------------------------------------------------------------------------------
+PETSMART, INC. <1% ++300,000 shares common stock
Phoenix, Arizona (acquired 6-1-95) 1,318,771 6,123,000
Retail chain of more than 928 stores
selling pet foods, supplies and services.
- ------------------------------------------------------------------------------------------------------------------------------------
THE RECTORSEAL CORPORATION 100.0% 27,907 shares common stock
Houston, Texas (acquired 1-5-73 and 3-31-73) 52,600 144,200,000
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
Manufacturing Company.
- ------------------------------------------------------------------------------------------------------------------------------------
+SPRINT NEXTEL CORPORATION <1% ++90,000 shares common stock
Reston, Virginia (acquired 6-20-84) 457,113 602,100
Diversified telecommunications company.
- ------------------------------------------------------------------------------------------------------------------------------------
TCI HOLDINGS, INC. - 21 shares 12% Series C Cumulative
Denver, Colorado Compounding Preferred stock
Cable television systems (acquired 1-30-90) -- 677,250
and microwave relay systems.
- ------------------------------------------------------------------------------------------------------------------------------------
+TEXAS CAPITAL BANCSHARES, INC. 1.6% ++489,656 shares common stock
Dallas, Texas (acquired 5-1-00) 3,550,006 8,265,393
Regional bank holding company with
banking operations in six Texas cities.
- ------------------------------------------------------------------------------------------------------------------------------------
VIA HOLDINGS, INC. 28.1% 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 11-1-07) 281,523 281,523
--------- --------
4,840,523 281,525
- ------------------------------------------------------------------------------------------------------------------------------------
WELLOGIX, INC. 19.7% 4,726,161 shares Series A-1 Convertible
Houston, Texas Participating Preferred Stock, con-
Developer and supporter of software vertible into 4,726,161 shares of
used by the oil and gas industry to common stock at $1.0579 per share
control drilling and maintenance expenses. (acquired 8-19-05 thru 3-15-08) 5,000,000 2
- ------------------------------------------------------------------------------------------------------------------------------------
THE WHITMORE MANUFACTURING COMPANY 80.0% 80 shares common stock
Rockwall, Texas (acquired 8-31-79) 1,600,000 38,000,000
Specialized mining, railroad and
industrial lubricants; coatings for
automobiles and primary metals;
fluid contamination control devices.
- ------------------------------------------------------------------------------------------------------------------------------------
+WINDSTREAM CORPORATION <1% ++9,181 shares common stock
Little Rock, Arkansas (acquired 7-17-06) 19,656 109,713
Provider of voice, broadband
and entertainment services.
- ------------------------------------------------------------------------------------------------------------------------------------
+Publicly-owned company ++Unrestricted securities as defined in Note (b)
7
Company Equity (a) Investment (b) Cost Value (c)
- ------------------------------------------------------------------------------------------------------------------------------------
MISCELLANEOUS - BankCap Partners Fund I, L.P. - 6.0%
limited partnership interest
(acquired 7-14-06 thru 12-21-07) $ 2,457,140 $ 2,457,140
- 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
- First Capital Group of Texas III,
L.P. - 3.3% limited partnership
interest (acquired 12-26-00
thru 8-12-05) 964,604 964,604
100.0% Humac Company - 1,041,000 shares
common stock (acquired 1-31-75
and 12-31-75) -- 181,000
- 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 1,144,481
- ------------------------------------------------------------------------------------------------------------------------------------
TOTAL INVESTMENTS $ 81,027,466 $547,570,502
============ ============
- ------------------------------------------------------------------------------------------------------------------------------------
+Publicly-owned company ++Unrestricted securities as defined in Note (b)
8
Notes to Portfolio of Investments
(a) The percentages in the "Equity" column express the potential equity
interests held by Capital Southwest Corporation and Capital Southwest Venture
Corporation (together, the "Company") in each issuer. Each percentage represents
the amount of the issuer's common stock the Company owns or can acquire as a
percentage of the issuer's total outstanding common stock, plus stock reserved
for all warrants, convertible securities and employee stock options. The symbol
"<1%" indicates that the Company holds a potential equity interest of less than
1%.
(b) Unrestricted securities (indicated by ++) are freely marketable securities
having readily available market quotations. All other securities are restricted
securities which are subject to one or more restrictions on resale and are not
freely marketable. At March 31, 2008, restricted securities represented
approximately 90.4% of the value of the consolidated investment portfolio.
(c) Under the valuation policy of the Company, unrestricted securities are
valued at the closing sale price for NYSE listed securities and at the lower of
the closing bid price or the last sale price for Nasdaq securities on the
valuation date. Restricted securities, including securities of publicly-owned
companies which are subject to restrictions on resale, are valued at fair value
as determined by the Board of Directors. Fair value is considered to be the
amount which the Company may reasonably expect to receive for portfolio
securities if such securities were sold on the valuation date. Valuations as of
any particular date, however, are not necessarily indicative of amounts which
may ultimately be realized as a result of future sales or other dispositions of
securities.
Among the factors considered by the Board of Directors in determining the
fair value of restricted securities are the logic and methodology of SFAS 157,
the financial condition and operating results of the issuer, the long-term
potential of the business of the issuer, the market for and recent sales prices
of the issuer's securities, the values of similar securities issued by companies
in similar businesses, the proportion of the issuer's securities owned by the
Company, the nature and duration of resale restrictions and the nature of any
rights enabling the Company to require the issuer to register restricted
securities under applicable securities laws. In determining the fair value of
restricted securities, the Board of Directors considers the inherent value of
such securities without regard to the restrictive feature and adjusts for any
diminution in value resulting from restrictions on resale. The values of the
Company's top four wholly or majority owned assets determined by our Board of
Directors, were reviewed by a nationally-recognized valuation firm as of March
31, 2008.
(d) Agreements between certain issuers and the Company provide that the issuers
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 March 31, 2008 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, Lifemark Group and The Whitmore Manufacturing Company.
(e) The descriptions of the companies and ownership percentages shown in the
portfolio of investments were obtained from published reports and other sources
believed to be reliable, are supplemental and are not covered by the report of
our independent registered public accounting firm. 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.
9
Portfolio Changes During the Year
New Investments and Additions to Previous Investments
Amount
------
Alamo Group Inc...........................................$ 125,890
All Components, Inc....................................... 3,000,000
Atlantic Capital Bancshares, Inc.......................... 3,000,000
BankCap Partners Fund I, L.P.............................. 1,861,521
CapitalSouth Partners Fund III, L.P....................... 701,255
CMI Holding Company, Inc.................................. 1,763,347
VIA Holdings, Inc......................................... 281,523
------------
$10,733,536
============
Dispositions
Amount
Cost Received
---- --------
Alltel Corporation ..................... $ 88,699 $ 634,920
Diamond State Ventures, L.P............. 35,000 35,000
Exopack, Inc............................ - 245,950
Hic-Star Corporation.................... 1,070,168 1
Sterling Group Partners I, L.P.......... - 518,020
---------- ----------
$1,193,867 $1,433,891
========== ==========
Repayments Received..................... $154,500
========
10
Capital Southwest Corporation and Subsidiaries
Consolidated Statements of Financial Condition
March 31
---------------------------
Assets 2008 2007
------------ ------------
Investments at market or fair value
Companies more than 25% owned
(Cost: 2008 - $28,758,246,
2007 - $28,632,356)................... $410,026,178 $526,993,983
Companies 5% to 25% owned
(Cost: 2008 - $20,412,243,
2007 - $18,798,896)................... 54,895,381 76,398,002
Companies less than 5% owned
(Cost: 2008 - $31,856,977,
2007 - $24,211,045)................... 82,648,943 77,763,048
------------- --------------
Total investments
(Cost: 2008 - $81,027,466,
2007 - $71,642,297)................... 547,570,502 681,155,033
Cash and cash equivalents.................. 31,327,758 38,844,203
Receivables................................ 156,322 337,892
Other assets............................... 7,630,486 9,170,185
------------- --------------
Totals.................................. $586,685,068 $729,507,313
============ ============
March 31
---------------------------
Liabilities and Shareholders' Equity 2008 2007
------------ ------------
Other liabilities.......................... $ 1,187,796 $ 1,457,847
Deferred income taxes...................... 1,797,058 2,317,777
----------------------------
Total liabilities ..... 2,984,854 3,775,624
----------------------------
Shareholders' equity
Common stock, $1 par value: authorized,
5,000,000 shares; issued, 4,326,516
shares at March 31, 2008 and 4,323,416
shares at March 31, 2007.............. 4,326,516 4,323,416
Additional capital...................... 115,687,153 116,373,960
Undistributed net investment income..... 7,036,929 5,655,020
Undistributed net realized loss on
investments........................... (2,860,118) (3,100,142)
Unrealized appreciation of investments.. 466,543,036 609,512,737
Treasury stock - at cost
(437,365 shares)...................... (7,033,302) (7,033,302)
-------------- ---------------
Net assets at market or fair value, equivalent
to $150.09 per share at March 31, 2008 on
the 3,889,151 shares outstanding and
$186.75 per share at March 31, 2007 on the
3,886,051 shares outstanding.......... 583,700,214 725,731,689
------------- -------------
Totals.................................. $586,685,068 $729,507,313
============ ============
The accompanying Notes are an integral part of these
Consolidated Financial Statements
11
Capital Southwest Corporation and Subsidiaries
Consolidated Statements of Operations
Years Ended March 31
-----------------------------------------------
2008 2007 2006
------------- ------------- -------------
Investment income:
Interest ........................................................$ 2,255,550 $ 2,308,660 $ 505,536
Dividends ....................................................... 3,656,833 3,954,875 3,485,430
Management and directors' fees .................................. 882,300 708,900 848,070
------------- ------------- -------------
6,794,683 6,972,435 4,839,036
------------- ------------- -------------
Operating expenses:
Salaries ........................................................ 1,619,008 1,356,062 1,211,584
Net pension benefit ............................................. (327,345) (144,945) (116,747)
Other operating expenses ........................................ 1,676,660 1,014,255 859,702
------------- ------------- -------------
2,968,323 2,225,372 1,954,539
------------- ------------- -------------
Income before interest expense and income taxes .................... 3,826,360 4,747,063 2,884,497
Interest expense ................................................... -- 460,399 436,021
------------- ------------- -------------
Income before income taxes ......................................... 3,826,360 4,286,664 2,448,476
Income tax expense ................................................. 111,160 53,324 59,220
------------- ------------- -------------
Net investment income ..............................................$ 3,715,200 $ 4,233,340 $ 2,389,256
============= ============= =============
Proceeds from disposition of investments ...........................$ 1,433,891 $ 42,919,988 $ 30,802,552
Cost of investments sold ........................................... 1,193,867 16,872,993 10,523,986
------------- ------------- -------------
Realized gain on investments before income taxes ................... 240,024 26,046,995 20,278,566
Income tax expense ................................................. -- 11,080,699 4,827,663
------------- ------------- -------------
Net realized gain on investments ................................... 240,024 14,966,296 15,450,903
------------- ------------- -------------
Net increase (decrease) in unrealized appreciation of investments .. (142,969,698) 147,681,609 124,355,303
------------- ------------- -------------
Net realized and unrealized gain (loss) on investments .............$(142,729,674) $ 162,647,905 $ 139,806,206
============= ============= =============
Increase (decrease) in net assets from operations ..................$(139,014,474) $ 166,881,245 $ 142,195,462
============= ============= =============
The accompanying Notes are an integral part of these
Consolidated Financial Statements
12
Capital Southwest Corporation and Subsidiaries
Consolidated Statements of Changes in Net Assets
Years Ended March 31
-----------------------------------------------
2008 2007 2006
------------- ------------- -------------
Operations:
Net investment income .....................................................$ 3,715,200 $ 4,233,340 $ 2,389,256
Net realized gain on investments .......................................... 240,024 14,966,296 15,450,903
Net increase (decrease) in unrealized appreciation of investments ......... (142,969,698) 147,681,609 124,355,303
------------- ------------- -------------
Increase (decrease) in net assets from operations ......................... (139,014,474) 166,881,245 142,195,462
Distributions from:
Undistributed net investment income ....................................... (2,333,291) (2,323,150) (2,314,231)
Net realized gains deemed distributed to shareholders ..................... -- (11,417,283) (13,573,139)
Capital share transactions:
Allocated increase in share value for deemed distribution ................. -- 11,417,283 13,573,139
Exercise of employee stock options ........................................ 231,390 1,794,850 208,000
Adjustment to initially apply FASB No. 158, net of tax .................... -- 1,173,751 --
Change in pension plan funded status ........................................ (1,178,764) -- --
Stock option expense ........................................................ 263,664 169,003 --
------------- ------------- -------------
Increase (decrease) in net assets ....................................... (142,031,475) 167,695,699 140,089,231
Net assets, beginning of year ............................................... 725,731,689 558,035,990 417,946,759
------------- ------------- -------------
Net assets, end of year .....................................................$ 583,700,214 $ 725,731,689 $ 558,035,990
============= ============= =============
The accompanying Notes are an integral part of these
Consolidated Financial Statements
13
Capital Southwest Corporation and Subsidiaries
Consolidated Statements of Cash Flows
Years Ended March 31
-----------------------------------------------
2008 2007 2006
------------- ------------- -------------
Cash flows from operating activities
Increase (decrease) in net assets from operations .................................$(139,014,474) $ 166,881,245 $ 142,195,462
Adjustments to reconcile increase in net assets from operations
to net cash provided by (used in) operating activities:
Proceeds from disposition of investments ..................................... 1,433,891 42,919,988 30,802,552
Purchases of securities ...................................................... (10,733,536) (803,269) (15,054,741)
Maturities of securities ..................................................... 154,500 884,935 480,197
Depreciation and amortization ................................................ 32,756 16,808 16,136
Net pension benefit .......................................................... (327,345) (144,945) (116,747)
Realized gain on investments before income taxes ............................. (240,024) (14,966,296) (15,450,905)
Net (increase) decrease in unrealized appreciation of investments ............ 142,969,698 (147,681,609) (124,355,303)
Stock option expense ......................................................... 263,664 169,003 --
(Increase) decrease in receivables ........................................... 181,570 (202,005) 514
Increase in other assets ..................................................... (80,195) (39,982) (3,226)
Increase (decrease) in other liabilities ..................................... (33,281) 8,934 (67,245)
Decrease in accrued pension liability ........................................ (135,768) (144,171) (154,673)
Increase in deferred income taxes ............................................ 114,000 50,700 40,800
------------- ------------- -------------
Net cash provided by (used in) operating activities ............................... (5,414,544) 46,949,336 18,332,821
------------- ------------- -------------
Cash flows from financing activities
Decrease in note payable to bank .................................................. -- (8,000,000) --
Decrease in note payable to portfolio company ..................................... -- -- (5,000,000)
Distributions from undistributed net investment income ............................ (2,333,291) (2,323,150) (2,314,231)
Proceeds from exercise of employee stock options .................................. 231,390 1,794,850 208,000
Payment of federal income tax for deemed capital gains distribution ............... -- (11,080,699) (4,827,659)
------------- ------------- -------------
Net cash used in financing activities ............................................. (2,101,901) (19,608,999) (11,933,890)
------------- ------------- -------------
Net increase (decrease) in cash and cash equivalents .............................. (7,516,445) 27,340,337 6,398,931
Cash and cash equivalents at beginning of year .................................... 38,844,203 11,503,866 5,104,935
------------- ------------- -------------
Cash and cash equivalents at end of year...........................................$ 31,327,758 $ 38,844,203 $ 11,503,866
============= ============= =============
Supplemental disclosure of cash flow information:
Cash paid during the year for:
Interest ...........................................$ -- $ 460,399 $ 436,920
Income taxes .......................................$ -- $ 20,000 $ 18,420
The accompanying Notes are an integral part of these
Consolidated Financial Statements
14
Notes to Consolidated Financial Statements
1. Summary of Significant Accounting Policies
Capital Southwest Corporation ("CSC") is a business development company
subject to regulation under the Investment Company Act of 1940. Capital
Southwest Venture Corporation ("CSVC"), a wholly-owned subsidiary of CSC, is a
Federal licensee under the Small Business Investment Act of 1958. Capital
Southwest Management Corporation ("CSMC"), a wholly-owned subsidiary of CSC, is
the management company for CSC and CSVC. The following is a summary of
significant accounting policies followed in the preparation of the consolidated
financial statements of CSC, CSVC and CSMC (together, the "Company"):
Principles of Consolidation. The consolidated financial statements have been
prepared in accordance with accounting principles generally accepted in the
United States of America for investment companies. Under rules and regulations
applicable to investment companies, we are precluded from consolidating any
entity other than another investment company. An exception to this general
principle occurs if the investment company has an investment in an operating
company that provides services to the investment company. Our consolidated
financial statements include our management company, CSMC.
Cash and Cash Equivalents. All temporary cash investments having a maturity
of three months or less when purchased are considered to be cash equivalents.
Investments. Investments are stated at market or fair value determined by the
Board of Directors as described in the Notes to Portfolio of Investments and
Note 2 below. The average cost method is used in determining cost of investments
sold. Investments are recorded on a trade date basis. Dividends are recognized
on the ex-dividend date and interest income is accrued daily.
Segment Information. The Company operates and manages its business in a
singular segment. As an investment company, the Company invests in portfolio
companies in various industries and geographic areas as presented in the
portfolio of investments.
Use of Estimates. The preparation of financial statements in conformity with
accounting principles generally accepted in the United States of America
requires management to make estimates and assumptions that affect the amounts
reported in the financial statements and accompanying notes. Actual results
could differ from those estimates.
Federal Income Taxes. CSC and CSVC intend to comply with the requirements of
the Internal Revenue Code 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. 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 the tax year, December 31. Therefore,
CSC and CSVC made no provision for federal income taxes on such gains and net
investment income in their financial statements.
CSMC, a wholly owned subsidiary of CSC, is not a RIC and is required to pay
taxes at the current corporate rate.
In June 2006, the Financial Accounting Standards Board ("FASB") issued
Interpretation No. 48 ("FIN 48"), which clarifies the accounting for uncertainty
in income taxes recognized in an entity's financial statements in accordance
with FASB Statement 109, "Accounting for Income Taxes". FIN 48 prescribes a
recognition threshold and measurement attribute for the financial statement
recognition and measurement of a tax position taken or expected to be taken in a
15
tax return. The Company adopted FIN 48 on April 1, 2007, which had no effect on
the Company's financial statements.
Deferred Taxes. 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 benefit
pension plan are recorded as incurred.
Stock-Based Compensation. In December 2004, the Financial Accounting
Standards Board (FASB) issued SFAS No. 123 (revised 2004), Share-Based Payment
(SFAS 123R), which revised SFAS 123. SFAS 123R also supersedes APB 25 and amends
SFAS No. 95, Statement of Cash Flows. SFAS 123R eliminates the alternative to
account for employee stock options under APB 25 and requires that the fair value
of all share-based payments to employees, including the fair value of grants of
employee stock options, be recognized in the income statement, generally over
the vesting period.
In March 2005, the Securities and Exchange Commission issued Staff Accounting
Bulletin (SAB) No. 107, which provides additional implementation guidance for
SFAS 123R. Among other things, SAB 107 provides guidance on share-based payment
valuations, income statement classification and presentation, capitalization of
costs and related income tax accounting.
Effective April 1, 2006, the Company adopted SFAS 123R using the modified
prospective transition method. The Company recognizes 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 years ended
March 31, 2008 and March 31, 2007, the Company recognized compensation expense
of $263,664 and $169,003, respectively.
As of March 31, 2008, the total remaining unrecognized compensation cost
related to non-vested stock options was $1,795,834 which will be amortized over
the weighted-average service period of approximately 5.90 years.
Defined Pension Benefits and Other Postretirement Plans
- -------------------------------------------------------
Effective March 31, 2007, the Company adopted Statement of Financial
Accounting Standards (SFAS) No. 158, Employers' Accounting for Defined Benefit
Pension and Other Postretirement Plans, an amendment of FASB Statements Nos. 87,
88, 106 and 132R (SFAS 158). SFAS 158 is required to be adopted on a prospective
basis and prior year financial statements and related disclosures are not
permitted to be restated. SFAS 158 requires an employer that sponsors one or
more postretirement defined benefit plan(s) to:
o Recognize the funded status of postretirement defined benefit plans -
measured as the difference between the fair value of plan assets and
the benefit obligations - in its balance sheet.
o Recognize changes in the funded status of postretirement defined
benefit plans in shareholder's equity in the year in which the changes
occur.
o Measure postretirement defined benefit plan assets and obligations as
of the date of the employer's fiscal year-end. The Company presently
uses March 31 as the measurement date for all of its postretirement
defined benefit plans.
Recent Accounting Pronouncements
- --------------------------------
In September 2006, the FASB issued Statement No. 157, Fair Value
Measurements, ("SFAS 157"). Effective April 1, 2008, the Company adopted SFAS
157. In February 2008, the FASB issued Staff Position No. 157-2, Effective Date
of FASB Statement No. 157 ("FSP 157-2"), which delayed the effective date of
SFAS 157 for certain nonfinancial assets and liabilities, including fair value
16
measurements under SFAS 141 and SFAS 142 of goodwill and other intangible
assets, to fiscal years beginning after November 15, 2008. Therefore, the
Company has adopted the provisions of SFAS 157 with respect to its financial
assets and liabilities only. SFAS 157 defines fair value, establishes a
framework for measuring fair value in generally accepted accounting principles,
and expands disclosures about fair value measurements. Fair value is defined
under SFAS 157 as the exchange price that would be received for an asset or paid
to transfer a liability (an exit price) in the principal or most advantageous
market for the asset or liability in an orderly transaction between market
participants on the measurement date. Valuation techniques used to measure fair
value under SFAS 157 must maximize the use of observable inputs and minimize the
use of unobservable inputs. The standard describes a fair value hierarchy based
on the following three levels of inputs, of which the first two are considered
observable and the last unobservable, that may be used to measure fair value:
Level 1 - Quoted prices in active markets for identical assets or liabilities;
Level 2 - Inputs other than Level 1 that are observable, either directly or
indirectly, such as quoted prices for similar assets or liabilities; quoted
prices in markets that are not active; or other inputs that are observable or
can be corroborated by observable market data for substantially the full term of
the assets or liabilities; and Level 3 - Unobservable inputs that are supported
by little or no market activity and that are significant to the fair value of
the assets or liabilities. The Company is currently evaluating this statement
and does not anticipate that the adoption of SFAS 157 will have a material
impact on our consolidated financial statements.
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. The Company is currently
evaluating this statement and has made elections. However, our investments are
carried at fair value, the Company does not anticipate that this Statement would
have a significant impact on the consolidated financial statements.
2. Valuation of Investments
The consolidated financial statements as of March 31, 2008 and 2007 include
restricted securities valued at $494,843,820 (90.4% of the value of the
consolidated investment portfolio) and $619,207,702 (90.9% of the value of the
consolidated investment portfolio), respectively, whose values have been
determined by the Board of Directors in the absence of readily ascertainable
market values. Because of the inherent uncertainty of valuation, these values
may differ significantly from the values that would have been used had a ready
market for the securities existed, and the differences could be material.
Unrestricted securities are valued at the closing sale price for NYSE listed
securities and at the lower of the closing bid price or the last sale price for
Nasdaq securities on the valuation date.
3. Income Taxes
For the tax years ended December 31, 2007 and 2006, CSC and CSVC qualified to
be taxed as RICs under applicable provisions of the Internal Revenue Code. As
RICs, CSC and CSVC must distribute at least 90% of their taxable net investment
income (investment company taxable income) and may either distribute or retain
their taxable net realized gain on investments (capital gains). To the extent
that we retain capital gains and declare a deemed dividend to shareholders, at
the corporate rate, on the distribution, and the shareholders would receive a
tax credit equal to their proportionate share of the tax paid.
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.
17
As permitted by the Internal Revenue Code, a RIC can designate dividends paid
in the subsequent tax year as dividends of the current year ordinary taxable
income and long-term capital gains if those dividends are both declared by the
extended due date of the RIC's federal income tax return and paid to
shareholders by the last day of the subsequent tax year. For the tax years ended
December 31, 2007 and 2006 we declared and paid dividends in the amounts of
$2,333,291 and $2,323,150, respectively.
Additionally, we are also subject to a nondeductible federal excise tax of 4%
if we do not distribute at least 98% of our investment company ordinary taxable
income during our tax year. For the tax years ended December 31, 2007 and 2006,
we distributed 100% of our investment company ordinary taxable income. As a
result, we have made no provision for income taxes on ordinary taxable income
for the tax years ended December 31, 2007 and 2006.
For the tax year ended December 31, 2007, we have an estimated net long-term
capital loss of $961,655 for tax purposes and $860,118 for book purposes, which
will be carried forward and offset by future net long-term capital gains. For
the tax year ended December 31, 2006, we had net long-term capital gains of
$31,659,140 for tax purposes and $31,932,775 for book purposes, which we elected
to retain and treat as a deemed distribution to our shareholders. In order to
make the election to retain capital gains, we incurred and paid a federal tax on
behalf of our shareholders of $11,080,699 for the tax year ended December 31,
2006.
CSMC, a wholly owned subsidiary of CSC, is not a RIC and is required to pay
taxes at the current corporate rate. The Company sponsors a qualified defined
benefit pension plan which covers its employees and employees of certain of our
wholly owned portfolio companies. Deferred taxes related to the qualified
defined pension plan are recorded as incurred.
4. Undistributed Net Realized Gains (Losses) on Investments
Distributions made by RICs often differ from aggregate GAAP-basis
undistributed net investment income and accumulated net realized gains (total
GAAP-basis net realized gains). The principal cause is that required minimum
fund distributions are based on income and gain amounts determined in accordance
with federal income tax regulations, rather than GAAP. The differences created
can be temporary, meaning that they will reverse in the future, or they can be
permanent. In subsequent periods, when all or a portion of a temporary
difference becomes a permanent difference, the amount of the permanent
difference will be reclassified to "additional capital."
For income tax purposes, the $11,417,283 and $13,573,139 are treated as
deemed distributions to our shareholders for the tax years ended December 31,
2006 and 2005. We reclassified the deemed distribution, net of tax, from our
undistributed net realized earnings capital in excess of par value. For the tax
year ended December 31, 2004, to the extent we had capital gains, they were
fully offset by either capital losses or capital loss carry forwards.
As of March 31, 2008 and 2007, our undistributed net realized gains (losses)
on investments determined in accordance with GAAP as reflected on our
consolidated statement of financial condition were comprised of the following:
As of March 31, 2008 2007
-------------------------------- ----------- -----------
Undistributed net realized gains
(losses) on investments ($2,860,118) ($3,100,142)
5. Employee Stock Option Plan
On July 19, 1999, shareholders approved the 1999 Stock Option
18
Plan ("Plan"), which provided for the granting of stock options to employees and
officers of the Company and authorized 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 10 years from the date of grant and are
generally exercisable on or after the first anniversary of the date of grant in
5 to 10 annual installments.
At March 31, 2008, there were 37,500 shares available for grant under the
Plan. The per share weighted-average fair value of the stock options granted on
May 15, 2006 was $31.276 per option using the Black-Scholes pricing model with
the following assumptions: expected dividend yield of 0.64%, risk-free interest
rate of 5.08%, expected volatility of 21.1%, and expected life of 7 years. The
per share weighted-average fair value of the stock options granted on July 17,
2006 was $33.045 per option using the Black-Scholes pricing model with the
following assumptions: expected dividend yield of 0.61%, risk-free interest rate
of 5.04%, expected volatility of 21.2%, and expected life of 7 years. The per
share weighted-average fair value of the stock options granted on July 16, 2007
was $41.78 per option using the Black-Scholes pricing model with the following
assumptions: expected dividend yield of 0.39%, risk-free interest rate of 4.95%,
expected volatility of 19.9%, and expected life of 5 years.
The following summarizes activity in the stock option plans for the years
ended March 31, 2008, 2007 and 2006:
Number Weighted Average
of shares Exercise Price
--------- --------------
Balance at March 31, 2006 45,300 $ 68.411
Granted 57,500 94.136
Exercised (25,800) 69.568
Canceled (24,500) 89.482
-------- ---------
Balance at March 31, 2007 52,500 86.184
Granted 25,000 152.980
Exercised (3,100) 74.642
Canceled (4,000) 93.490
------- ---------
Balance at March 31, 2008 70,400 $109.998
====== ========
Weighted Average Aggregate Intrinsic
Remaining Contractual Term Value
-------------------------- -----
March 31, 2008
Outstanding 5.9 years $2,184,883
Exercisable 5.5 years $ 241,320
At March 31, 2008, the range of exercise prices and weighted-average
remaining contractual life of outstanding options was $65.00 to $152.98 and 5.91
years, respectively. The total intrinsic value of options exercised during the
years ended March 31, 2008, 2007 and 2006 were $75,129, $571,565 and $66,147,
respectively. The exercise prices ranged from $65.00 to $93.49 per share for the
year ended March 31, 2008 and $65.00 to $77.00 per share for the each of the
years ended March 31, 2007 and 2006. New shares were issued for the $231,390,
$1,794,850 and $208,000 cash received from option exercises for the years ended
March 31, 2008, 2007 and 2006, respectively.
At March 31, 2008, 2007 and 2006, the number of options exercisable was
9,930, 8,515 and 29,500, respectively and the weighted-average exercise price of
those options was $79.01, $78.51 and $69.01, respectively.
6. Employee Stock Ownership Plan
The Company and one of its wholly-owned portfolio companies sponsor a
qualified employee stock ownership plan ("ESOP") in which certain employees
participate. Contributions to the plan, which are invested in Company stock, are
made at the discretion of the Board of Directors. A participant's interest in
contributions to the ESOP fully vests after five years of active service.
Effective April 1, 2007, the vesting period for the ESOP is three years.
During the 3 years ended March 31, 2008, the Company made contributions to the
ESOP, which were charged against net investment income, of $94,210 in 2008,
$84,488 in 2007 and $99,167 in 2006.
19
7. Retirement Plans
The Company sponsors a qualified defined benefit pension plan which covers
its employees and employees of certain of its wholly-owned portfolio companies.
The following information about the plan represents amounts and information
related to the Company's participation in the plan and is presented as though
the Company sponsored a single-employer plan. Benefits are based on years of
service and an average of the highest five consecutive years of compensation
during the last 10 years of employment. The funding policy of the plan is to
contribute annual amounts that are currently deductible for tax reporting
purposes. No contribution was made to the plan during the three years ended
March 31, 2008.
The following tables set forth the qualified plan's benefit obligations and
fair value of plan assets at March 31, 2008, 2007 and 2006:
Years Ended March 31
--------------------
2008 2007 2006
---------- ---------- ----------
Change in benefit obligation
Benefit obligation at beginning
of year...........................$3,965,100 $4,004,017 $3,833,411
Service cost.......................... 67,514 103,342 95,590
Interest cost......................... 222,895 230,711 223,374
Actuarial loss........................ (160,840) 68,854 228,122
Benefits paid......................... (395,384) (386,982) (376,480)
Plan change........................... -- (54,842) --
---------- ---------- ----------
Benefit obligation at end of year ....$3,699,285 $3,965,100 $4,004,017
========== ========== ==========
Change in plan assets
Fair value of plan assets at beginning
of year..........................$12,973,292 $11,640,693 $ 9,326,254
Actual return on plan assets......... (1,457,571) 1,719,581 2,690,919
Benefits paid........................ ( 395,384) (386,982) (376,480)
----------- ----------- -----------
Fair value of plan assets at end of
year............................. $11,120,337 $12,973,292 $11,640,693
=========== =========== ===========
The following table sets forth the qualified plan's funded status and amounts
recognized in the Company's consolidated statements of financial condition:
March 31
--------
2008 2007
----------- -----------
Actuarial present value of benefit obligations:
Accumulated benefit obligation.............. $(3,387,397) $(3,435,396)
=========== ===========
Projected benefit obligation for service
rendered to date............................ $(3,699,285) $(3,965,100)
Plan assets at fair value*....................... 11,120,337 12,973,292
----------- -----------
Funded status.................................... 7,421,052 9,008,192
Unrecognized net (gain) loss from past experience
different from that assumed and effects of
changes in assumptions...................... 209,044 (1,761,054)
Unrecognized prior service costs................. 129,179 132,904
Additional asset, FAS 158........................ (338,223) 1,628,150
----------- -----------
Prepaid pension cost included in other assets ... $ 7,421,052 $ 9,008,192
=========== ===========
- -------------
*Primarily equities and bonds including approximately 25,000 shares of common
stock of the Company.
Components of net pension benefit related to the qualified plan include the
following:
Years Ended March 31
--------------------
2008 2007 2006
---------- ---------- -----------
Service cost - benefits earned during
the year .......................... $ 67,514 $ 103,342 $ 95,590
Interest cost on projected benefit
obligation ........................ 222,895 230,711 223,374
Expected return on assets .............. (673,366) (580,104) (551,026)
Net amortization ....................... 3,725 27,487 38,897
---------- ---------- -----------
Net pension benefit from qualified plan $ (379,232) $ (218,564) $ (193,165)
========== ========== ===========
20
The Company also sponsors an unfunded Retirement Restoration Plan, which is a
nonqualified plan that provides for the payment, upon retirement, of the
difference between the maximum annual payment permissible under the qualified
retirement plan pursuant to Federal limitations and the amount which would
otherwise have been payable under the qualified plan.
The following table sets forth the Retirement Restoration Plan's benefit
obligations at March 31, 2008, 2007 and 2006:
Years Ended March 31
--------------------
2008 2007 2006
---------- ---------- ----------
Change in benefit obligation
Benefit obligation at beginning
of year........................ $1,178,891 $1,280,542 $1,302,368
Service cost......................... 10,483 20,245 19,094
Interest cost........................ 57,588 68,937 72,886
Actuarial (gain) loss................ (169,072) (36,529) 40,867
Benefits paid........................ (135,768) (144,170) (154,673)
Plan change.......................... -- (10,134) --
---------- ---------- ----------
Benefit obligation at end of year ... $ 942,122 $1,178,891 $1,280,542
=========== ========== ==========
The following table sets forth the status of the Retirement Restoration Plan
and the amounts recognized in the consolidated statements of financial
condition:
March 31
--------
2008 2007
--------- -----------
Projected benefit obligation ........................ $(942,122) $(1,178,891)
Unrecognized net loss from past ex-
perience different from that assumed
and effects of changes in assumptions ............ (112,552) 56,523
Unrecognized prior service costs .................... (217,958) (234,144)
Additional asset, FAS 158 ........................... 330,510 177,621
--------- -----------
Accrued pension cost included in other liabilities .. $(942,122) $(1,178,891)
========= ===========
The Retirement Restoration Plan expenses recognized during the years ended
March 31, 2008, 2007 and 2006 of $51,885, $73,619 and $76,417, respectively, are
offset against the net pension benefit from the qualified plan.
The following assumptions were used in estimating the actuarial present value
of the projected benefit obligations:
Years Ended March 31
--------------------
2008 2007 2006
--------- ---------- ----------
Discount rate...................... 6.25% 6.0% 5.75%
Rate of compensation increases..... 5.0% 5.0% 5.0%
The following assumptions were used in estimating the net periodic
(income)/expense:
Years Ended March 31
--------------------
2008 2007 2006
--------- ---------- ----------
Discount rate...................... 6.0% 5.75% 5.75%
Expected return on plan assets..... 6.5% 6.0% 6.0%
Rate of compensation increases..... 5.0% 5.0% 5.0%
The expected rate of return on assets assumption was determined based on the
anticipated performance of the various asset classes in the plan's portfolio and
the allocation of assets to each class. The anticipated asset class return is
developed using historical and predicted asset return performance, considering
the investments underlying each asset class and expected investment performance
based on forecasts of inflation, interest rates and market indices for fixed
income and equity securities.
The Company's pension plan asset allocations are as follows:
Percentage of plan assets
at March 31
-------------------
Asset Category 2008 2007
- -------------- -------- --------
Equity securities........................... 75.0% 79.1%
Debt securities............................. 13.8% 11.4%
Cash ....................................... 11.2% 9.5%
-------- --------
100.0% 100.0%
The Company's pension plan is administered by a board-appointed committee of
that has fiduciary responsibility for the plan's management. The trustee of the
21
plan is JPMorgan Asset Management. Currently, approximately 18% of the assets
are selected and managed by the trustee and the remainder of the assets are
managed by the committee, invested mostly in equity securities, including the
Company's stock.
Following are the expected benefit payments for the next five years and in
the aggregate for the years 2014-2018:
Years Ended March 31
----------------------------------------------
2014-
(In Thousands) 2009 2010 2011 2012 2013 2018
---- ---- ---- ---- ---- ----
$362 $339 $316 $301 $277 $1,143
Incremental effect of applying FASB Statement No. 158 on individual line
items in the Statement of Financial Condition:
March 31, 2007
Before Application After application
Of Statement 158 Adjustments of Statement 158
---------------- ----------- ----------------
Other assets.............. $ 7,542,035 $1,628,150 $ 9,170,185
Other liabilities......... 1,635,468 (177,621) 1,457,847
Deferred income taxes..... 1,144,026 1,173,751 2,317,777
Additional capital........ 115,741,940 632,020 116,373,960
Net assets at market or
fair value.............. $724,557,938 $1,173,751 $725,731,689
8. Commitments
The Company has agreed, subject to certain conditions, to invest up to
$5,429,760 in 3 portfolio companies.
The Company leases office space under an operating lease which requires base
annual rentals of approximately $80,000 through February, 2013. For the three
years ended March 31, total rental expense charged to investment income was
$80,569 in 2008, $79,979 in 2007 and $76,877 in 2006.
9. Sources of Income
Income was derived from the following sources:
Investment Income
-----------------
Realized Gain
Years Ended (Loss) on
March 31 Investments
- -------- Other Before Income
2008 Interest Dividends Income Taxes
- ---- ---------- ---------- ---------- ----------
Companies more than
25% owned ............. $ -- $2,979,631 $ 839,800 $ --
Companies 5% to 25%
owned ................. 364,762 326,940 42,500 --
Companies less than
5% owned .............. 469,066 350,262 -- 240,024
Other sources, including
temporary investments ... 1,421,722 -- -- --
---------- ---------- ---------- ----------
$2,255,550 $3,656,833 $ 882,300 $ 240,024
========== ========== ========== ==========
Investment Income
-----------------
Realized Gain
Years Ended (Loss) on
March 31 Investments
- -------- Other Before Income
2007 Interest Dividends Income Taxes
- ---- ------------ ------------ ------------ ------------
Companies more than
25% owned .........$ -- $ 3,449,558 $ 659,500 $ 31,070,149
Companies 5% to 25%
owned ............. 125,733 171,578 20,000 --
Companies less than
5% owned .......... 938,761 333,739 29,400 (5,023,154)
Other sources,
including temporary
investments ....... 1,244,166 -- -- --
------------ ------------ ------------ ------------
$ 2,308,660 $ 3,954,875 $ 708,900 $ 26,046,995
============ ============ ============ ============
22
Investment Income
-----------------
Realized Gain
Years Ended (Loss) on
March 31 Investments
- -------- Other Before Income
2006 Interest Dividends Income Taxes
- ---- ----------- ----------- ----------- -----------
Companies more than
25% owned ........... $ -- $ 2,926,964 $ 642,500 $ --
Companies 5% to 25
owned ............... (55,236) 188,233 10,000 --
Companies less than
5% owned ............ 302,622 370,233 195,570 20,278,566
Other sources,
including temporary
investments ......... 258,150 -- -- --
----------- ----------- ----------- -----------
$ 505,536 $ 3,485,430 $ 848,070 $20,278,566
=========== =========== =========== ===========
23
Selected Per Share Data and Ratios
Years Ended March
---------------------------------------------------
2008 2007 2006 2005 2004
------- ------- ------- ------- -------
Per Share Data
Investment income .....................................................$ 1.75 $ 1.79 $ 1.25 $ 1.26 $ 1.22
Operating expenses .................................................... (.76) (.57) (.51) (.51) (.39)
Interest expense ...................................................... -- (.12) (.11) (.11) (.14)
Income taxes .......................................................... (.03) (.01) (.01) (.02) (.02)
------- ------- ------- ------- -------
Net investment income ................................................. .96 1.09 .62 .62 .67
Distributions from undistributed net investment income ................ (.60) (.60) (.60) (.60) (.60)
Net realized gain (loss) on investments ............................... .06 3.85 4.00 (2.62) 3.27
Net increase (decrease) in unrealized appreciation of investments ..... (36.76) 38.00 32.22 7.21 29.57
Exercise of employee stock options* ................................... (.09) (.49) (.04) -- (.25)
Stock option expense .................................................. .07 .04 -- -- --
Net change in pension plan funded status .............................. (.30) -- -- -- --
Adjustment to initially apply FASB No. 158, net of tax ................ -- .30 -- -- --
------- ------- ------- ------- -------
Increase (decrease) in net asset value ................................ (36.66) 42.19 36.20 4.61 32.66
Net asset value
Beginning of year ................................................... 186.75 144.56 108.36 103.75 71.09
------- ------- ------- ------- -------
End of year .........................................................$150.09 $186.75 $144.56 $108.36 $103.75
======= ======= ======= ======= =======
Ratios and Supplemental Data
Ratio of operating expenses to average net assets ..................... .46% .36% .42% .49% .47%
Ratio of net investment income to average net assets .................. .58% .68% .51% .60% .81%
Portfolio turnover rate ............................................... .22% .13% 2.36% .56% 3.74%
Net asset value total return .......................................... 19.27% 29.85% 34.31% 5.25% 47.42%
Shares outstanding at end of period (000s omitted) .................... 3,889 3,886 3,860 3,857 3,857
---------------
* Net decrease is due to the exercise of employee stock options at prices less
than beginning of period net asset value.
24
Management's Report on Internal Control Over Financial Reporting
Management is responsible for establishing and maintaining adequate internal
control over financial reporting, as such term is defined in Rules 13a-15(f) and
15d-15(f) under the Securities Exchange Act of 1934. The Company's internal
control over financial reporting is designed to provide reasonable assurance
regarding the reliability of financial reporting and the preparation of
financial statements for external purposes in accordance with accounting
principles generally accepted in the United States.
Because of its inherent limitations, internal controls over financial
reporting may not prevent or detect misstatements. Also, projections of any
evaluation of effectiveness to future periods are subject to risk that controls
may become inadequate because of changes in conditions, or that the degree of
compliance with the policies or procedures may deteriorate.
The Company has assessed the effectiveness of its internal control over
financial reporting as of March 31, 2008. In making this assessment, it used the
criteria described in "Internal Control-Integrated Framework" issued by the
Committee of Sponsoring Organizations of the Treadway Commission (COSO). Based
on this assessment, management believes that, as of March 31, 2008, the
Company's internal control over financial reporting was effective.
During the fiscal quarter ended March 31, 2008, the Company implemented the
following control in order to remediate the material weakness we identified in
our internal controls over accounting for taxes, which resulted in the
restatement of our consolidated financial statements for the year ended March
31, 2007 and years represented in our Form 10-K for the year ended March 31,
2007.
o On a quarterly basis the Company will consult with a RIC compliance
expert, on our current RIC status and the potential impact of proposed
transactions and scenarios on the Company's future RIC compliance
status. The Company has engaged KPMG, LLP to serve in this capacity.
There were no other changes to our internal controls over financial reporting
that have materially affected, or are reasonably likely to materially affect our
internal controls over financial reporting.
Grant Thornton LLP, the independent registered public accounting firm that
audited our consolidated financial statements included in this annual report on
Form 10-K for the year ended March 31, 2008, has issued an attestation report on
our internal control over financial reporting as of March 31, 2008. That report
appears on the next page.
Date: May 23, 2008
/s/ Gary L. Martin
- ------------------
Gary L. Martin
President & Chief Executive Officer
/s/ Tracy L. Morris
- -------------------
Tracy L. Morris
Controller
(chief financial/accounting officer)
25
Report of Independent Registered Public Accounting Firm
Board of Directors and Shareholders
Capital Southwest Corporation
We have audited Capital Southwest Corporation (a Texas Corporation) and
subsidiaries', (the "Company") internal control over financial reporting as of
March 31, 2008, based on criteria established in Internal Control--Integrated
Framework issued by the Committee of Sponsoring Organizations of the Treadway
Commission (COSO). The Company's management is responsible for maintaining
effective internal control over financial reporting and for its assessment of
the effectiveness of internal control over financial reporting, included in the
accompanying Management's Report on Internal Control Over Financial Reporting.
Our responsibility is to express an opinion on the Company's internal control
over financial reporting based on our audit.
We conducted our audit in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether effective
internal control over financial reporting was maintained in all material
respects. Our audit included obtaining an understanding of internal control over
financial reporting, assessing the risk that a material weakness exists, testing
and evaluating the design and operating effectiveness of internal control based
on the assessed risk, and performing such other procedures as we considered
necessary in the circumstances. We believe that our audit provides a reasonable
basis for our opinion.
A company's internal control over financial reporting is a process designed
to provide reasonable assurance regarding the reliability of financial reporting
and the preparation of financial statements for external purposes in accordance
with generally accepted accounting principles. A company's internal control over
financial reporting includes those policies and procedures that (1) pertain to
the maintenance of records that, in reasonable detail, accurately and fairly
reflect the transactions and dispositions of the assets of the company; (2)
provide reasonable assurance that transactions are recorded as necessary to
permit preparation of financial statements in accordance with generally accepted
accounting principles, and that receipts and expenditures of the company are
being made only in accordance with authorizations of management and directors of
the company; and (3) provide reasonable assurance regarding prevention or timely
detection of unauthorized acquisition, use, or disposition of the company's
assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial
reporting may not prevent or detect misstatements. Also, projections of any
evaluation of effectiveness to future periods are subject to the risk that
controls may become inadequate because of changes in conditions, or that the
degree of compliance with the policies or procedures may deteriorate.
In our opinion, the Company maintained, in all material respects, effective
internal control over financial reporting as of March 31, 2008, based on
criteria established in Internal Control--Integrated Framework issued by COSO.
We also have audited, in accordance with the standards of the Public Company
Accounting Oversight Board (United States), the consolidated statement of
financial condition of the Company as of March 31, 2008 and 2007, including the
portfolio of investments as of March 31, 2008, and the related consolidated
statements of operations, changes in net assets, cash flows, and the selected
per share data and ratios for each of the three years in the period ended March
31, 2008, and our report dated May 23, 2008 expressed an unqualified opinion.
/s/Grant Thornton LLP
Dallas, Texas
May 23, 2008
26
Report of Independent Registered Public Accounting Firm
Board of Directors and Shareholders
Capital Southwest Corporation
We have audited the accompanying consolidated statements of financial
condition of Capital Southwest Corporation (a Texas Corporation) and
subsidiaries (the "Company") as of March 31, 2008 and 2007, including the
portfolio of investments as of March 31, 2008, and the related consolidated
statements of operations, changes in net assets, cash flows for each of the
three years in the period ended March 31, 2008, and the selected per share data
and ratios for each of the four years in the period ended March 31, 2008. These
financial statements and per share data and ratios are the responsibility of the
Company's management. Our responsibility is to express an opinion on these
financial statements and per share data and ratios based on our audits. The
selected per share data and ratios for the year ended March 31, 2004, were
audited by another independent registered public accounting firm whose report
dated May 12, 2004, except for Note 2, which is as of January 9, 2008 expressed
an unqualified opinion.
We conducted our audits in accordance with the standards of the Public
Company Accounting Oversight Board (United States). Those standards require that
we plan and perform the audit to obtain reasonable assurance about whether the
financial statements and selected per share data and ratios are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. Our procedures included
verification by examination of securities held by the custodian as of March 31,
2008 and 2007, and confirmation of securities not held by the custodian. An
audit also includes assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall financial
statement presentation. We believe that our audits provide a reasonable basis
for our opinion.
In our opinion, the consolidated financial statements and the selected per
share data and ratios referred to above present fairly, in all material
respects, the consolidated financial position of Capital Southwest Corporation
and subsidiaries as of March 31, 2008 and 2007, and the consolidated results of
its operations, changes in its net assets, its cash flows for each of the three
years in the period ended March 31, 2008, and the selected per share data and
ratios for each of the four years in the period ended March 31, 2008, in
conformity with accounting principles generally accepted in the United States of
America.
As described in Note 5 to the consolidated financial statements, the Company
adopted the provisions of Financial Accounting Standards Board (FASB) Statement
of Financial Accounting Standards No. 123 (revised 2004), Share-Based Payment,
effective April 1, 2006. As described in Note 7 to the consolidated financial
statements, the Company also adopted the provisions of FASB Statement of
Financial Accounting Standards No. 158, Employers' Accounting for Defined
Benefit Pension and Other Postretirement Plans: An Amendment of FASB Statements
No. 87, 88, 106, and 132(R), effective March 31, 2008.
We also have audited, in accordance with the standards of the Public Company
Accounting Oversight Board (United States), Capital Southwest Corporation and
subsidiaries' internal control over financial reporting as of March 31, 2008,
based on criteria established in Internal Control-Integrated Framework issued by
the Committee of Sponsoring Organizations of the Treadway Commission and our
report dated May 23, 2008, expressed an unqualified opinion thereon.
/s/Grant Thornton LLP
Dallas, Texas
May 23, 2008
27
Management's Discussion and Analysis of
Financial Condition and Results of Operations
Results of Operations
The composite measure of the Company's financial performance in the
Consolidated Statements of Operations is captioned "Increase in net assets from
operations" and consists of three elements. The first is "Net investment
income," which is the difference between the Company's income from interest,
dividends and fees and its combined operating and interest expenses, net of
applicable income taxes. The second element is "Net realized gain (loss) on
investments," which is the difference between the proceeds received from
disposition of portfolio securities and their stated cost, net of applicable
income tax expense based on the Company's tax year. The third element is the
"Net increase in unrealized appreciation of investments," which is the net
change in the market or fair value of the Company's investment portfolio,
compared with stated cost. It should be noted that the "Net realized gain (loss)
on investments" and "Net increase in unrealized appreciation of investments" are
directly related in that when an appreciated portfolio security is sold to
realize a gain, a corresponding decrease in net unrealized appreciation occurs
by transferring the gain associated with the transaction from being "unrealized"
to being "realized." Conversely, when a loss is realized on a depreciated
portfolio security, an increase in net unrealized appreciation occurs.
Net Investment Income
The Company's principal objective is to achieve capital appreciation.
Therefore, a significant portion of the investment portfolio is structured to
maximize the potential return from equity participation and provides minimal
current yield in the form of interest or dividends. The Company also earns
interest income from the short-term investment of cash funds, and the annual
amount of such income varies based upon the average level of funds invested
during the year and fluctuations in short-term interest rates. During the three
years ended March 31, the Company had interest income from temporary cash
investments of $1,421,048 in 2008, $1,187,676 in 2007 and $257,374 in 2006. The
Company also receives management fees primarily from its wholly-owned portfolio
companies which aggregated $784,800 in 2008, $626,400 in 2007 and $792,570 in
2006. During the three years ended March 31, 2008, the Company recorded dividend
income from the following sources:
Years Ended March 31
----------------------------------
2008 2007 2006
---------- ---------- ----------
Alamo Group Inc. ................... $ 678,732 $ 677,112 $ 677,112
Balco, Inc.......................... 224,400 -- 252,960
Dennis Tool Company................. 62,499 62,499 49,999
Encore Wire Corporation............. 326,940 -- --
Kimberly-Clark Corporation.......... 167,481 154,360 142,011
Lifemark Group...................... 571,333 600,000 600,000
PalletOne, Inc...................... -- 89,842 179,685
The RectorSeal Corporation.......... 1,154,133 1,869,947 1,106,893
Sprint Nextel Corporation........... 6,750 9,000 18,000
TCI Holdings, Inc................... 81,270 81,270 81,270
The Whitmore Manufacturing Company.. 288,533 240,000 240,000
Other............................... 94,762 170,845 137,500
---------- ---------- ----------
$3,656,833 $3,954,875 $3,485,430
========== ========== ==========
Total operating expenses, excluding interest expense, increased by $742,951
or 33.4% during the year ended March 31, 2008. Due to the nature of its
business, the majority of the Company's operating expenses are related to
employee and director compensation, office expenses, legal, professional and
accounting fees and the net pension benefit.
Net Realized Gain (Loss) on Investments
Net realized gain on investments was $240,024 during the year ended March 31,
2008, compared with a gain of $14,966,296 (after income tax expense of
28
$11,080,699) during 2007 and a gain of $15,450,903 (after income tax of
$4,827,663) during 2006. Management does not attempt to maintain a comparable
level of realized gains from year to year, but instead attempts to maximize
total investment portfolio appreciation. This strategy often dictates the
long-term holding of portfolio securities in pursuit of increased values and
increased unrealized appreciation, but may at opportune times dictate realizing
gains or losses through the disposition of certain portfolio investments.
Net Increase in Unrealized Appreciation of Investments
For the three years ended March 31, the Company recorded a decrease in
unrealized appreciation of investments of $142,969,698, in 2008 and an increase
of $147,681,609 and $124,355,303, in 2007 and 2006, respectively. As explained
in the first paragraph of this discussion and analysis, the realization of gains
or losses results in a corresponding decrease or increase in unrealized
appreciation of investments. Set forth in the following table are the
significant increases and decreases in unrealized appreciation excluding the
effect of gains or losses realized during the year by portfolio company for
securities held at the end of each year.
Years Ended March 31
---------------------------------------
2008 2007 2006
----------- ----------- -----------
Alamo Group Inc. ..............$ (2,803,090) $ 2,821,000 $ (5,642,000)
Encore Wire Corporation....... (18,390,625) (12,260,000) 49,041,000
Heelys, Inc....................(160,724,088) 170,040,908 27,000,000
The Whitmore Manufacturing
Company...................... 12,000,000 4,000,000 4,000,000
Lifemark Group................. 31,000,000 (2,000,000) 2,000,000
Media Recovery, Inc............ (7,500,000) 3,000,000 15,744,000
Palm Harbor Homes, Inc......... (39,275,516) (27,493,000) 27,493,000
The RectorSeal Corporation..... 46,200,000 10,500,000 15,000,000
As shown in the table above for the year ended March 31, 2008, we sustained
major increases in The RectorSeal Corporation, LifeMark Group and The Whitmore
Manufacturing Company. The $46,200,000 increase in RectorSeal and the
$12,000,000 increase in Whitmore were attributable to strong earnings derived
from organic growth and the performance of recent acquisitions. LifeMark Group's
$31,000,000 increase is attributable to an increase in value of its cemetery and
funeral home operations including the new Lifemark Center Funeral Home and
continued escalations in non-business land values.
Offsetting these major increases were significant decreases in Heely's, Inc.,
Palm Harbor Homes, Inc., and Encore Wire Corporation. While the Heely's
investment represented our largest holding at March 31, 2007, the market for
Heely's stock declined during the year to a level that decreased our value by
$160,724,088. Palm Harbor's decrease of $39,275,516 is attributable to several
financial setbacks as the residual real estate markets eroded during the year.
Additionally, Encore Wire experienced adversity related to the eroding residual
markets and severe competition that had negative impact on its market price
prompting us to decrease our value by $18,390,625.
A description of the investments listed above and other material components
of the investment portfolio is included elsewhere in this report under the
caption "Portfolio of Investments - March 31, 2008."
Portfolio Investments
During the year ended March 31, 2008, the Company invested $10,733,536 in
various portfolio securities listed elsewhere in this report under the caption
"Portfolio Changes During the Year," which also lists dispositions of portfolio
securities. During the 2007 and 2006 fiscal years, the Company invested a total
of $803,269 and $15,054,741, respectively.
Financial Liquidity and Capital Resources
At March 31, 2008, the Company had cash and cash equivalents of approximately
$31.3 million. Pursuant to Small Business Administration (SBA) regulations, cash
and cash equivalents of $4.7 million held by CSVC may not be transferred or
29
advanced to CSC without the consent of the SBA. Under current SBA regulations
and subject to the SBA's approval of its credit application, CSVC would be
entitled to borrow up to $16.4 million.
With the exception of a capital gain distribution made in the form of a
distribution of the stock of a portfolio company in the fiscal year ended March
31, 1996, the Company has 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 the Company's investment activity. Approximately $52.7 million of the
Company's investment portfolio is represented by unrestricted publicly-traded
securities and represent a source of liquidity.
Funds to be used by the Company for operating or investment purposes may be
transferred in the form of dividends, management fees or loans from Lifemark
Group, The RectorSeal Corporation and The Whitmore Manufacturing Company,
wholly-owned portfolio companies of the Company, to the extent of their
available cash reserves and borrowing capacities.
Management believes that the Company's cash and cash equivalents and cash
available from other sources described above are adequate to meet its expected
requirements. Consistent with the long-term strategy of the Company, the
disposition of investments from time to time may also be an important source of
funds for future investment activities.
Contractual Obligations
As shown below, the Company had the following contractual obligations as of
March 31, 2008. For further information see Note 8 of the Consolidated Financial
Statements.
Payments Due By Period ($ in Thousands)
---------------------------------------
Less than 1-3 3-5 More Than
Contractual Obligations Total 1 Year Years Years 5 Years
- --------------------------------------------------------------------------------
Operating lease obligations $393 $80 $240 $73 --
---------------------------------------------
Total $393 $80 $240 $73 --
---------------------------------------------
Critical Accounting Policies
Valuation of Investments
In accordance with the Investment Company Act of 1940, investments in
unrestricted securities (freely marketable securities having readily available
market quotations) are valued at market and investments in restricted securities
(securities subject to one or more resale restrictions) are valued at fair value
determined in good faith by the Company's Board of Directors. Under the
valuation policy of the Company, unrestricted securities are valued at the
closing sale price for NYSE listed securities and at the lower of the closing
bid price or the last sale price for Nasdaq securities on the valuation date.
Restricted securities, including securities of publicly-owned companies which
are subject to restrictions on resale, are valued at fair value, which is
considered to be the amount the Company may reasonably expect to receive if such
securities were sold on the valuation date. Valuations as of any particular
date, however, are not necessarily indicative of amounts which may ultimately be
realized as a result of future sales or other dispositions of securities.
30
Among the factors considered by the Board of Directors in determining the
fair value of restricted securities are the financial condition and operating
results of the issuer, the long-term potential of the business of the issuer,
the market for and recent sales prices of the issuer's securities, the values of
similar securities issued by companies in similar businesses, the proportion of
the issuer's securities owned by the Company, the nature and duration of resale
restrictions and the nature of any rights enabling the Company to require the
issuer to register restricted securities under applicable securities laws.
Impact of Inflation
The Company does not believe that its business is materially affected by
inflation, other than the impact which inflation may have on the securities
markets, the valuations of business enterprises and the relationship of such
valuations to underlying earnings, all of which will influence the value of the
Company's investments.
Risks
Pursuant to Section 64(b)(1) of the Investment Company Act of
1940, a business development company is required to describe the risk factors
involved in an investment in the securities of such company due to the nature of
the company's investment portfolio. Accordingly the Company states that:
The Company's objective is to achieve capital appreciation through
investments in businesses believed to have favorable growth potential. Such
businesses are often undercapitalized small companies which lack management
depth and have not yet attained profitability. The Company's venture investments
often include securities which do not yield interest or dividends and are
subject to legal or contractual restrictions on resale, which restrictions
adversely affect the liquidity and marketability of such securities.
Because of the speculative nature of the Company's investments and the lack
of any market for the securities initially purchased by the Company, there is a
significantly greater risk of loss than is the case with traditional investment
securities. The high-risk, long-term nature of the Company's venture investment
activities may prevent shareholders of the Company from achieving price
appreciation and dividend distributions.
31
Selected Consolidated Financial Data
(all figures in thousands except per share data)
1998 1999 2000 2001 2002 2003 2004
- --------------------------------------------------------------------------------------------------------------------------------
Financial Position (as of March 31)
Investments at cost .................$ 61,154 $ 73,580 $ 85,002 $ 87,602 $ 82,194 $ 91,462 $ 97,283
Unrealized appreciation ............. 340,132 276,698 238,627 228,316 265,287 195,598 309,666
--------- --------- --------- --------- --------- --------- ---------
Investments at market or
fair value ....................... 401,286 350,278 323,629 315,918 347,481 287,060 406,949
Total assets ........................ 522,324 360,786 392,586 322,668 357,183 298,490 423,979
Notes payable * ..................... 5,000 5,000 10,000 16,000 14,000 23,000 20,500
Net assets .......................... 414,697 352,974 319,438 303,436 339,891 272,211 400,157
Shares outstanding .................. 3,788 3,815 3,815 3,815 3,829 3,829 3,857
- --------------------------------------------------------------------------------------------------------------------------------
Changes in Net Assets (years ended March 31)
Net investment income ...............$ 2,726 $ 1,762 $ 1,663 $ 1,723 $ 2,042 $ 2,299 $ 2,587
Net realized gain (loss) on
investments ...................... 3,301 1,264 5,162 (5,126) (762) 2,007 12,603
Net increase (decrease) in
unrealized appreciation
before distributions ............. 106,749 (63,434) (38,072) (10,311) 36,971 (69,689) 114,068
--------- --------- --------- --------- --------- --------- ---------
Increase (decrease) in net
assets from operations
before distributions ............. 112,776 (60,408) (31,247) (13,714) 38,251 (65,383) 129,258
Cash dividends paid ................. (2,268) (2,280) (2,289) (2,289) (2,295) (2,297) (2,309)
Employee stock options
exercised ........................ 720 965 -- -- 499 -- 997
Stock option expense ................ -- -- -- -- -- -- --
Change in pension plan
funded status .................... -- -- -- -- -- -- --
Adjustment to initially apply FASB
Statement No. 158, net of tax .... -- -- -- -- -- -- --
--------- --------- --------- --------- --------- --------- ---------
Increase (decrease) in net assets ... 111,228 (61,723) (33,536) (16,003) 36,455 (67,680) 127,946
- --------------------------------------------------------------------------------------------------------------------------------
Per Share Data (as of March 31)
Net assets...........................$ 109.48 $ 92.52 $ 83.73 $ 79.54 $ 88.77 $ 71.09 $ 103.75
Closing market price................. 94.00 73.00 54.75 65.00 68.75 48.15 75.47
Cash dividends paid.................. .60 .60 .60 .60 .60 .60 .60
o Excludes quarter-end borrowing which is repaid on the first business day after
year end.
32
Selected Consolidated Financial Data
(all figures in thousands except per share data)
2005 2006 2007 2008
- ------------------------------------------------------------------------------------------------
Financial Position (as of March 31)
Investments at cost ............................$ 84,546 $ 88,597 $ 71,642 $ 81,027
Unrealized appreciation ........................ 337,476 461,831 609,513 466,544
--------- --------- --------- ---------
Investments at market or
fair value .................................. 422,022 550,428 681,155 547,571
Total assets ................................... 434,384 569,368 729,507 586,685
Notes payable * ................................ 13,000 8,000 -- --
Net assets ..................................... 417,947 558,036 725,732 583,700
Shares outstanding ............................. 3,857 3,860 3,886 3,889
- ------------------------------------------------------------------------------------------------
Changes in Net Assets (years ended March 31)
Net investment income ..........................$ 2,406 $ 2,389 $ 4,233 $ 3,715
Net realized gain (loss) on
investments ................................. (10,112) 15,451 14,966 240
Net increase (decrease) in
unrealized appreciation
before distributions ........................ 27,810 124,355 147,682 (142,969)
--------- --------- --------- ---------
Increase (decrease) in net
assets from operations
before distributions ........................ 20,104 142,195 166,881 (139,014)
Cash dividends paid ............................ (2,314) (2,314) (2,323) (2,333)
Employee stock options
exercised ................................... -- 208 1,795 231
Stock option expense ........................... -- -- 169 263
Change in pension plan
funded status ............................... -- -- -- (1,178)
Adjustment to initially apply FASB
Statement No. 158, net of tax ............... -- -- 1,173 --
--------- --------- --------- ---------
Increase (decrease) in net assets .............. 17,790 140,089 167,695 (142,031)
- ------------------------------------------------------------------------------------------------
Per Share Data (as of March 31)
Net assets......................................$ 108.36 $ 144.56 $ 186.75 $ 150.09
Closing market price............................ 79.10 95.50 153.67 123.72
Cash dividends paid............................. .60 .60 .60 .60
o Excludes quarter-end borrowing which is repaid on the first business day after
year end.
33
Shareholder Information
Stock Transfer Agent
American Stock Transfer & Trust Company, 59 Maiden Lane, New York, NY 10038
(telephone 800-937-5449) serves as transfer agent for the Company's common
stock. Certificates to be transferred should be mailed directly to the transfer
agent, preferably by registered mail.
Shareholders
The Company had approximately 700 record holders of its common stock at March
31, 2008. This total does not include an estimated 4,000 shareholders with
shares held under beneficial ownership in nominee name or within clearinghouse
positions of brokerage firms or banks.
Market Prices
The Company's common stock trades on The Nasdaq Global Market under the
symbol CSWC. The following high and low selling prices for the shares during
each quarter of the last two fiscal years were taken from quotations provided to
the Company by Nasdaq:
Quarter Ended High Low
- -----------------------------------------------------------------------
June 30, 2006.................................... $104.45 $ 90.65
September 30, 2006............................... 121.00 96.47
December 31, 2006............................... 154.36 115.33
March 31, 2007................................... 155.99 122.05
Quarter Ended High Low
- -------------------------------------------------------------------------
June 30, 2007.................................... $190.33 $144.50
September 30, 2007............................... 162.13 110.00
December 31, 2007............................... 130.00 105.16
March 31, 2008................................... 127.49 100.00
Dividends
The payment dates and amounts of cash dividends per share since April 1, 2006
are as follows:
Payment Date Cash Dividend
- -----------------------------------------------------------------------
May 31, 2006.............................................. $0.20
November 30, 2006......................................... 0.40
May 31, 2007.............................................. 0.20
November 30, 2007......................................... 0.40
May 31, 2008.............................................. 0.40
The amounts and timing of cash dividend payments have generally been dictated
by requirements of the Internal Revenue Code regarding the distribution of
taxable net investment income (ordinary income) of regulated investment
companies. Instead of distributing realized long-term capital gains to
shareholders, the Company has ordinarily elected to retain such gains to fund
future investments.
Automatic Dividend Reinvestment and Optional Cash Contribution Plan
As a service to its shareholders, the Company offers an Automatic Dividend
Reinvestment and Optional Cash Contribution Plan for shareholders of record who
own a minimum of 25 shares. The Company pays all costs of administration of the
Plan except brokerage transaction fees. Upon request, shareholders may obtain
information on the Plan from the Company, 12900 Preston Road, Suite 700, Dallas,
Texas 75230. Telephone (972) 233-8242. Questions and answers about the Plan are
on the next page.
Annual Meeting
The Annual Meeting of Shareholders of Capital Southwest Corporation will be
held on Monday, July 21, 2008, at 10:00 a.m. in the North Dallas Bank Tower
Meeting Room (second floor), 12900 Preston Road, Dallas, Texas.
34