Capital Southwest Corporation — Form 10-Q Summary
Reporting period: Fiscal third quarter and nine months ended December 31, 2012. Capital Southwest is a business development company and investment company whose results primarily reflect investment income, realized gains and changes in portfolio fair value. Financial amounts below are in millions unless stated otherwise.
Key financial metrics
- Quarterly investment income: $6.97, versus $5.62 in the prior-year quarter. Quarterly operating expenses were $2.87, versus $1.21; net investment income was $4.14, versus $4.39.
- Nine-month investment income: $9.77, up 20.9% from $8.08. Net investment income was $4.04, down from $4.42, as operating expenses increased 60% to $5.73 from $3.58.
- Increase in net assets from operations: $27.08 for the quarter, versus $50.82 a year earlier; $65.66 for nine months, versus $14.67. The nine-month result included $67.52 of net realized gains after tax and a $5.90 decrease in unrealized appreciation.
- Cash flow: Nine-month operating cash flow was $69.34. Financing activities used $66.61, including the $66.83 capital-gain dividend. Cash and cash equivalents ended at $67.62, up from $64.90 at March 31, 2012.
- Portfolio and NAV: Investments at fair value totaled $551.28, compared with $558.55 at March 31. Net assets were $628.09 and NAV was $165.36 per share, versus $628.71 and $167.45, respectively, at March 31.
- Liquidity and debt: Total liabilities were $7.12; the filing reports no corporate borrowings. Of the $67.62 in cash, $14.7 held by subsidiary CSVC could not be transferred to CSW without SBA consent. Management said available cash and other sources were adequate for expected requirements.
- Margins: Conventional operating margins are not a useful measure for this investment company; results are driven by investment income, expenses and portfolio gains or losses.
Material changes versus comparable periods
- Nine-month realized gains rose to $68.65 before tax from $11.33. Key 2012 transactions included the sale of 2,774,250 Encore Wire shares, producing a $66.04 gain, and the sale of Extreme International, producing a $7.60 gain. Sales and liquidations also generated losses, including a $4.93 loss on VIA Holdings.
- Operating expenses rose by $2.15 year over year. Management attributed $1.66 of the increase to bonus and phantom-option accruals established in the December quarter; compensation changes and staff growth accounted for other increases.
- Unrealized appreciation declined $5.90 over nine months, compared with a $0.17 increase in the prior-year period. Encore Wire’s unrealized appreciation fell $81.09, primarily following the share sale; gains included $63.30 at RectorSeal and $8.80 at Trax.
- The company paid a $17.59-per-share capital-gain dividend totaling $66.83 during the period. It also elected to retain certain long-term capital gains as deemed distributions and paid $1.13 in tax on shareholders’ behalf.
- Restricted securities increased to 70.1% of portfolio value from 56.9% at March 31. Level 3 investments were $386.5, or 70.1% of portfolio value, and rely on significant unobservable valuation inputs.
Outlook, risks and unusual items
- No specific earnings or investment-return guidance was provided. Management’s stated objective is capital appreciation and it does not seek to maintain a consistent level of realized gains.
- Management said liquidity was adequate and had agreed, subject to conditions, to invest up to $8.46 in nine portfolio companies. Nine-month investment activity included $5.95 in TitanLiner and $3.09 in existing portfolio companies.
- Fair values for many private investments depend on board-approved estimates and assumptions; realized outcomes may differ materially. The company also cited portfolio-company performance, economic cycles, competition, commodity costs and market prices as risks. It does not use derivatives to mitigate market risks.
- Maintaining regulated investment company status depends in part on meeting tax and portfolio-diversification requirements; future diversification compliance may not be fully controllable. The filing reports no pending legal proceedings and no material changes to previously disclosed risk factors.
- Unusual operating-expense increases included bonus and phantom-stock accruals. A $4.0 Trax debt security and accrued interest were converted into Series B preferred stock in December 2012, a non-cash transaction.
Important facts for investors to verify
- Review the composition and valuation assumptions of the Level 3 portfolio, particularly given its 70.1% share of investment value.
- Assess portfolio concentration and the operating performance supporting major private-company marks, including RectorSeal, Whitmore and Trax.
- Confirm the impact of the Encore Wire sale and the $66.83 capital-gain distribution on future portfolio income, liquidity and NAV.
- Track whether higher compensation, bonus and phantom-option costs persist, and whether committed investments are funded.
- Verify the availability of CSVC’s restricted $14.7 cash balance and the company’s continued compliance with RIC requirements.