Capital Southwest Corporation — FY2013 Form 10-K
Reporting period: Fiscal year ended March 31, 2013. The filing also reports fourth-quarter results; these are not a calendar-year 2012 annual report. Capital Southwest is a venture-capital investment company and BDC, with a wholly owned SBIC subsidiary. Its objective is long-term capital appreciation through investments in portfolio companies.
Financial performance and position
| Metric | FY2013 / March 31, 2013 | Comparable prior period |
|---|---|---|
| Total investment income | $10.84 million | $9.33 million in FY2012 |
| Net investment income | $1.91 million; $0.50 per share | $2.54 million; $0.68 per share |
| Net realized investment gain | $88.43 million after tax | $10.58 million in FY2012 |
| Increase in unrealized appreciation | $16.37 million | $78.63 million in FY2012 |
| Increase in net assets from operations | $106.71 million; $28.01 per share | $91.76 million; $24.42 per share |
| Net assets / NAV per share | $659.78 million / $173.20 | $628.71 million / $167.45 |
| Investments at fair value | $574.19 million | $558.55 million |
| Cash and cash equivalents | $81.77 million | $64.90 million |
| Total liabilities | $7.90 million | $4.28 million |
| Operating cash flow / change in cash | $94.34 million / increase of $16.87 million | $23.55 million / increase of $19.40 million |
Operating expenses rose 25.0% to $8.34 million, mainly from compensation and phantom-stock liabilities, professional fees, advertising, rent and insurance. The ratio of operating expenses to average net assets was 1.36%; net investment income to average net assets was 0.31%. The filing does not present a conventional operating margin measure applicable to this investment company.
Cash flow from operations benefited substantially from $99.54 million of investment-disposition proceeds. Financing cash outflow was $77.47 million, including $77.30 million of capital-gain distributions. The company reported no SBA-guaranteed debentures at either March 31, 2013 or 2012; the balance sheet reports no borrowings. Liabilities were primarily other and pension-related obligations. Of cash and equivalents, $24.9 million held by CSVC could not be transferred to CSW without SBA consent.
Material changes and unusual items
- Investment income increased 16.1%, principally as dividend income rose 20.4%, including larger dividends from RectorSeal and Whitmore. However, higher expenses drove net investment income down 25.0%.
- FY2013 realized gains were unusually large. The company sold Encore Wire shares for a $66.04 million gain and exited Heelys for a $20.86 million gain; sales of Extreme International and Hologic generated further gains. These were partly offset by losses, including $4.93 million on VIA Holdings. The filing reports $89.56 million of realized gains before tax and $88.43 million after tax.
- Unrealized appreciation rose $16.37 million, compared with $78.63 million in FY2012. Major FY2013 increases included RectorSeal ($72.60 million), Alamo Group ($23.14 million) and Whitmore ($13.30 million); decreases included Encore Wire ($74.91 million) and Heelys ($20.40 million), reflecting sales and valuation changes.
- The company distributed $77.30 million, or $20.34 per share, in capital-gain dividends during the fiscal year. Total cash dividends paid were $21.14 per share, including ordinary dividends and separate capital-gain payments. The tax-year capital-gain distribution timing and amounts differ from fiscal-year reporting.
- At year-end, 70.8% of portfolio value was classified as Level 3, relying on significant unobservable valuation inputs, up from 56.9% a year earlier. Restricted securities were also 70.8% of portfolio value. Publicly traded investments were approximately $168 million.
- The portfolio was highly concentrated: the 12 largest investments represented 95.59% of portfolio value. RectorSeal was valued at $238.9 million, Alamo at $108.3 million and Whitmore at $80.5 million.
Outlook, risks and contingencies
Management said available cash and other funding sources were adequate for expected needs and described investment dispositions as a potential funding source. The filing provides no numerical earnings, investment, or dividend guidance. Capital commitments, subject to conditions, totaled up to $13.78 million across eight portfolio companies. Remaining operating-lease obligations were approximately $200,000 through September 2014.
Key risks include uncertain fair values for private investments; concentration in a few holdings; portfolio-company operating, leverage, default and refinancing risks; economic weakness; competition for investments; and limits on liquidity and follow-on funding. Public-equity price changes directly affect marketable holdings, and the company uses no derivatives to hedge market risk. Management also warns that RIC qualification and dividend capacity depend on satisfying tax, asset-diversification and regulatory requirements. Shares ended the year at $115.00 versus NAV of $173.20, a substantial discount to NAV.
The company reported no pending legal proceedings. Grant Thornton issued unqualified opinions on the financial statements and internal control over financial reporting. A subsequent event disclosed that CEO and president Gary L. Martin planned to retire effective June 17, 2013, with Joseph B. Armes named as successor.
Most important facts for investors to verify
- How the largest private holdings—especially RectorSeal, Whitmore and other Level 3 investments—were valued, and how sensitive those values are to assumptions.
- Whether realized gains and dividends of this scale are repeatable; FY2013 operating performance included substantial gains from investment sales and was not driven primarily by recurring net investment income.
- The availability and transfer restrictions on cash, including the $24.9 million held by CSVC, and the funding plan for up to $13.78 million of commitments.
- The sustainability and tax characterization of distributions, including the distinction between fiscal-year cash dividends and calendar-year tax distributions.
- Portfolio-company performance, defaults, leverage and concentration, as well as the impact of the management transition disclosed after year-end.