Business Context and Reporting Period
Company: Capital Southwest Corporation (CSC)
Filing Type: Form 10-Q (Quarterly Report)
Period Ended: September 30, 2009
Business Overview: CSC is a business development company (BDC) and a closed-end, non-diversified investment company registered under the Investment Company Act of 1940. It operates through its wholly-owned subsidiary, Capital Southwest Venture Corporation (CSVC). The company invests in a composite of companies, providing significant managerial assistance to portfolio companies. It operates as a single segment.
Key Financial Metrics
| Metric | Six Months Ended Sep 30, 2009 | Six Months Ended Sep 30, 2008 |
|---|---|---|
| Total Assets | $457,262,861 | $417,543,139 (Mar 31, 2009) |
| Total Investments (Fair Value) | $442,935,960 | $396,635,023 (Mar 31, 2009) |
| Net Investment Income | $806,114 | $1,014,241 |
| Net Realized Gain on Investments | $1,846,516 | $(48,041) |
| Net Unrealized Appreciation | $37,262,293 | $(31,227,236) |
| Total Increase in Net Assets from Operations | $39,914,923 | $(30,261,036) |
| Cash and Cash Equivalents | $6,744,329 | $14,721,730 (Mar 31, 2009) |
| Net Asset Value (NAV) per Share | $121.26 | $110.98 (Mar 31, 2009) |
| Shares Outstanding | 3,741,638 | 3,741,638 |
Material Changes vs. Prior Period
- Net Asset Value: NAV per share increased from $110.98 at March 31, 2009, to $121.26 at September 30, 2009, driven primarily by significant unrealized appreciation in the portfolio.
- Investment Portfolio: Total investment value rose by approximately $46.3 million ($396.6M to $442.9M). This increase was fueled by a $37.3 million net increase in unrealized appreciation, reversing the $31.2 million decrease seen in the prior year period.
- Realized Gains: The company recorded a net realized gain of $1.85 million for the six months ended September 30, 2009, compared to a loss of $48,041 in the same period in 2008. This was largely due to the sale of all shares of Dennis Tool Company, generating a gain of $1.43 million.
- Investment Income: Net investment income decreased to $806,114 from $1,014,241 in the prior year. Interest income declined due to lower interest rates and reduced excess cash. Dividend income also decreased slightly.
- Liquidity: Cash and cash equivalents decreased by approximately $8.0 million to $6.7 million, primarily due to net cash used in operating activities ($6.5 million) and distributions ($1.5 million).
Outlook, Risks, and Management Commentary
- Portfolio Performance Drivers: Significant unrealized gains were reported in Alamo Group Inc. ($11.3M), Encore Wire Corporation ($8.2M), and Heelys, Inc. ($3.8M). These were partially offset by unrealized losses at Media Recovery, Inc. ($3.0M) and The RectorSeal Corporation ($2.7M) due to business slowdowns.
- Investment Activity: During the quarter, the company invested $9.0 million in new portfolio companies and $405,000 in existing ones. There are future commitments to invest up to $5.8 million in seven portfolio companies, subject to conditions.
- Liquidity and Capital Resources: Management believes current cash and equivalents, combined with potential borrowings (up to $20.6 million available to CSVC under SBA regulations) and dividends from portfolio companies, are adequate to meet requirements. Approximately $18.6 million of the portfolio consists of unrestricted publicly-traded securities providing liquidity.
- Legal Proceedings: The company is a defendant in lawsuits related to the Heelys, Inc. IPO. A class action settlement of $1 million (attorneys' fees) has been preliminarily approved, with Heelys' insurance expected to fund the majority. A separate individual shareholder suit has been settled for $5.3 million, with insurance covering approximately $2.4 million. Management does not believe these will have a material adverse effect.
- Risk Factors: The company is subject to market risks, including changes in equity security prices. Most portfolio companies do not hedge raw material or commodity price fluctuations. The company does not use derivative financial instruments to mitigate risk.
- Subsequent Events: On October 19, 2009, the Board granted 38,750 stock options to officers under the 2009 Stock Incentive Plan at an exercise price of $76.74.
Key Facts for Investor Verification
- Concentration Risk: Verify the valuation of the top holdings (Alamo Group, Encore Wire, The RectorSeal, Lifemark Group) which represent a significant portion of the portfolio's fair value and unrealized gains.
- Restricted Securities: Approximately 95.8% of the consolidated investment portfolio value consists of restricted securities, which are valued in good faith by the Board of Directors rather than at quoted market prices.
- Legal Settlements: Confirm the final approval and funding status of the Heelys, Inc. related litigation settlements ($1M and $5.3M) to ensure no unexpected out-of-pocket costs remain.
- Commitments: Monitor the $5.8 million in future investment commitments to seven portfolio companies and the conditions required to fulfill them.
- Regulatory Status: Verify the company's continued qualification as a Regulated Investment Company (RIC) to maintain tax-exempt status on distributed income.