Capital Southwest Corporation — Q1 FY2012 (quarter ended June 30, 2011)
Capital Southwest is a business development company investing in controlled and developing private companies and publicly traded securities. The filing covers the three months ended June 30, 2011; comparable income and cash-flow figures are for the three months ended June 30, 2010. Balance-sheet comparisons are with March 31, 2011. Amounts below are in U.S. dollars.
Financial results and position
| Metric | June 2011 quarter / June 30, 2011 | Comparable / March 31, 2011 |
|---|---|---|
| Investment income | $1.20 million | $2.97 million |
| Net investment income | $14,000 | $1.96 million |
| Realized investment gain (loss) | $(5.91) million | $74.02 million |
| Change in unrealized appreciation | $(4.56) million | $(65.74) million |
| Change in net assets from operations | $(10.46) million | $10.24 million |
| Operating cash flow | $(9.32) million | $75.40 million |
| Cash and cash equivalents | $34.68 million | $45.50 million |
| Total investments, at fair value | $488.48 million | $489.27 million |
| Total assets | $531.57 million | $543.21 million |
| Total liabilities | $4.05 million | $3.98 million |
| Net assets / NAV per share | $527.52 million / $140.56 | $539.23 million / $143.68 |
The filing reports no borrowings or debt balance. Investment income is the relevant income measure for this investment company; the filing does not present conventional sales revenue or operating margins. The quarter’s distribution from undistributed investment income was $1.50 million, or $0.40 per share.
Material changes and management commentary
- Investment income fell 59.7% year over year, mainly because dividend income declined 76.1%. The prior-year quarter included $1.82 million of Balco dividends; no Balco dividend was recorded this quarter. Interest income increased 50.3%.
- Operating expenses rose 19.6% to $1.17 million, which management attributed primarily to two new officer positions.
- The company sold all its Phi Health preferred shares for approximately $39,000 in proceeds and recognized a $5.91 million realized loss.
- In the prior-year quarter, the sale of Lifemark generated approximately $74.82 million in cash proceeds and a $74.02 million realized gain before taxes. This large one-time gain makes the year-over-year operating comparison less representative of recurring performance.
- Portfolio fair value decreased by approximately $0.80 million. Management cited declines in Alamo Group, Media Recovery and KBI Biopharma, partly offset by gains in Encore Wire, The Whitmore Manufacturing Company and All Components.
- The company invested $5.00 million in new investments and $4.82 million in existing portfolio companies. It had conditional commitments to invest up to $9.22 million in eight portfolio companies.
- Management said cash and other available sources were adequate for expected requirements and noted that investment dispositions may fund future investments. No quantified earnings or NAV guidance was provided.
Liquidity, valuation and risks
- Cash declined $10.82 million during the quarter. Of the $34.68 million cash balance, $2.7 million held by the SBIC subsidiary could not be transferred to the parent without SBA consent.
- Approximately 94.8% of the investment portfolio was restricted, and 94.8% was classified as Level 3, relying on significant unobservable valuation inputs. The Board determines fair values for most private and restricted holdings; realized values may differ materially from reported estimates.
- Market, portfolio-company operating, commodity-cost and currency risks may reduce investment values and NAV. The company does not use derivatives to hedge these risks. Its $17.0 million of fixed-rate debt investments represented 3.5% of the portfolio and were generally below investment grade.
- The company intended to continue qualifying as a regulated investment company, but noted that future portfolio-diversification requirements may not be fully within its control. It reported no pending legal proceedings and no material changes to previously disclosed risk factors.
Most important facts for investors to verify
- Whether the sharp decline in investment and dividend income persists, particularly given the absence of the prior-year Balco dividend.
- The basis and sensitivity of Level 3 valuations, including the material holdings whose values changed during the quarter and the portfolio’s high restricted-security share.
- Whether committed investments of up to $9.22 million are funded from available cash or future portfolio dispositions, and the resulting liquidity impact.
- The performance and collectability of private-company investments, including below-investment-grade debt, and the factors behind the Phi Health realized loss.
- Future NAV movements and the company’s ability to satisfy RIC distribution and diversification requirements.