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CSWC > SEC Filings for CSWC > Form 10-Q on 7-Nov-2013All Recent SEC Filings

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Form 10-Q for CAPITAL SOUTHWEST CORP


7-Nov-2013

Quarterly Report


Item 2. - Management's Discussion and Analysis of Financial Condition and Results of Operations

The following discussion should be read in conjunction with our financial statements and the notes thereto included elsewhere in our Annual Report on Form 10-K for the fiscal year ended March 31, 2013 (the "Form 10-K").

The information contained herein may contain "forward-looking statements" based on our current expectations, assumptions and estimates about us and our industry. These forward-looking statements involve risks and uncertainties.
Words such as "believe," "anticipate," "estimate," "expect," "intend," "plan," "will," "may," "might," "could," "continue" and other similar expressions identify forward-looking statements. In addition, any statements that refer to expectations, projections or other characterizations of future events or circumstances are forward-looking statements. Our actual results could differ materially from those anticipated in the forward-looking statements as a result of several factors more fully described in "Risk Factors" and elsewhere in this Form 10-Q, and in our Form 10-K for the year ended March 31, 2013. The forward-looking statements made in this Form 10-Q related only to events as of the date on which the statements are made. You should read the following discussion in conjunction with the consolidated financial statements and related footnotes and other financial information included in our Form 10-K for the year ended March 31, 2013. We undertake no obligation to update publicly any forward-looking statements for any reason, even if new information becomes available or other events occur in the future.


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On July 15, 2013, a four-for-one split of our issued common stock was approved by our shareholders. The stock split was payable on August 15, 2013 to shareholders of record at the close of business July 31, 2013. Our common stock began trading at the split-adjusted price on August 16, 2013. All share numbers and per share amounts presented herein reflect the stock split.

Results of Operations

The composite measure of our 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 income from interest, dividends and fees and 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

For the six months ended September 30, 2013, total investment income was $2,031,657, a $763,143, or 27.3% decrease from the $2,794,800, total investment income for the six months ended September 30, 2012. This comparable period decrease was primarily attributable to Cinatra Clean Technologies, Inc.'s fully reserved interest income during the six months ended September 30, 2013 and CapitalSouth Partners Fund III, L.P.'s distribution of profits of $104,053 during the first quarter of fiscal year 2012.

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 six months ended September 30, 2013 and 2012, the Company had interest income from temporary cash investments of $35,130 and $35,628, respectively.

The Company's management fees, received primarily from its controlled affiliates, totaled $279,900 and $300,400 for the six months ended September 30, 2013 and 2012, respectively.


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During the three and six months ended September 30, 2013 and 2012, the Company recorded dividend income from the following sources:

                                       Three Months Ended             Six Months Ended
                                          September 30,                 September 30,
                                       2012          2012           2013            2012
Alamo Group, Inc.                    $ 198,310     $ 170,058     $   396,571     $   339,876
CapitalSouth Partners Fund III               -             -               -         151,350
Encore Wire Corporation                 26,250        26,250          52,500         107,985
The RectorSeal Corporation             240,000       240,000         480,000         480,000
TCI Holdings, Inc.                      20,317        20,317          40,635          40,635
The Whitmore Manufacturing Company      60,000        60,000         120,000         120,000
                                     $ 544,877     $ 516,625     $ 1,089,706     $ 1,239,846

Due to the nature of its business, the majority of the Company's operating expenses are related to officer and employee compensation, office expenses, legal, professional and accounting fees. Total operating expenses increased by $1,649,210 or 57.7% for the six months ended September 30, 2013 as compared to the six months ended September 30, 2012. This increase is primarily due to the $1,503,256, or 110.3%, increase in salaries related to bonus and phantom options accruals recorded during the six months ended September 30, 2013. Bonus and phantom option accruals were first recorded during the quarter ended December 31, 2012 for the nine month period. There were no bonus or phantom option accruals recorded during the six months ended September 30, 2012. Consequently there is no offsetting accrual to compare to for the prior year.

Net Realized Gain (Loss) on Investments

During the six months ended September 30, 2013, we received a capital gain dividend in the amount of $55,000 from Diamond State Venture, L.P.

During the six months ended September 30, 2012, we sold 2,774,250 shares of common stock in Encore Wire Corporation held by our subsidiary, CSVC, to Encore Wire generating a capital gain of $66,037,485. We also sold 50,000 shares of common stock of Hologic, Inc. generating a capital gain of $850,548. These gains were offset by a $7,000 capital loss adjustment related to a final true-up of the Lifemark Group, Inc. divesture from June 2010. In addition, we declared and paid a cash dividend in the amount of $17.59 per share of common stock in June 2012. As a result, we had undistributed net realized gains of $55,251 during the six months ended September 30, 2012.

Management does not attempt to maintain a consistent 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/(Decrease) in Unrealized Appreciation of Investments

For the six months ended September 30, 2013, we recognized a $56,007,066 increase in net change in unrealized appreciation of investments. The increases in unrealized appreciation are attributable to Alamo Group, Inc. and Encore Wire Corporation, which increased by $30,200,783 and $5,801,250, respectively, due to increases in their stock price at September 30, 2013, while The Rectorseal Corporation increased by $18,100,000; The Whitmore Manufacturing Company increased by $2,500,000; and Media Recovery, Inc. increased by $4,800,000 due to increases in the entities' respective earnings. Offsetting these increases were Hologic, Inc., which decreased by $1,136,499 due to a decrease in its stock price at September 30, 2013. Additionally, Cinatra Clean Technologies, Inc. and TitanLiner Inc. decreased by $1,711,324 and $1,239,000, respectively, due to each entity's under performance in their respective markets. In addition, CapitalSouth Partners Fund III, L.P. decreased by $2,833,201; during the quarter ended September 30, 2013, we received a distribution of 108,106 shares of Capitala Finance Corporation (CPTA), which represented 71% of our interest in Capital South Partners Fund III, L.P.


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Set forth in the following table are the significant increases and decreases in unrealized appreciation by portfolio company:

                                               Six Months Ended
                                                September 30,
                                            2013             2012
Alamo Group, Inc.                       $ 30,200,783     $  10,485,486
Capitala Finance Corporation                 684,810                 -
Capital South Partners Fund III, L.P.     (2,833,201 )         180,000
Cinatra Clean Technologies, Inc.          (1,711,324 )      (2,386,393 )
Encore Wire Corporation                    5,801,250       (82,454,460 )*
Hologic, Inc.                             (1,136,499 )      (1,835,180 )*
Media Recovery, Inc.                       4,800,000        (6,600,000 )
The RectorSeal Corporation                18,100,000        42,300,000
The Whitmore Manufacturing Company         2,500,000         9,900,000
TitanLiner, Inc.                          (1,239,000 )               -

* During the six months ended September 30, 2012, we sold 2,774,250 shares of common stock in Encore Wire Corporation held by our subsidiary, CSVC, to Encore Wire generating a capital gain of $66,037,485. We also sold 50,000 shares of common stock of Hologic, Inc. generating a capital gain of $850,548.

A description of the investments listed above and other material components of the investment portfolio are included elsewhere in this report under the caption "Consolidated Schedule of Investments - September 30, 2013 and March 31, 2013."

Portfolio Investments

During the six months ended September 30, 2013, we invested $8,000,000 in Deepwater Corrosion Services, Inc., a full service corrosion control company providing the oil and gas industry with expertise in cathodic protection and asset integrity management. Deepwater's products and services provide life extension to and support regulatory compliance of mission-critical, energy production assets. In addition, we funded $1,822,330 in commitments to existing portfolio companies.

We have commitments, subject to certain conditions, to invest up to $5,495,820 in seven portfolio companies as of September 30, 2013.

Financial Liquidity and Capital Resources

At September 30, 2013, the Company had cash and cash equivalents of approximately $68.2 million. Pursuant to the SBA regulations, cash and cash equivalents of $25.5 million held by CSVC may not be transferred or advanced to CSC without notifying the SBA.

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.


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Application of Critical Accounting Policies and Accounting Estimates

There have been no changes during the six months ended September 30, 2013 to the critical accounting policies or the area that involve the use of significant judgments or estimates we described in our Annual Report on Form 10-K for the fiscal year ended March 31, 2013.

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