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CSWC > SEC Filings for CSWC > Form 10-Q on 6-Feb-2014All Recent SEC Filings

Show all filings for CAPITAL SOUTHWEST CORP

Form 10-Q for CAPITAL SOUTHWEST CORP


6-Feb-2014

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.

General

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.

On November 20, 2013, Kelly Tacke was appointed as the Company's Senior Vice President, Chief Financial Officer, Chief Compliance Officer, Secretary and Treasurer, effective November 18, 2013. Ms. Tacke replaced Tracy Morris, who resigned as the Company's Chief Financial Officer, Chief Operating Officer and Secretary, effective November 15, 2013, to pursue other opportunities.

Ms. Tacke was with Palm Harbor Homes, Inc., a publicly traded manufacturer and marketer of factory-built homes for 18 years, where she served as Executive Vice President, Chief Financial Officer and Corporate Secretary. The Company was a long-time investor in Palm Harbor Homes. Ms. Tacke began her career with PricewaterhouseCoopers, where she was a Senior Audit Manager. She holds a Bachelors of Business Administration degree from the University of Texas at Austin and is a Certified Public Accountant.

On January 20, 2014, the Board of Directors of the Company elected Joseph B. Armes as Chairman of the Board and appointed David R. Brooks and William R. Thomas III to the Board. The Board increased its size from six to seven members and appointed Messrs. Brooks and Thomas to fill the vacancies created by the resignation of Richard F. Strup in November 2013 and the increase in the size of the Board.

Mr. Armes has served as a director and President and Chief Executive Officer of the Company since June 2013. Mr. Brooks has been the Chairman of the Board and Chief Executive Officer of Independent Bank Group, Inc., a publicly-traded bank holding company with approximately $2.0 billion in assets, since its founding in 2002. Mr. Thomas is a private investor and has served as the President of the Thomas Heritage Foundation, a non-profit grant-making corporation, since 2008. Mr. Thomas worked for the Company from July 2006 to September 2012, most recently as a Vice President. Mr. Thomas currently serves as a director of Encore Wire Corporation.


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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 three months ended December 31, 2013, total investment income was $8,363,469, a $1,390,797, or 19.9% increase from $6,972,672 for the three months ended December 31, 2012. For the nine months ended December 31, 2013, total investment income was $10,395,126, a $627,654, or a 6.4% increase from $9,767,472, total investment income for the nine months ended December 31, 2012. This comparable period increase was primarily attributable to a $1,364,628 and a $350,000 increase in third quarter dividend income from The Rectorseal Corporation and Capstar Corporation, respectively, offset by Cinatra Clean Technologies, Inc.'s current year's fully reserved interest income.

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. The Company received interest income from temporary cash investments of $16,599 and $14,772 during the quarters ended December 31, 2013 and 2012, respectively. During the nine months ended December 31, 2013 and 2012, the Company had interest income from temporary cash investments of $51,729 and $50,400, respectively.

The Company's management fees, received primarily from its controlled affiliates, totaled $419,850 and $456,850 for the nine months ended December 31, 2013 and 2012, respectively. During the quarters ended December 31, 2013 and 2012, the Company received management fees of $139,950 and $156,450, respectively.


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During the three and nine months ended December 31, 2013 and 2012, the Company recorded dividend income from the following sources:

                                               Three Months Ended               Nine Months Ended
                                                  December 31,                    December 31,
                                              2013            2012            2013            2012
Alamo Group, Inc.                          $   198,311     $   169,938     $   594,882     $   509,814
CapitalSouth Partners Fund III                       -          47,297               -         198,647
Capitala Finance Corporation                    50,809                          50,809               -
Capstar Holdings Corporation                   350,000                         350,000               -
Encore Wire Corporation                         52,500          26,250         105,000         134,235
The RectorSeal Corporation                   6,200,000       4,835,372       6,680,000       5,315,372
TCI Holdings, Inc.                              20,318          20,318          60,953          60,953
The Whitmore Manufacturing Company           1,200,000       1,208,842       1,320,000       1,328,842
                                           $ 8,071,938     $ 6,308,017     $ 9,161,644     $ 7,547,863

Due to the nature of its business, the majority of the Company's operating expenses are related to officer and employee compensation, office expenses, and legal, professional and accounting fees. Total operating expenses decreased by $70,158 or 2.4% for the three months ended December 31, 2013 as compared to the three months ended December 31, 2012. This decrease is primarily due to $61,411, or 32.3%, decrease in professional fees during the three months ended December 31, 2013. Total operating expenses increased by $1,579,052 or 27.6% for the nine months ended December 31, 2013 as compared to the nine months ended December 31, 2012. This increase is primarily due to $1,382,507, or 37.2%, increase in salaries related to bonus and phantom option accruals recorded as well as the expense associated with certain staffing changes incurred during the nine months ended December 31, 2013.

Net Realized Gain (Loss) on Investments

During the nine months ended December 31, 2013, we received a capital gain dividend in the amount of $55,000 from Diamond State Venture, L.P.

During the nine months ended December 31, 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. In addition, we sold all investment ownership in Extreme International, Inc., generating net cash proceeds of $11,890,630 and a realized gain of $7,600,125. We also received cash proceeds in the amount of $2,823 from Palm Harbor Home Liquidating Trust. These gains were offset by a $4,926,289 realized loss associated with sales of all investment ownership in VIA Holdings., a $760,742 realized loss related to liquidation of Sterling Group Partners, L.P., a $150,594 realized loss related to liquidation of StarTech Seed Fund I, L.P., and a $7,000 capital loss adjustment related to a final true-up of the Lifemark Group, Inc. divesture from June 2010. The net realized gain for the nine months ended December 31, 2012 was $68,646,356. We declared and paid a cash dividend in the amount of $66,825,782 or $17.59 per share of common stock in June 2012. In total, we recognized net realized gains of $1,820,574 for the nine months ended December 31, 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.


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Net Increase/(Decrease) in Unrealized Appreciation of Investments

For the nine months ended December 31, 2013, we recognized a $109,315,301 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 $63,553,497 and $25,068,750, respectively, due to increases in their stock price at December 31, 2013, while The Rectorseal Corporation increased by $19,000,000; The Whitmore Manufacturing Company increased by $2,500,000; Media Recovery, Inc. increased by $5,300,000; and Trax Holdings, Inc. increased by $1,900,000 due to increases in each entity's respective earnings. Offsetting these increases were Cinatra Clean Technologies, Inc., TitanLiner Inc., and Instawares Holding Company, LLC., which decreased by $2,328,844, $3,414,000, and $2,323,000, 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 nine months ended December 31, 2013 due to a distribution of 108,105 shares of Capitala Finance Corporation (CPTA) valued at $2,151,290, which represented 71% of our interest in Capital South Partners Fund III, L.P.

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

                                              Nine Months Ended
                                                 December 31,
                                            2013             2012
Alamo Group, Inc.                       $ 63,553,497     $   7,258,374
Capital South Partners Fund III, L.P.     (2,833,201 )         378,000
Cinatra Clean Technologies, Inc.          (2,328,844 )      (4,107,390 )
Encore Wire Corporation                   25,068,750       (81,089,460 )*
Instawares Holding Company LLC.           (2,323,000 )         829,000
Media Recovery, Inc.                       5,300,000        (5,400,000 )
The RectorSeal Corporation                19,000,000        63,300,000
The Whitmore Manufacturing Company         2,500,000         4,200,000
TitanLiner, Inc.                          (3,414,000 )               -
Trax Holdings, Inc.                        1,900,000         8,800,000

* During the nine months ended December 31, 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.

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 - December 31, 2013 and March 31, 2013.

Portfolio Investments

During the nine months ended December 31, 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 $2,500,574 in commitments to existing portfolio companies.

We have commitments, subject to certain conditions, to invest up to $4,817,576 in five portfolio companies as of December 31, 2013.


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Financial Liquidity and Capital Resources

At December 31, 2013, the Company had cash and cash equivalents of approximately $65.7 million.

Management believes that the Company's cash and cash equivalents and cash available 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.

Application of Critical Accounting Policies and Accounting Estimates

There have been no changes during the nine months ended December 31, 2013 to the critical accounting policies or the areas 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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