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CSWC > SEC Filings for CSWC > Form 10-Q on 7-Aug-2014All Recent SEC Filings

Show all filings for CAPITAL SOUTHWEST CORP

Form 10-Q for CAPITAL SOUTHWEST CORP


7-Aug-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, 2014 (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, 2014. 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, 2014. 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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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/loss," which is the difference between income from interest, dividends and fees and our 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 the disposition of portfolio securities and their stated cost, net of applicable income tax expense based on our 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 our investment portfolio, compared with stated cost. It should be noted that the "Net realized gain 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 June 30, 2014, total investment income was $780,279, a $274,666, or 26.04%, decrease from total investment income of $1,054,945 for the three months ended June 30, 2013. This decrease was primarily attributable to a decrease in interest income from PalletOne and i-Memories. PalletOne was sold in FY 2014 and we ceased accruing interest from i-Memories in current quarter.

Our principal objective is to achieve capital appreciation. Therefore, a significant portion of our investment portfolio is structured to maximize the potential return from equity participation which typically provides minimal current yield in the form of interest or dividends. We also earn 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 three months ended June 30, 2014 and 2013, the Company had interest income from temporary cash investments of $17,264 and $17,926, respectively.

The Company's management fees, received primarily from its controlled affiliates, totaled $139,950 for both the three months ended June 30, 2014 and 2013.

During the three months ended June 30, 2014 and 2013, the Company recorded dividend income from the following sources:

                                       Three Months Ended
                                            June 30,
                                       2014          2013
Alamo Group, Inc.                    $ 198,310     $ 198,261
Encore Wire Corporation                      -        26,250
North American Energy Partners           1,190             -
The RectorSeal Corporation             240,000       240,000
TCI Holdings, Inc.                           -        20,318
The Whitmore Manufacturing Company      60,000        60,000
                                     $ 499,500     $ 544,829

Due to the nature of our business, the majority of our operating expenses are related to employees' and directors' compensation, office expenses, legal, professional and accounting fees and pension expense. Total operating expenses increased by $24,434, or 1.1%, for the quarter ended June 30, 2014 as compared to the quarter ended June 30, 2013. This increase is primarily due to an increase of $165,349 in professional fees, $52,527 in pension expense, $44,361 in insurance expense offset by a decrease of $166,288 in compensation and $57,673 in stock option expense.


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Net Realized Gain (Loss) on Investments

During the quarter ended June 30, 2014, we received proceeds of $588,577 and realized a gain of $351,591 from the sale of North American Energy Partners, Inc. We also received proceeds of $2,398,706 and realized a loss of $14,889,677 from the liquidation of Cinatra Clean Technologies, Inc. In addition, we received proceeds of $139,713 and realized a loss of $1,175,287 from the sale of our limited partnership interest in Discovery Alliance, LLC.

During the quarter ended June 30, 2013, we received a capital gain dividend of $55,000 from Diamond State Venture, L.P.

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 quarter ended June 30, 2014, we recognized a $36,917,417 increase in net change in unrealized appreciation of investments. This increase in unrealized appreciation is attributable to The Rectorseal Corporation, The Whitmore Manufacturing Company, Media Recovery and Balco, Inc., which increased by $13,600,000, $7,100,000, $600,000 and $600,000, respectively, due to increases in each entity's earnings; Deepwater Corrosion Services, Inc. increased by $1,055,000 as it was the first quarter we utilized a market valuation approach since we made our investment; Encore Wire Corporation increased by $669,375 due to an increase in its stock price. Offsetting these increases were iMemories, Inc. and Instawares Holding Company, LLC, which decreased by $1,591,002 and $2,302,000 respectively, due to a reduction in its enterprise value and a decrease in valuation multiple, respectively; Alamo Group, Inc. decreased by $642,947 due to a decrease in its stock price.

For the quarter ended June 30, 2013, we recognized a $10,391,960 increase in net change in unrealized appreciation of investments. The largest increases in unrealized appreciation are attributable to Alamo Group, Inc., which increased by $7,295,566 due to an increase in its stock price at June 30, 2013, while The Rectorseal Corporation increased by $6,000,000; The Whitmore Manufacturing Company increased by $2,100,000; and Media Recovery, Inc. increased by $1,500,000 all due to increases in the entities' respective earnings. Offsetting these increases were Hologic, Inc., which decreased by $1,923,306, and Encore Wire Corporation, which decreased by $1,194,375 each due to a decrease in the respective entity's stock price at June 30, 2013. Additionally, Cinatra Clean Technologies, Inc. decreased by $1,170,995 due to under performance in their market.

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

                                          Three Months Ended
                                               June 30,
                                         2014             2013
Alamo Group, Inc.                    $   (642,947 )   $  7,295,566
Balco, Inc                                600,000                -
Deepwater Corrosion Services, Inc.      1,055,000                -
Encore Wire Corporation                   669,375       (1,194,375 )
iMemories, Inc.                        (1,591,002 )              -
Instawares Holding Company, LLC        (2,302,000 )        151,000
Media Recovery, Inc.                      600,000        1,500,000
The RectorSeal Corporation             13,600,000        6,000,000
Trax Holdings, Inc.                      (500,000 )              -
The Whitmore Manufacturing Company      7,100,000        2,100,000


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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 - June 30, 2014 and March 31, 2014."

Financial Liquidity and Capital Resources

At June 30, 2014, the Company had cash and cash equivalents of approximately $88.2 million. Funds may be transferred to the Company in the form of dividends from our controlled affiliates to the extent available. Additionally, approximately $219.5 million of our June 30, 2014 investment portfolio is represented by unrestricted publicly traded securities and represents a potential source of liquidity.

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.

Application of Critical Accounting Policies and Accounting Estimates

There have been no changes during the quarter ended June 30, 2014 to the critical accounting policies or the area that involves the use of significant judgments or estimates we described in our Annual Report on Form 10-K for the fiscal year ended March 31, 2014.

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