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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
 
FORM 10-Q

(Mark One)

 
x
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended December 31, 2011

OR

 
o
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from _________________________to  _________________________
 
Commission File Number: 814-61

CAPITAL SOUTHWEST CORPORATION
(Exact name of registrant as specified in its charter)

Texas
 
75-1072796
(State or other jurisdiction of  incorporation or organization)
 
(I.R.S. Employer Identification No.)

12900 Preston Road, Suite 700, Dallas, Texas
 
75230
(Address of principal executive offices)
 
(Zip Code)

Registrant's telephone number, including area code: (972) 233-8242

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.  Yes x  No o  

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such filings).  Yes x  No o

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer.  See definition of “accelerated filer,” “large accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check One):
 
Large accelerated filer  o
Accelerated filer  x
Non-accelerated filer  o
Smaller reporting company o

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).  Yes o No x
 
Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.

3,754,538 shares of Common Stock, $1 par value, as of February 8, 2012
 


 
 

 
 
TABLE OF CONTENTS

PART I
 
FINANCIAL INFORMATION
Page
       
Item 1.
 
Consolidated Financial Statements
 
   
3
   
4
   
5
   
6
   
7
   
16
Item 2.
 
29
Item 3.
 
32
Item 4.
 
33
       
PART II
 
OTHER INFORMATION
 
       
Item 1.
 
33
Item 1A.
 
33
Item 6.
 
33
       
   
34
 
PART I – FINANCIAL INFORMATION

Item 1.
Consolidated Financial Statements

CAPITAL SOUTHWEST CORPORATION AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF ASSETS AND LIABILITIES
(In thousands except per share data)
 
   
December 31
2011
   
March 31
2011
 
Assets
 
(Unaudited)
   
 
 
Investments at market or fair value
           
Companies more than 25% owned (Cost: December 31, 2011 - $14,870, March 31, 2011 - $25,521)
  $ 320,032     $ 310,181  
Companies 5% to 25% owned (Cost: December 31, 2011 - $14,003, March 31, 2011 - $14,049)
    97,420       83,335  
Companies less than 5% owned (Cost: December 31, 2011 - $59,820, March 31, 2011 - $58,784)
    62,323       95,757  
Total investments (Cost: December 31, 2011 - $88,693, March 31, 2011 - $98,354)
    479,775       489,273  
Cash and cash equivalents
    63,216       45,498  
Receivables
               
Dividends and interest
    5,991       523  
Affiliates
    290       340  
Pension assets
    7,684       7,398  
Other assets
    161       182  
Total assets
  $ 557,117     $ 543,214  
Liabilities
               
Other liabilities
  $ 569     $ 574  
Pension liability
    1,318       1,257  
Income taxes payable
    1,249          
Deferred income taxes
    2,231       2,150  
Total liabilities
    5,367       3,981  
Net Assets
               
Common stock, $1 par value: authorized, 5,000,000 shares; issued, 4,339,416 shares at December 31, 2011 and 4,337,916 shares at March 31, 2011
    4,339       4,338  
Additional capital
    177,975       173,905  
Accumulated net investment income
    2,290       872  
Accumulated net realized gain (loss)
          (6,863 )
Unrealized appreciation of investments
    391,083       390,918  
Treasury stock - at cost on 584,878 shares
    (23,937 )     (23,937 )
Total net assets
    551,750       539,233  
Total liabilities and net assets
  $ 557,117     $ 543,214  
Net asset value per share (on the 3,754,538 shares outstanding at December 31, 2011 and 3,753,038 shares outstanding at March 31, 2011)
  $ 146.95     $ 143.68  
 
The accompanying Notes are an integral part of these Consolidated Financial Statements


CAPITAL SOUTHWEST CORPORATION AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)
(In thousands)
 
   
Three Months Ended
December 31
   
Nine Months Ended
December 31
 
   
2011
   
2010
   
2011
   
2010
 
Investment income:
                       
Interest
  $ 506     $ 328     $ 1,444     $ 1,078  
Dividends
    4,955       1,899       6,148       4,860  
Management and directors’ fees
    163       135       486       554  
      5,624       2,362       8,078       6,492  
Operating expenses:
                               
Salaries
    588       526       1,571       1,389  
Stock option expense
    253       245       757       713  
Net pension benefit
    (75 )     (73 )     (225 )     (218 )
Professional fees
    202       204       741       617  
Other operating expenses
    244       207       739       646  
      1,212       1,109       3,583       3,147  
Income before income taxes
    4,412       1,253       4,495       3,345  
Income tax expense
    27       26       74       74  
                                 
Net investment income
  $ 4,385     $ 1,227     $ 4,421     $ 3,271  
                                 
Proceeds from disposition of investments
  $ 13,417     $ (4,219 )   $ 31,956       74,836  
Cost of investments sold
    14,528       -       20,628       4,510  
Realized gain (loss) on investments
                               
before income tax
    (1,111 )     (4,219 )     11,328       70,326  
Income tax expense
    1,249       24,578       1,249       24,578  
Net realized gain (loss) on investments
    (2,360 )     (28,797 )     10,079       45,748  
                                 
Net increase (decrease) in unrealized appreciation of investments
    48,798       21,837       165       (20,545 )
                                 
Net realized and unrealized gain (loss) on investments
  $ 46,438     $ (6,960 )   $ 10,244     $ 25,203  
                                 
Increase (decrease) in net assets from operations
  $ 50,823     $ (5,733 )   $ 14,665     $ 28,474  
 
The accompanying Notes are an integral part of these Consolidated Financial Statements


CAPITAL SOUTHWEST CORPORATION AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CHANGES IN NET ASSETS
(Unaudited)
(In thousands)
 
   
Nine Months
Ended
December 31, 2011
   
Nine Months
Ended
December 31, 2010
 
Operations:
           
Net investment income
  $ 4,421     $ 3,271  
Net realized gain on investments
    10,079       45,748  
Net increase (decrease) in unrealized appreciation of investments
    165       (20,545 )
Increase in net assets from operations
    14,665       28,474  
Distributions from:
               
Undistributed net investment income
    (3,003 )     (2,994 )
Net realized gains deemed distributed to shareholders
    (3,216 )     (45,748 )
Capital share transactions:
               
Allocated increase in share value for deemed distribution
    3,216       45,748  
Exercise of employee stock options
    98       745  
Stock option expense
    757       713  
Increase in net assets
    12,517       26,938  
Net assets, beginning of period
    539,233       486,925  
Net assets, end of period
  $ 551,750     $ 513,863  
 
The accompanying Notes are an integral part of these Consolidated Financial Statements


CAPITAL SOUTHWEST CORPORATION AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
(In thousands)
 
   
Three Months Ended
December 31
   
Nine Months Ended
December 31
 
    2011     2010     2011     2010  
Cash flows from operating activities
                       
Increase (decrease) in net assets from operations
  $ 50,823     $ (5,733 )   $ 14,665     $ 28,474  
Adjustments to reconcile increase (decrease)  in net assets from operations to net cash provided by (used in) operating activities:
                               
Net proceeds from disposition of investments
    13,417       (4,219 )     31,956       71,133  
Proceeds from repayment of loan securities or investments
          4,273       2,111       4,407  
Purchases of securities
    (1,577 )     (2,832 )     (13,077 )     (6,865 )
Depreciation and amortization
    6       7       16       18  
Net pension benefit
    (75 )     (73 )     (225 )     (218 )
Realized (gain) loss on investments before income tax
    1,111       4,219       (11,328 )     (70,326 )
Taxes payable on behalf of shareholders on deemed distribution
    1,249       24,578       1,249       24,578  
Net (increase) decrease in unrealized appreciation of investments
    (48,798 )     (21,837 )     (164 )     20,545  
Stock option expense
    253       245       757       712  
Increase in dividend and interest receivable
    (5,031 )     (1,434 )     (5,468 )     (684 )
Decrease (increase) in receivables from affiliates
    (5       (18 )     50       558  
Decrease in other assets
          6       4       12  
Increase (decrease) in other liabilities
    (5 )     85       (5 )     (718 )
Increase in deferred income taxes
    27       26       81       76  
Net cash provided by (used in) operating activities
    11,395       (2,707 )     20,622       71,702  
Cash flows from financing activities
                               
Distributions from undistributed net investment income
    (1,502     (1,497 )     (3,003 )     (2,993 )
Proceeds from exercise of employee stock options
          694       98       745  
Net cash used in financing activities
    (1,502 )     (803 )     (2,905 )     (2,248 )
Net increase (decrease) in cash and cash equivalents
    9,893       (3,510 )     17,717       69,454  
Cash and cash equivalents at beginning of period
    53,323       77,058       45,499       4,094  
Cash and cash equivalents at end of period
  $ 63,216     $ 73,548     $ 63,216     $ 73,548  
Supplemental disclosure of cash flow information:
                               
Income taxes
  $     $     $     $  
Non-cash transaction:
                               
a. 
In July 2011, the $1,000,000 investment in iMemories, Inc. debt security was rolled into Series C Convertible Preferreed Stock. In June 2010, the Company transferred $3,703,619 in certain tracts of Real Estate from Lifemark Group to their newly formed CapStar Holdings Corporation, wholly-owned by the Company.
  
 
This transaction had the following non-cash effect on the Company’s Consolidated Statements of Assets and Liabilities:
Total Investments
  $     $     $ 1,000     $ 3,704  
 
The accompanying Notes are an integral part of these Consolidated Financial Statements
 
 
CAPITAL SOUTHWEST CORPORATION AND SUBSIDIARIES

CONSOLIDATED SCHEDULE OF INVESTMENTS
(Unaudited)
December 31, 2011
 
Company  
Equity (a)
   
Investment (b)
 
Cost
    Value (c)  
¥†ALAMO GROUP INC.
Seguin, Texas
Tractor-mounted mowing and mobile excavation equipment for governmental, industrial and agricultural markets; street-sweeping equipment for municipalities.
    22.0 %  
2,832,300 shares common stock (acquired 4-1-73 thru 5-09-11)
  $ 2,190,937     $ 61,602,525  
ATLANTIC CAPITAL BANCSHARES, INC
Atlanta, Georgia
Holding company of Atlantic Capital Bank, a full service commercial bank.
    1.9 %  
300,000 shares common stock (acquired 4-10-07)
    3,000,000       2,068,000  
¥BALCO, INC.
Wichita, Kansas
Specialty architectural products used in the construction and remodeling of commercial and institutional buildings.
    90.9  
445,000 shares common stock and 60,920 shares Class B non-voting common stock (acquired 10-25-83 and 5-30-02)
    624,920       4,100,000  
*BOXX TECHNOLOGIES, INC.
Austin, Texas
Workstations for computer graphic imaging and design.
    14.9 %  
3,125,354 shares Series B Convertible Preferred Stock, convertible into 3,125,354 shares of common stock at $0.50 per share (acquired 8-20-99 thru 8-8-01)
    1,500,000       378,000  
CINATRA CLEAN TECHNOLOGIES, INC.
Houston, Texas
Cleans above ground oil storage tanks with a patented, automated system.
    73.4 %   12% subordinated secured promissory note, due 2015 (acquired 5-19-10 thru 10-20-10)     779,278       545,495  
           
12% subordinated secured promissory note, due 2016 (acquired 5-9-11 thru 10-26-11)
    2,285,700       1,599,990  
           
12% subordinated secured promissory note, due 2016 (acquired 9-9-11 and 10-26-11)
    1,264,754       885,328  
           
10% subordinated secured promissory note, due 2016 (acquired 7-14-08 thru 4-28-10)
    6,200,700       4,340,490  
           
3,033,410 shares Series A Convertible Preferred Stock, convertible into 3,033,410 shares common stock at $1.00 per share (acquired 7-14-08 thru 11-18-10)
    3,033,410       1  
           
Warrants to purchase 1,269,833 shares of common stock at $1.00 per share, expiring 2021 (acquired 5-9-11 thru 8-31-11)
           
                  13,563,842       7,371,304  
*†ENCORE WIRE CORPORATION
McKinney, Texas
Electric wire and cable for residential, commercial and industrial construction use.
    16.9 %  
4,086,750 shares common stock (acquired 7-16-92 thru 10-7-98)
    5,800,000       95,016,938  
 
Publicly-owned company   ¥ Control investment   * Affiliated investment Unrestricted securities as defined in Note (b)
 
The accompanying Notes are an integral part of these Consolidated Financial Statements
 
 
CAPITAL SOUTHWEST CORPORATION AND SUBSIDIARIES

CONSOLIDATED SCHEDULE OF INVESTMENTS
(Unaudited)
December 31, 2011
 
Company   Equity (a)    
Investment (b)
  Cost     Value (c)  
EXTREME INTERNATIONAL, INC.
Sugar Land, Texas
Owns Bill Young Productions, Texas Video and Post, and Extreme and television commercials and corporate communications videos.
   
53.6
 
%  
13,035 shares Series A Common Stock (acquired 9-26-08 and 12-18-08)
   
325,875
     
695,000
 
           
39,359.18 shares Series C Convertible Preferred Stock, convertible into 157,437.72 shares of common stock at $25.00 per share (acquired 9-30-03)
   
2,625,000
     
8,388,000
 
           
3,750 shares 8% Series A Convertible Preferred Stock, convertible into 15,000 shares of common stock at $25.00 per share (acquired 9-30-03)
   
375,000
     
799,000
 
                 
3,325,875
     
9,882,000
 
¥†HEELYS, INC.
Carrollton, Texas
Heelys stealth skate shoes, equipment and apparel sold through sporting goods chains, department stores and footwear retailers.
    31.1  %  
9,317,310  shares common stock (acquired 5-26-00)
   
102,490
     
15,261,754
 
HOLOGIC, INC.
Bedford, Massachusetts
Medical instruments including bone densitometers, mammography devices and digital radiography systems.
     1  
‡632,820 shares common stock (acquired 8-27-99)
   
220,000
     
11,074,350
 
iMEMORIES, INC.
Scottsdale, Arizona
Enables online video and photo sharing and DVD creation for home movies recorded in analog and new digital format.
    25.3 %  
17,391,304 shares Series B Convertible Preferred Stock, convertible into 19,891,304 shares of common stock at $0.23 per share (acquired 7-10-09)
   
4,000,000
     
4,000,000
 
           
4,684,967 shares Series C Convertible Preferred Stock, convertible into 4,684,967 shares of common stock at $0.23 per share (acquired 7-20-11)
   
1,078,479
     
1,078,479
 
           
Warrants to purchase 2,500,000  shares of common stock at $0.12 per share, expiring 2020 (acquired 9-13-10 thru 1-21-11)
   
     
 
                 
5,078,479
     
5,078,479
 
INSTAWARES HOLDING COMPANY, LLC
Atlanta, Georgia
Provides services to the    restaurant industry via its five subsidiary companies.
    4.4 %  
3,846,154 Class D shares (acquired 5-20-11)
   
5,000,000
     
5,000,000
 
 
KBI BIOPHARMA, INC.
Durham, North Carolina
Provides fully-integrated, outsourced drug development and bio-manufacturing services.
    17.1 %  
7,142,857 shares Series B-2 Convertible Preferred Stock, convertible into 10,204,082 shares of common stock at $0.49 per share (acquired 9-08-09)
   
5,000,000
     
1,900,000
 
 
Publicly-owned company   ¥ Control investment   * Affiliated investment Unrestricted securities as defined in Note (b)
 
The accompanying Notes are an integral part of these Consolidated Financial Statements
 
 
CAPITAL SOUTHWEST CORPORATION AND SUBSIDIARIES

CONSOLIDATED SCHEDULE OF INVESTMENTS
(Unaudited)
December 31, 2011
 
Company   Equity (a)    
Investment (b)
  Cost     Value (c)  
¥MEDIA RECOVERY, INC.
Dallas, Texas
Computer datacenter and office automation supplies and accessories; impact, tilt monitoring and temperature sensing devices to detect mishandling shipments; dunnage for protecting shipments.
   
97.9
 
%  
800,000 shares Series A Convertible Preferred Stock, convertible into 800,000 shares of common stock at $1.00 per share (acquired 11-4-97)
   
800,000
     
3,100,000
 
           
4,000,002 shares common stock (acquired 11-4-97)
   
4,615,000
     
15,500,000
 
                 
5,415,000
     
18,600,000
 
*PALLETONE, INC.
Bartow, Florida
Manufacturer of wooden pallets and pressure-treated lumber.
    7.7  %  
12.3% senior subordinated notes, $2,000,000 principal due 2015 (acquired  9-25-06)
   
1,553,150
     
2,000,000
 
           
150,000 shares common stock (acquired 10-18-01)
   
150,000
      2  
                 
1,703,150
     
2,000,002
 
¥THE RECTORSEAL CORPORATION
Houston, Texas
Specialty chemicals for plumbing, HVAC, electrical, construction, industrial, oil field and automotive applications; smoke containment systems for building fires; also owns 20% of The Whitmore Manufacturing Company.
    100.0  %   27,907 shares common stock (acquired 1-5-73 and 3-31-73)    
52,600
 
     
153,700,000
 
 
TCI HOLDINGS, INC.
Denver, Colorado
Cable television systems and microwave relay systems.
   
 
    21 shares 12% Series C Cumulative Compounding Preferred Stock (acquired 1-30-90)    
 
     
811,000
 
 
TRAX HOLDINGS, INC.
Scottsdale, Arizona
Provides a comprehensive set of solutions to improve the transportation validation, accounting, payment and information management process.
    26.2  %   18% convertible  promissory note, $3,200,000 principal  due 2012 (acquired 4-6-11 thru 11-10-11)     3,200,000       
3,200,000
 
 
            1,061,279 shares Series A Convertible Preferred Stock, convertible into 1,061,279 common stock at $4.64 per share (acquired 12-8-08 and 2-17-09)    
5,000,000
 
     
5,800,000
 
 
                 
8,200,000
     
9,000,000
 
VIA HOLDINGS, INC.
Sparks, Nevada
Designer, manufacturer and distributor of high-quality office seating.
    3.2  %   12,686 shares common stock (acquired 3-4-11 and 3-25-11)    
4,926,290
 
       
*WELLOGIX, INC.
Houston, Texas
Developer and supporter of software used by the oil and gas industry.
 
    19.1  %   4,788,371 shares Series A-1 Convertible Participating Preferred Stock, convertible into 4,788,371 shares of common stock at $1.0441 per share (acquired 8-19-05 thru 6-15-08)    
5,000,000
 
      25,000   
 
Publicly-owned company   ¥ Control investment   * Affiliated investment Unrestricted securities as defined in Note (b)
 
The accompanying Notes are an integral part of these Consolidated Financial Statements
 
 
CAPITAL SOUTHWEST CORPORATION AND SUBSIDIARIES

CONSOLIDATED SCHEDULE OF INVESTMENTS
(Unaudited)
December 31, 2011
 
Company   Equity (a)    
Investment (b)
  Cost     Value (c)  
¥THE WHITMORE MANUFACTURING COMPANY
Rockwall, Texas
Specialized surface mining, railroad and industrial lubricants; coatings for automobiles and primary metals; fluid contamination control devices.
    80.0 %   80 shares common stock (acquired 8-31-79)    
1,600,000
 
       61,000,000  
MISCELLANEOUS
        Ballast Point Ventures II, L.P.
2.2% limited partnership interest (acquired 8-4-08 thru 6-18-10)
   
1,425,000
 
     
1,252,000
 
 
     
 
    BankCap Partners Fund I, L.P.
5.5% limited partnership interest (acquired 7-14-06 thru 11-30-11)
   
5,808,470
 
     
5,135,000
 
 
     
 
    CapitalSouth Partners Fund III, L.P.
1.9% limited partnership interest (acquired 1-22-08 and 11-16-11)
   
1,331,256
 
     
1,432,000
 
 
      100  %   ¥CapStar Holdings   Corporation
500 shares common stock (acquired 6-10-10)
   
3,703,619
 
     
4,372,000
 
 
     
 
    Diamond State Ventures, L.P.
1.4% limited partnership interest (acquired 10-12-99 thru 8-26-05)
   
76,000
 
     
175,000
 
 
     
 
    ¥Discovery Alliance, LLC
90.0% limited liability company (acquired  9-12-08 thru 10-20-11)
   
1,180,000
 
     
1,242,000
 
 
     
 
    Essex Capital Corporation
10% unsecured promissory note due 8-19-10 (acquired 8-16-09)
   
 
     
500,000
 
 
     
 
    First Capital Group of Texas III, L.P.
3.0% limited partnership interest (acquired 12-26-00 thru 8-12-05)
   
778,895
 
     
750,000
 
 
      100 %   ¥Humac Company
1,041,000 shares common stock (acquired 1-31-75 and 12-31-75)
   
 
     
154,000
 
 
     
 
    STARTech Seed Fund I
12.1% limited partnership interest (acquired 4-17-98 thru 1-5-00)
   
178,066
 
     
40,000
 
 
     
   
STARTech Seed Fund II
3.2% limited partnership interest (acquired 4-28-00 thru 2-23-05)
   
843,891
     
338,000
 
         
Sterling Group Partners I, L.P.
1.7% limited partnership interest (acquired 4-20-01 thru 1-24-05)
   
1,064,042
     
516,000
 
TOTAL INVESTMENTS               $  88,692,822     $ 479,775,353  
 
 
Publicly-owned company   ¥ Control investment   * Affiliated investment Unrestricted securities as defined in Note (b)
 
The accompanying Notes are an integral part of these Consolidated Financial Statements
 
 
CAPITAL SOUTHWEST CORPORATION AND SUBSIDIARIES

CONSOLIDATED SCHEDULE OF INVESTMENTS
 
March 31, 2011
 
Company   Equity (a)    
Investment (b)
  Cost     Value (c)  
¥ALAMO GROUP INC.
Seguin, Texas
Tractor-mounted mowing and mobile excavation equipment for governmental, industrial and agricultural markets; street-sweeping equipment for municipalities.
    22.0 %  
2,830,300 shares common stock (acquired 4-1-73 thru 5-25-07)
  $
2,190,937
    $  62,266,600  
ALL COMPONENTS, INC.
Pflugerville, Texas
Electronics contract manufacturing; distribution and production of memory and other components for computer manufacturers, retailers and value-added resellers.
    80.4    
8.25% subordinate note, $2,000,000 principal due 2012 (acquired 6-27-07)
   
2,000,000
 
     
2,000,000
 
           
150,000 shares Series A Convertible Preferred Stock; convertible into 600,000 shares of common stock at $0.25 per share (acquired 9-16-94)
   
150,000
 
     
8,431,388
 
 
            Warrant to purchase 350,000 shares of common stock at $11.00 per share, expiring 2017 (acquired 6-27-07)    
 
     
3,068,552
 
 
                 
2,150,000
     
13,499,940
 
ATLANTIC CAPITAL BANCSHARES, INC
Atlanta, Georgia
Holding company of Atlantic Capital Bank, a full service commercial bank.
    1.9     300,000 shares common stock (acquired 4-10-07)    
3,000,000
     
2,257,000
 
 
¥BALCO, INC.
Wichita, Kansas
Specialty architectural products used in the construction and remodeling of commercial and institutional buildings.
    90.9     445,000 shares common stock and 60,920 shares Class B non-voting common stock (acquired 10-25-83 and 5-30-02)    
624,920
 
     
5,200,000
 
 
*BOXX TECHNOLOGIES, INC.
Austin, Texas
Workstations for computer graphic imaging and design.
    14.9     3,125,354 shares Series B Convertible Preferred Stock, convertible into 3,125,354 shares of common stock at $0.50 per share (acquired 8-20-99 thru 8-8-01)    
1,500,000
 
      2  
CINATRA CLEAN TECHNOLOGIES, INC.
Houston, Texas
Cleans above ground oil storage tanks with a patented, automated system.
    68.8     12% subordinated secured promissory note, due 2012 (acquired 5-19-10 thru 10-20-10)    
890,604
 
     
890,604
 
 
            10% subordinated secured promissory note, due 2013 (acquired 7-14-08 thru 4-28-10)    
6,200,700
     
6,200,700
 
            3,033,410 shares Series A Convertible Preferred Stock, convertible into 3,033,410 shares common stock at $1.00 per share (acquired 7-14-08 thru 11-18-10)    
3,033,410
 
     
3,033,410
 
 
                 
10,124,714
     
10,124,714
 
 
Publicly-owned company   ¥ Control investment   * Affiliated investment Unrestricted securities as defined in Note (b)
 
The accompanying Notes are an integral part of these Consolidated Financial Statements
 
 
CAPITAL SOUTHWEST CORPORATION AND SUBSIDIARIES

CONSOLIDATED SCHEDULE OF INVESTMENTS
 
March 31, 2011
 
Company   Equity (a)    
Investment (b)
  Cost     Value (c)  
¥ENCORE WIRE CORPORATION
McKinney, Texas
Electric wire and cable for residential, commercial and industrial construction use.
    16.9 %  
4,086,750 shares common stock (acquired 7-16-92 thru 10-7-98)
   
5,800,000
       81,735,000  
EXTREME INTERNATIONAL, INC.
Sugar Land, Texas
Owns Bill Young Productions, Texas Video and Post, and Extreme and television commercials and corporate communications videos.
   
53.6
%  
13,035 shares Series A Common Stock (acquired 9-26-08 and 12-18-08)
   
325,875
 
     
815,000
 
 
           
39,359.18 shares Series C Convertible Preferred Stock, convertible into 157,437.72 shares of common stock at $25.00 per share (acquired 9-30-03)
   
2,625,000
 
     
9,850,000
 
 
            3,750 shares 8% Series A Convertible Preferred Stock, convertible into 15,000 shares of common stock at $25.00 per share (acquired 9-30-03)    
375,000
 
     
938,000
 
 
                 
3,325,875
     
11,603,000
 
¥†HEELYS, INC.
Carrollton, Texas
Heelys stealth skate shoes, equipment and apparel sold through sporting goods chains, department stores and footwear retailers.
    31.6 %   9,317,310  shares common stock (acquired 5-26-00)    
102,490
     
19,193,659
 
HOLOGIC, INC.
Bedford, Massachusetts
Medical instruments including bone densitometers, mammography devices and digital radiography systems.
    < 1 %   ‡632,820 shares common stock (acquired 8-27-99)    
220,000
 
     
14,042,276
 
 
iMEMORIES, INC.
Scottsdale, Arizona
Enables online video and photo sharing and DVD creation for home movies recorded in analog and new digital format.
    27.2 %   10% convertible promissory note, due 2012 (acquired 9-13-10)      1,000,000      
1,000,000
 
 
            17,391,304 shares Series B Convertible Preferred Stock, convertible into 17,391,304 shares of common stock at $0.23 per share (acquired 7-10-09)    
4,000,000
     
4,000,000
 
 
            Warrant to purchase 968,750 shares of common stock at $0.12 per share, expiring 2020 (acquired 9-13-10)    
     
 
 
                 
5,000,000
     
5,000,000
 
KBI BIOPHARMA, INC.
Durham, North Carolina
Provides fully-integrated, outsourced drug development and bio-manufacturing services.
    17.1 %   7,142,857 shares Series B-2 Convertible Preferred Stock, convertible into 10,204,082 shares of common stock at $0.49 per share (acquired 9-08-09)    
5,000,000
     
4,200,000
 
 
Publicly-owned company   ¥ Control investment   * Affiliated investment Unrestricted securities as defined in Note (b)
 
The accompanying Notes are an integral part of these Consolidated Financial Statements
 
 
CAPITAL SOUTHWEST CORPORATION AND SUBSIDIARIES

CONSOLIDATED SCHEDULE OF INVESTMENTS
 
March 31, 2011
 
Company   Equity (a)    
Investment (b)
  Cost     Value (c)  
¥MEDIA RECOVERY, INC.
Dallas, Texas
Computer datacenter and office automation supplies and accessories; impact, tilt monitoring and temperature sensing devices to detect mishandling shipments; dunnage for protecting shipments.
    97.5 %  
800,000 shares Series A Convertible Preferred Stock, convertible into 800,000 shares of common stock at $1.00 per share (acquired 11-4-97)
   
800,000
       3,000,000  
           
4,000,002 shares common stock (acquired 11-4-97)
   
4,615,000
     
15,100,000
 
                 
5,415,000
     
18,100,000
 
*PALLETONE, INC.
Bartow, Florida
Manufacturer of wooden pallets and pressure-treated lumber.
    8.4 %   12.3% senior subordinated notes, $2,000,000 principal due 2015 (acquired  9-25-06)    
1,553,150
 
     
1,600,000
 
 
           
150,000 shares common stock (acquired 10-18-01)
   
150,000
      2  
           
Warrant to purchase 15,294 shares of common stock at $1.00 per share, expiring 2011 (acquired 2-17-06)
   
45,746
     
 
 
               
1,748,896
     
1,600,002
 
¥PALM HARBOR HOMES, INC.
Dallas, Texas
Integrated manufacturing, retailing, financing and insuring of manufactured housing and modular homes.
    30.4 %   7,855,121 shares common stock (acquired 1-3-85 thru 7-31-95)    
10,931,955
      2  
           
Warrant to purchase 286,625 shares of common stock at $3.14 per share, expiring 2019 (acquired 4-24-09)
   
     
 
                 
10,931,955
      2  
PHI HEALTH, INC.
Richardson, Texas
Develops and sells cardiac MRI systems and software.
    67.0 %  
1,559,111 shares Series A-1 Convertible Preferred Stock convertible into 1,559,111 shares of common stock at $0.0015 per share (acquired 1-27-11)
   
2,339
 
     
2,339
 
 
           
555,556 shares Series B-1 Convertible Preferred Stock convertible into 555,556 shares common stock at $2.25 per share (acquired 1-27-11)
   
1,250,000
 
     
1,250,000
 
 
            4,500,000 Shares Series C-1 Convertible Preferred Stock convertible into 4,500,000 shares common stock at $0.20 per share (acquired 1-7-11 and 1-27-11)    
4,500,000
 
     
4,500,000
 
 
                 
5,752,339
     
5,752,339
 
 
Publicly-owned company   ¥ Control investment   * Affiliated investment Unrestricted securities as defined in Note (b)
 
The accompanying Notes are an integral part of these Consolidated Financial Statements
 
 
CAPITAL SOUTHWEST CORPORATION AND SUBSIDIARIES

CONSOLIDATED SCHEDULE OF INVESTMENTS
 
March 31, 2011
 
Company   Equity (a)    
Investment (b)
  Cost     Value (c)  
¥THE RECTORSEAL CORPORATION
Houston, Texas
Specialty chemicals for plumbing, HVAC, electrical, construction, industrial, oil field and automotive applications; smoke containment systems for building fires; also owns 20% of The Whitmore Manufacturing Company.
    100.0 %  
27,907 shares common stock (acquired 1-5-73 and 3-31-73)
   
52,600
        144,700,000  
TCI HOLDINGS, INC.
Denver, Colorado
Cable television systems and microwave relay systems.
   
 
    21 shares 12% Series C Cumulative Compounding Preferred Stock (acquired 1-30-90)    
 
     
840,778
 
 
TEXAS CAPITAL BANCSHARES, INC.
Dallas, Texas
Regional bank holding company with banking operations in six Texas cities.
    1.6     ‡489,656 shares common stock (acquired 5-1-00)    
3,550,006
 
     
12,711,470
 
 
TRAX HOLDINGS, INC.
Scottsdale, Arizona
Provides a comprehensive set of solutions to improve the transportation validation, accounting, payment and information management process.
    30.7     1,061,279 shares Series A Convertible Preferred Stock, convertible into 1,077,203 common stock at $4.64 per share (acquired 12-8-08 and 2-17-09)    
5,000,000
 
     
5,758,030
 
 
VIA HOLDINGS, INC.
Sparks, Nevada
Designer, manufacturer and distributor of high-quality office seating.
    28.1     12,686 shares common stock (acquired 3-4-11 and 3-25-11)    
4,926,290
 
      4  
*WELLOGIX, INC.
Houston, Texas
Developer and supporter of software used by the oil and gas industry.
    19.2     4,788,371 shares Series A-1 Convertible Participating Preferred Stock, convertible into 4,788,371 shares of common stock at $1.0441 per share (acquired 8-19-05 thru 6-15-08)    
5,000,000
 
      2  
¥THE WHITMORE MANUFACTURING COMPANY
Rockwall, Texas
Specialized surface mining, railroad and industrial lubricants; coatings for automobiles and primary metals; fluid contamination control devices.
    80.0     80 shares common stock (acquired 8-31-79)    
1,600,000
 
     
55,600,000
 
 
MISCELLANEOUS
 
 
   
 
   
Ballast Point Ventures II, L.P.
2.2% limited partnership interest (acquired 8-4-08 thru 6-18-10)
   
1,200,000
 
     
1,200,000
 
 
 
Publicly-owned company   ¥ Control investment   * Affiliated investment Unrestricted securities as defined in Note (b)
 
The accompanying Notes are an integral part of these Consolidated Financial Statements
 
 
CAPITAL SOUTHWEST CORPORATION AND SUBSIDIARIES

CONSOLIDATED SCHEDULE OF INVESTMENTS
 
March 31, 2011
 
Company  
Equity (a)
   
Investment (b)
 
Cost
    Value (c)  
MISCELLANEOUS (continued)
   
 
   
BankCap Partners Fund I, L.P.
5.5% limited partnership interest (acquired 7-14-06 thru 12-13-10)
 
   
5,762,270
 
     
5,101,727
 
 
     
 
    CapitalSouth Partners Fund III, L.P.
1.9% limited partnership interest (acquired 1-22-08 and 2-12-09)
   
831,256
 
     
790,000
 
 
     
100.0
    ¥CapStar Holdings Corporation
500 shares common stock (acquired 6-10-10)
   
3,703,619
 
     
4,380,481
 
 
     
 
    Diamond State Ventures, L.P.
1.4% limited partnership interest (acquired 10-12-99 thru 8-26-05)
   
76,000
 
     
177,996
 
 
     
 
    ¥Discovery Alliance, LLC
90.0% limited liability company (acquired  9-12-08 thru 5-14-10)
   
900,000
 
     
574,488
 
 
     
    Essex Capital Corporation
10% unsecured promissory note due 8-19-10 (acquired 8-16-09)
   
 
     
1,000,000
 
 
     
    First Capital Group of Texas III, L.P.
3.0% limited partnership interest (acquired 12-26-00 thru 8-12-05)
   
778,894
 
     
407,731
 
 
     
100.0
    ¥Humac Company
1,041,000 shares common stock (acquired 1-31-75 and 12-31-75)
   
 
     
166,000
 
 
     
 
    STARTech Seed Fund I
12.1% limited partnership interest (acquired 4-17-98 thru 1-5-00)
   
178,066
 
     
52,606
 
 
     
 
    STARTech Seed Fund II
3.2% limited partnership interest (acquired 4-28-00 thru 2-23-05)
   
843,891
 
     
317,392
 
 
     
 
    Sterling Group Partners I, L.P.
1.6% limited partnership interest (acquired 4-20-01 thru 1-24-05)
   
1,064,042
 
     
919,417
 
 
TOTAL INVESTMENTS
              $ 98,354,060     $ 489,272,655  
 
Publicly-owned company   ¥ Control investment   * Affiliated investment Unrestricted securities as defined in Note (b)
 
The accompanying Notes are an integral part of these Consolidated Financial Statements
 
 
Notes to Consolidated Schedule of Investments
 
(a)           Equity

The percentages in the “Equity” column express the potential equity interests held by Capital Southwest Corporation and Capital Southwest Venture Corporation (together, the “Company”) in each issuer.  Each percentage represents the amount of the issuer’s common stock the Company owns or can acquire as a percentage of the issuer’s total outstanding common stock, plus stock reserved for all warrants, convertible securities and employee stock options.

(b)           Investments

Unrestricted securities (indicated by ±) are freely marketable securities having readily available market quotations.  All other securities are restricted securities, which are subject to one or more restrictions on resale and are not freely marketable.  At December 31, 2011, and March 31, 2011, restricted securities represented approximately 97.7% and 94.5% of the value of the consolidated investment portfolio, respectively.

Our investments are carried at fair value in accordance with the Investment Company Act of 1940 (the “1940 Act”) and FASB Accounting Standards Codification™ (ASC) Topic 820, Fair Value Measurements and Disclosures.  In accordance with the 1940 Act, unrestricted minority-owned publicly traded securities, for which the market quotations are readily available, are valued at the closing sale price for the NYSE listed securities and the lower of the closing bid price or the last sale price for NASDAQ securities on the valuation date; and restricted publicly traded securities and other privately held securities are valued as determined in good faith by our Board of Directors.

ASC Topic 820 defines fair value in terms of the price that would be received upon the sale of an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date (the “exit price”) and excludes transaction costs.  Under ASC Topic 820, the fair value measurement also assumes that the transaction to sell an asset occurs in the principal market for the asset or, in the absence of a principal market, the most advantageous market for the asset.  The principal market is the market in which the reporting entity would sell or transfer the asset with the greatest volume and level of activity for the asset.  In determining the principal market for an asset or liability under ASC Topic 820, it is assumed that the reporting entity has access to the market as of the measurement date.

(c)           Value

Debt Securities are generally valued on the basis of the price the security would command in order to provide a yield-to-maturity equivalent to the present yield of comparable debt instruments of similar quality.  Issuers whose debt securities are judged to be of poor quality and doubtful collectability may instead be valued by assigning percentage discounts commensurate with the quality of such debt securities.  Debt securities may also be valued based on the resulting value from the sale of the business at the estimated fair market value.

Partnership Interests, Preferred Equity and Common Equity, including unrestricted marketable securities are valued at the closing sale price for the NYSE listed securities and the lower of the closing bid price or the last sale price for NASDAQ securities on the valuation date, and restricted marketable securities for which there is a public market are valued at the closing sale price for the NYSE listed securities and the lower of the closing bid price or the last sale price for NASDAQ securities on the valuation date adjusted in good faith by our Board of Directors if they deem a discount or premium would be likely or obtainable upon a sale or transfer of our interest.  For those without a principal market, the Board of Directors considers the financial condition and operating results of the issuer; the long-term potential of the business of the issuer; the market for and recent sales prices of the issuer’s securities; the values of similar securities issued by companies in similar businesses; the proportion of the issuer’s securities owned by the Company; protective put analysis based on the Black-Scholes option pricing model; the nature and duration of resale restrictions; and the nature of any rights enabling the Company to require the issuer to register restricted securities under applicable securities laws.  In determining the fair value of restricted securities, the Board of Directors considers the inherent value of such securities without regard to the restrictive feature and adjusts for any diminution in value resulting from restrictions on resale.  Investments in certain entities that calculate net asset value per share (or its equivalent) and for which fair market value is not readily determinable, are valued using the net asset value per share (or its equivalent, such as member units or ownership interest in partners’ capital to which a proportionate share of net assets is attributed) of the investment.
 
 
Equity Warrants are valued using the Black-Scholes model which defines the fair value of a warrant in relation to the market price of its common stock, share price volatility, and time to maturity.

(d)           Agreements Between Certain Issuers and the Company

Agreements between certain issuers and the Company provide that the issuer will bear substantially all costs in connection with the disposition of common stock, including those costs involved in registration under the Securities Act of 1933, but excluding underwriting discounts and commissions.  These agreements cover common stock owned at December 31, 2011 and common stock which may be acquired thereafter through the exercise of warrants and conversion of debentures and preferred stock.  They apply to restricted securities of all issuers in the investment portfolio of the Company except securities of the following issuers which are not obligated to bear registration costs:  Humac Company and The Whitmore Manufacturing Company.

(e)           Descriptions and Ownership Percentages

The descriptions of the companies and ownership percentages shown in the Consolidated Schedule of Investments were obtained from published reports and other sources believed to be reliable.  Acquisition dates indicated are the dates specific securities were acquired, which may differ from the original investment dates.  Certain securities were received in exchange for or upon conversion or exercise of other securities previously acquired.
 
Notes to Consolidated Financial Statements

1. 
ORGANIZATION AND BASIS OF PRESENTATION

Organization

Capital Southwest Corporation (“CSC” or the “Company”) was organized as a Texas corporation on April 19, 1961.  Until September 1969, we operated as a licensee under the Small Business Investment Act of 1958.  At that time, we transferred to our wholly-owned subsidiary, Capital Southwest Venture Corporation ("CSVC") certain assets and our license as a small business investment company ("SBIC").  CSVC is a closed-end, non-diversified investment company of the management type registered under the Investment Company Act of 1940 (the “1940 Act”).  Prior to March 30, 1988, we were registered as a closed-end, non-diversified investment company under the 1940 Act.  On that date, we elected to become a Business Development Company (“BDC”) subject to the provisions of the 1940 Act, as amended by the Small Business Incentive Act of 1980.  Because we wholly own CSVC, the portfolios of both entities are referred to collectively as “our,” “we” and “us.”  Capital Southwest Management Company (“CSMC”), a wholly-owned subsidiary of CSC, is the management company for CSC and CSVC.  CSMC generally incurs all normal operating and administrative expenses, including but not limited to, salaries and related benefits, rent, equipment and other administrative costs required for its day-to-day operations.

Our portfolio is a composite of companies, consisting of companies in which we have controlling interests, developing companies and marketable securities of established publicly traded companies.  We make available significant managerial assistance to the companies in which we invest and believe that providing managerial assistance to such investee companies is critical to their business development activities.  CSMC receives a monthly fixed fee for management services provided to certain of its control portfolio companies.

Basis of Presentation

The consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America (GAAP).  Under rules and regulations applicable to investment companies, we are precluded from consolidating any entity other than another investment company.  An exception to this general principle occurs if the investment company has an investment in an operating company that provides services to the investment company.  Accordingly, consolidated financial statements include our management company.

The financial statements included herein have been prepared in accordance with GAAP for interim financial information and the instructions to Form 10-Q and Article 6 of Regulations S-X.  The financial statements should be read in conjunction with the consolidated financial statements and notes thereto included in our Form 10-K for the year ended March 31, 2011, as filed with the Securities and Exchange Commission (SEC).  Certain information and footnotes normally included in financial statements prepared in accordance with GAAP have been condensed or omitted, although we believe that the disclosures are adequate for a fair presentation.  The information reflects all adjustments (consisting of normal recurring adjustments) which are, in the opinion of management, necessary for a fair presentation of the results of operations for the interim period.


Portfolio Investment Classification

We classify our investments in accordance with the requirements of the 1940 Act.  Under the 1940 Act, “Control Investments” are defined as investments in which we own more than 25% of the voting securities or have rights to maintain greater than 50% of the board representation; “Affiliated Investments” are defined as investments in which we own between 5% and 25% of the voting securities; and “Non-Control/Non-Affiliated Investments” are defined as investments that are neither “Control Investments” nor “Affiliated Investments.”

2. 
SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

The following is a summary of significant accounting policies followed in the preparation of the consolidated financial statements of CSC, CSVC and CSMC.

Fair Value Measurements The Company adopted FASB ASC Topic 820 on April 1, 2008.  ASC Topic 820 (1) creates a single definition of fair value, (2) establishes a framework for measuring fair value, and (3) expands disclosure requirements about items measured at fair value.  The Statement applies to both items recognized and reported at fair value in the financial statements and items disclosed at fair value in the notes to the financial statements.  The Statement does not change existing accounting rules governing what can or what must be recognized and reported at fair value in the Company’s financial statements, or disclosed at fair value in the Company’s notes to the financial statements.  Additionally, ASC Topic 820 does not eliminate practicability exceptions that exist in accounting pronouncements amended by this Statement when measuring fair value.

Fair value is generally determined based on quoted market prices in the active markets for identical assets or liabilities.  If quoted market prices are not available, we use valuation techniques that place greater reliance on observable inputs and less reliance on unobservable inputs.  Due to the inherent uncertainty in the valuation process, our estimate of fair value may differ materially from the values that would have been used had a ready market for the securities existed.  In addition, changes in the market environment, portfolio company performance and other events may occur over the lives of the investments that may cause the gains or losses ultimately realized on these investments to be materially different than the valuations currently assigned.  We determine the fair value of each individual investment and record changes in fair value as unrealized appreciation or depreciation.

Pursuant to our internal valuation process, each portfolio company is valued once a quarter.  In addition to our internal valuation process, our Board of Directors retains a nationally recognized firm to provide limited scope third party valuation services on certain portfolio investments.  Our Board of Directors retained Duff & Phelps to provide limited scope third party valuation services on six investments comprising 78% of our net asset value at March 31, 2011.  For full disclosure of Duff & Phelps’ services, see page 5 of our Annual Report on Form 10-K under the heading “Determination of Net Asset Value and Portfolio Valuation Process.”

We believe our investments at December 31, 2011 and March 31, 2011 approximate fair value as of those dates based on the markets in which we operate and other conditions in existence at those reporting periods.

Investments  Investments are stated at fair value determined by our Board of Directors as described in Notes to the Consolidated Schedule of Investments and Note 3.  The average cost method is used in determining cost of investments sold.  Investments are recorded on a trade date basis.
 
 
Cash and Cash Equivalents  Cash and cash equivalents consist of highly liquid investments with an original maturity of three months or less at the date of purchase.  Cash and cash equivalents are carried at cost, which approximates fair value.

Segment Information  The Company operates and manages its business in a singular segment.  As an investment company, the Company invests in companies in various industries and geographic areas as presented in the Consolidated Schedule of Investments.

Use of Estimates  The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect amounts reported in the financial statements and accompanying notes.  Actual results could differ from those estimates.

Interest and Dividend Income  Interest and dividend income is recorded on an accrual basis to the extent amounts are expected to be collected.  Dividend income is recorded at the ex-dividend date for securities of publicly traded companies.  In accordance with our valuation policy, accrued interest and dividend income is evaluated periodically for collectability.  When a debt or loan becomes 90 days or more past due, and if we otherwise do not expect the debtor to be able to service all of its debt or other obligations, we will generally establish a reserve against the interest income, thereby placing the loan or debt security’s status on non-accrual basis, and cease to recognize interest income on that loan or debt security until the borrower has demonstrated the ability and intent to pay contractual amounts due.  If a loan or debt security’s status significantly improves regarding ability to service debt or other obligations, it will be restored to accrual basis.

Federal Income Taxes  CSC and CSVC have elected and intend to comply with the requirements of the Internal Revenue Code (IRC) necessary to qualify as regulated investment companies (RICs).  By meeting these requirements, they will not be subject to corporate federal income taxes on ordinary income distributed to shareholders.  In order to comply as a RIC, each company is required to timely distribute to its shareholders at least 90% of investment taxable income, as defined by the IRC, each year.  Taxable income generally differs from net income for financial reporting purposes due to temporary and permanent differences in the recognition of income and expenses.  Taxable income generally excludes net unrealized appreciation or depreciation, as investment gains and losses are not included in taxable income until they are realized.  The Company’s policy is to retain and pay the applicable corporate tax on realized long-term capital gains.  For investment companies that qualify as RICs under the IRC, federal income taxes payable on security gains that the Company elects to retain are accrued only on the last day of our tax year, December 31.  See Note 4 for further discussion.

CSMC, a wholly owned subsidiary of CSC, is not a RIC and is required to pay taxes at the current corporate rate.

We account for interest and penalties as part of operating expenses.  There were no interest or penalties incurred during the nine months ended December 31, 2011 and 2010.

Deferred Taxes  CSMC sponsors a qualified defined benefit pension plan which covers its employees and employees of certain of its controlled affiliates.  Deferred taxes related to the qualified defined benefit pension plan are recorded as incurred.

Stock-Based Compensation      We account for our stock-based compensation using the fair value method, as prescribed by ASC 718, Compensation – Stock Compensation.  Accordingly, we recognize stock-based compensation cost over the straight-line method for all share-based payments granted and for all awards granted to employees prior to April 1, 2006 that remain unvested.  The fair value of stock options is determined on the date of grant using the Black-Scholes pricing model and is expensed over the vesting period of the related stock options.  See Note 6 for further discussion.

 
Defined Pension Benefits and Other Postretirement Plans  We record annual amounts relating to the defined benefit pension plan based on calculations, which include various actuarial assumptions such as discount rates and assumed rates of return depending on the pension plan.  Material changes in pension costs may occur in the future due to changes in the discount rate, changes in the expected long-term rate of return, changes in level of contributions to the plans and other factors.  The funded status is the difference between the fair value of plan assets and the benefit obligation.  We recognize changes in the funded status of defined benefit plan in the Statement of Assets and Liabilities in the year in which the changes occur and measure defined benefit plan assets and obligations as of the date of the company's fiscal year-end.  We presently use March 31 as the measurement date for our defined benefit plan.

Concentration of Risk  We place our idle cash in financial institutions, and at times, such balances may be in excess of the federally insured limits.  On 11/19/2010, the FDIC issued a Final Rule implementing section 434 of the Dodd-Frank Wall Street Reform and Consumer Protection Act that provides for unlimited insurance coverage of noninterest bearing transaction accounts beginning December 31, 2010 and continuing through December 31, 2012.

Recent Accounting Pronouncements

In May 2011, the FASB issued ASU 2011-04 “Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and IFRSs,” which results in common fair value measurement and disclosure requirements in U.S. GAAP and IFRSs.  ASU 2011-04 results in common fair value measurement and disclosure requirements in U.S. GAAP and IFRSs. ASU 2011-04 is effective for interim and annual reporting periods beginning after December 15, 2011.  Adoption of ASU 2011-04 is not expected to have a significant impact on the company’s financial condition and results of operations.

3.             INVESTMENTS

We record our investments at fair value as determined in good faith by our Board of Directors in accordance with GAAP.  When available, we base the fair value of our investments on directly observable market prices or on market data derived for comparable assets.  For all other investments, inputs used to measure fair value reflect management’s best estimate of assumptions that would be used by market participants in pricing the investments in a hypothetical transaction.

The levels of fair value inputs used to measure our investments are characterized in accordance with the fair value hierarchy established by ASC.  We use judgment and consider factors specific to the investment in determining the significance of an input to a fair value measurement.  While management believes our valuation methodologies are appropriate and consistent with market participants, the use of different methodologies or assumptions to determine the fair value of certain financial instruments could result in a different estimate of fair value at the reporting date.  The three levels of the fair value hierarchy and investments that fall into each of the levels are described below:

 
·
Level 1:  Investments whose values are based on unadjusted quoted prices in active markets for identical assets or liabilities that the Company has the ability to access.  We use Level 1 inputs for publicly traded unrestricted securities.  Such investments are valued at the closing price for listed securities and at the lower of the closing bid price or the closing sale price for over-the-counter (NASDAQ) securities on the valuation date.
 
 
 
· 
Level 2: Investments whose values are based on observable inputs other than quoted prices included in Level 1 that are observable for the asset or liability, either directly or indirectly.  These inputs may include quoted prices for the identical instrument in non-active markets, quoted prices for similar instruments in active markets and similar data.  We did not value any of our investments using Level 2 inputs as of December 31, 2011 and 2010.

 
· 
Level 3: Investments whose values are based on prices or valuation techniques that require inputs that are both unobservable and significant to the overall fair value measurement.  These inputs reflect management’s own assumptions about the assumptions a market participant would use in pricing the investment.  We use Level 3 inputs for measuring the fair value of substantially all of our investments.  See “Notes to Consolidated Schedule of Investments” (c) on page 18 for the investment policy used to determine the fair value of these investments.

As required by ASC 820, when the inputs used to measure fair value fall within different levels of the hierarchy, the level within the fair value measurement is categorized based on the lowest level input that is significant to the fair value measurement which may include inputs that are observable (Levels 1 and 2) and unobservable (Level 3).  Therefore, gains and losses for such investments categorized within the Level 3 table below may include changes in fair value that are attributable to both observable inputs (Levels 1 and 2) and unobservable (Level 3).  We conduct reviews of fair value hierarchy classifications on a quarterly basis.  Changes in the observability of valuation inputs may result in a reclassification of certain investments.

As of December 31, 2011 and March 31, 2011, 97.7% and 94.5%, respectively, of our portfolio investments were categorized as Level 3.
 
The following fair value hierarchy tables set forth our investment portfolio by level as of December 31, 2011 and March 31, 2011 (in millions):
 
         
Fair Value Measurements
at 12/31/11 Using
 
Asset Category
 
Total
   
Quoted
Prices in
Active
Markets for
Identical
Assets
(Level 1)
   
Significant
Other
Observable
Inputs
(Level 2)
   
Significant
Unobservable
Inputs
(Level 3)
 
Debt
  $ 13.0     $     $     $ 13.0  
Partnership Interests
    10.9                   10.9  
Preferred Equity
    31.3                   31.3  
Common Equity
    424.6       11.1             413.5  
Total Investments
  $ 479.8     $ 11.1     $     $ 468.7  
 
         
Fair Value Measurements
at 3/31/11 Using
 
Asset Category
 
Total
   
Quoted
Prices in
Active
Markets for
Identical
Assets
(Level 1)
   
Significant
Other
Observable
Inputs
(Level 2)
   
Significant
Unobservable
Inputs
(Level 3)
 
Debt
  $ 12.7     $     $     $ 12.7  
Partnership Interests
    9.5                   9.5  
Preferred Equity
    45.8                   45.8  
Common Equity
    421.3       26.8             394.5  
Total Investments
  $ 489.3     $ 26.8     $     $ 462.5  

The following table provides a summary of changes in the fair value of investments measured using Level 3 inputs during the nine months ended December 31, 2011 (in millions):

   
Fair
Value
3/31/11
   
Net
Unrealized
Appreciation
(Depreciation)
   
Net
Changes
from
Unrealized
to Realized
   
New /
Add-On
Invest-
ments
   
Divesti-
tures
   
Fair
Value
12/31/11
 
Debt
  $ 12.7     $ (3.3 )   $ (2.0 )   $ 6.6     $ (1.0 )   $ 13.0  
Partnership Interest
    9.5       0.3             1.1             10.9  
Preferred Equity
    45.8       (14.7 )           6.3       (6.1 )     31.3  
Common Equity
    394.5       19.0                         413.5  
Total Investments
  $ 462.5     $ 1.3     $ (2.0 )   $ 14.0     $ (7.1 )   $ 468.7  
 
The following table provides a summary of changes in the fair value of investments measured using Level 3 inputs during the quarter ended December 31, 2011 (in millions):

   
Fair Value 9/30/11
   
Net
Unrealized
Appreciation
(Depreciation)
   
Net
Changes
from
Unrealized
to Realized
   
New /
Add-On
Invest-
ments
   
Divesti-
tures
   
Fair
Value
12/31/11
 
Debt
  $ 15.3     $ (3.2 )   $     $ 0.9     $     $ 13.0  
Partnership Interest
    9.9       0.3             0.7             10.9  
Preferred Equity
    31.8       (0.5 )                       31.3  
Common Equity
    366.1       47.4                         413.5  
Total Investments
  $ 423.1     $ 44.0     $     $ 1.6     $     $ 468.7  

The total unrealized gains (losses) included in earnings that related to assets still held at report date for the nine months ended December 31, 2011 and 2010 were $10,243,394 and $45,944,129, respectively.

4.             INCOME TAXES

We operate to qualify as a RIC under Subchapter M of the IRC.  In order to qualify as a RIC, we must annually distribute at least 90% of our taxable ordinary income, based on our tax year, to our shareholders in a timely manner.  Ordinary income includes net short-term capital gains but excludes net long-term capital gains.  A RIC is not subject to federal income tax on the portion of its ordinary income and long-term capital gains that are distributed to its shareholders, including “deemed distributions” discussed below.  As permitted by the Code, a RIC can designate dividends paid in the subsequent tax year as dividends of current year ordinary income and net long-term gains if those dividends are both declared by the extended due date of the RIC’s federal income tax return and paid to shareholders by the last day of the subsequent tax year.  We have a calendar tax year end of December 31.

We have distributed or intend to distribute sufficient dividends to eliminate taxable income for our completed tax years.  If we fail to satisfy the 90% distribution requirement or otherwise fail to qualify as a RIC in any tax year, we would be subject to tax in such year on all of our taxable income, regardless of whether we made any distributions to our shareholders.  For the tax year ended December 31, 2011 and 2010, we declared and paid ordinary dividends in the amount of $3,003,030 and $2,993,623, respectively.

Additionally, we are subject to a nondeductible federal excise tax of 4% if we do not distribute at least 98% of our investment company ordinary taxable income before the end of our tax year.  For the tax years ended December 31, 2010 and 2009, we distributed 100% of our investment company ordinary taxable income.  As a result, we have made no tax provisions for income taxes on ordinary taxable income for the tax years ended December 31, 2011 and 2010.

A RIC may elect to retain its long-term capital gains by designating them as “deemed distribution” to its shareholders and paying a federal tax rate of 35% on the long-term capital gains for the benefit of its shareholders.  Shareholders then report their share of the retained capital gains on their income tax returns as if it had been received and report a tax credit for tax paid on their behalf by the RIC.  Shareholders then add the amount of the “deemed distribution” net of such tax, to the basis of their shares.
 

 
·
For the tax year ended December 31, 2011, we had net long-term capital gains of $3,568,376 for tax purposes and $4,465,088 for book purposes, which we elected to retain and treat as deemed distributions to our shareholders.  In order to make the election to retain capital gains, we incurred federal taxes on behalf of our shareholders in the amount of $1,248,932 for the tax year ended December 31, 2011.

 
·
For the tax year ended December 31, 2010, we had net long-term capital gains of $70,221,589 for tax purposes and $70,325,930 for book purposes, which we elected to retain and treat as deemed distributions to our shareholders.  During the quarter ended December 31, 2010 we recorded a $4,217,985 reduction in the gain on sale of Lifemark Group, Inc.  This reduction was the result of a net asset adjustment calculated in accordance with the Stock Purchase Agreement signed on June 10, 2010. In order to make the election to retain capital gains, we incurred federal taxes on behalf of our shareholders in the amount of $24,577,557 for the tax year ended December 31, 2010.

For the quarters ended December 31, 2011 and 2010, CSC and CSVC qualified to be taxed as RICs.  We intend to meet the applicable qualifications to be taxed as a RIC in future years.  Management feels it is probable that we will maintain our RIC status for a period longer than one year.  However, either company’s ability to meet certain portfolio diversification requirements of RICs in future years may not be controllable by such company.

CSMC, a wholly owned subsidiary of CSC, is not a RIC and is required to pay taxes at the current corporate rate.  The Company sponsors a qualified defined benefit pension plan which covers its employees and employees of certain of its wholly owned portfolio companies.  Deferred taxes related to the qualified defined pension plan are recorded as incurred.

5.             ACCUMULATED NET REALIZED GAIN (LOSS)

Distributions made by RICs often differ from aggregate GAAP-basis undistributed net investment income and accumulated net realized gains (total GAAP-basis net realized gains).  The principal cause is that required minimum fund distributions are based on income and gain amounts determined in accordance with federal income tax regulations, rather than GAAP.  The differences created can be temporary, meaning that they will reverse in the future, or they can be permanent.  In subsequent periods, when all or a portion of a temporary difference becomes a permanent difference, the amount of the permanent difference will be reclassified to “additional capital.”

We incur federal taxes on behalf of our shareholders as a result of our election to retain long-term capital gains.  As of December 31, 2011 we had accumulated long-term capital gains of $11,328,436; however, as of March 31, 2011 we had accumulated long-term capital losses of $6,863,347. In accordance with the RIC rules, we elected to retain our long-term capital gains for the tax year ended December 31, 2011, pay the applicable income taxes of $1,248,932, and designate the after-tax gain as deemed distributions to our shareholders. Deemed distributions” are reclassed from accumulated net realized gains into additional paid in capital. As of December 31, 2011, we reclassed $3,216,159 as deemed distributions.


6.             EMPLOYEE STOCK OPTION PLANS

On July 20, 2009, shareholders approved the Company’s 2009 Stock Incentive Plan (the “2009 Plan”), which provides for the granting of stock options to employees and officers of the Company and authorizes the issuance of common stock upon exercise of such options for up to 140,000 shares.  All options are granted at or above market price, generally expire up to ten years from the date of grant and are generally exercisable on or after the first anniversary of the date of grant in five annual installments.  The following table illustrates the number of options granted since the 2009 Plan was approved:

Date of Grant
 
Number of
Options Granted
   
Exercise Price (market
price at time of grant)
 
July 18, 2011
    10,000     $ 96.92  
July 19, 2010
    15,000     $ 88.20  
March 22, 2010
    20,000     $ 95.79  
October 19, 2009
    38,750     $ 76.74  

All 83,750 options remain outstanding, thus leaving 56,250 options available for grant under the plan as of December 31, 2011.

The Company previously granted stock options under its 1999 Stock Option Plan (the “1999 Plan”), as approved by shareholders on July 19, 1999.  The 1999 Plan expired on April 19, 2009.  Options previously made under the Company’s 1999 Stock Option Plan and outstanding on July 20, 2009 continue in effect governed by provisions of the 1999 plan.  All options granted under the 1999 Plan were granted at or above market price, generally expire up to ten years from the date of grant and are generally exercisable on or after the first anniversary of the date of grant in five to ten annual installments.

We recognize compensation cost over the straight-line method for all share-based payments granted and for all awards granted to employees prior to April 1, 2006 that remain unvested.  The fair value of stock options are determined on the date of grant using the Black-Scholes pricing model and are expensed over the vesting period of the related stock options.  Accordingly, for the quarters ended December 31, 2011 and 2010, we recognized compensation expense of $253,350 and $244,650 respectively. For the nine months ended December 31, 2011 and 2010, we recognized compensation expense of $756,573 and $712,517, respectively.

As of December 31, 2011, the total remaining unrecognized compensation cost related to non-vested stock options was $2,367,156, which will be amortized over the remaining weighted average service period of approximately 2.7 years.
 
The following table summarizes the 2009 Plan and the 1999 Plan price per option at grant date using the Black-Scholes pricing model:

         
Black-Scholes Pricing Model Assumptions
       
Date of Issuance
 
Weighted
Average
Fair
Value
   
Expected
Dividend
Yield
   
Risk-
Free
Interest
Rate
   
Expected
Volatility
   
Expected
Life 
(in years)
 
2009 Plan
                             
July 18,2011
  $ 33.07       0.83 %     1.45 %     40.0 %     5  
July 19, 2010
  $ 28.59       0.91 %     1.73 %     37.5 %     5  
March 22, 2010
  $ 32.56       0.84 %     2.43 %     37.8 %     5  
October 19, 2009
  $ 25.36       1.04 %     2.36 %     37.6 %     5  
                                         
1999 Plan
                                       
July 30, 2008
  $ 29.93       0.62 %     3.36 %     20.2 %     5  
July 21, 2008
  $ 27.35       0.67 %     3.41 %     20.2 %     5  
July 16, 2007
  $ 41.78       0.39 %     4.95 %     19.9 %     5  
July 17, 2006
  $ 33.05       0.61 %     5.04 %     21.2 %     7  
May 15, 2006
  $ 31.28       0.64 %     5.08 %     21.1 %     7  

The following table summarizes activity in the 2009 Plan and the 1999 Plan as of December 31, 2011:

   
Number of
Shares
   
Weighted
Average
Exercise Price
 
2009 Plan
           
Balance at March 31, 2010
    58,750     $ 83.23  
Granted
    15,000       88.20  
Exercised
           
Canceled
           
Balance at March 31, 2011
    73,750     $ 84.24  
Granted
    10,000       96.92  
Exercised
           
Canceled
           
Balance at December 31, 2011
    83,750     $ 85.75  
                 
1999 Plan
               
Balance at March 31, 2010
    107,900     $ 114.78  
Granted
           
Exercised
    (11,400 )     65.37  
Canceled
           
Balance at March 31, 2011
    96,500     $ 114.78  
Granted
           
Exercised
    (1,500 )     65.70  
Canceled
           
Balance at December 31, 2011
    95,000     $ 113.63  
Combined Balance at December 31, 2011
    178,750     $ 104.74  

December 31, 2011
Weighted Average Aggregate
Intrinsic Remaining Contractual Term
   
Value
 
Outstanding
2.7 years
    $ 5,382,148  
Exercisable
2.3 years
    $ 2,601,171  

 
At December 31, 2011, the range of exercise prices and weighted-average remaining contractual life of outstanding options was $76.74 to $152.98 and 2.7 years, respectively.  The number of options exercisable under the 2009 Plan and the 1999 Plan, at December 31, 2011, was 83,590 with a weighted-average exercise price of $113.04.  There were 1,500 options exercised and new shares-issued for $98,550 in cash during the nine months ended December 31, 2011 and 782 options exercised and new shares issued for $51,377 in cash during the nine months ended December 31, 2010.

7.             COMMITMENTS

From time to time the Company may be liable for claims against its portfolio companies.  We do not believe the effects of such claims would have a material impact on our results of operations and financial condition.

CSC has agreed, subject to certain conditions, to invest up to $9,658,215 in nine portfolio companies.

8.             SUMMARY OF PER SHARE INFORMATION

The following presents a summary of per share data for the nine and three months ended December 31, 2011 and 2010.

   
Three Months Ended
December 31,
   
Nine Months Ended
December 31,
 
Per Share Data
 
2011
   
2010
   
2011
   
2010
 
Investment income
  $ 1.50     $ .63     $ 2.15     $ 1.73  
Operating expenses
    (.32 )     (.29 )     (.96 )     (.84 )
Income taxes
    (.01 )     (.01 )     (.01 )     (.02 )
Net investment income
    1.17       .33       1.18       .87  
Distributions from undistributed net investment income
    (.40 )     (.40 )     (.80 )     (.80 )
Net realized gain  net of tax
    (.64 )     (7.67 )     2.68       12.19  
Net increase (decrease) in unrealized appreciation of investments
    13.00       5.82       .04       (5.47 )
Exercise of employee stock options
          (.19 )     (.03 )     (.20 )
Stock option expense
    .07       .06       .20       .19  
Increase (decrease) in net asset value
    13.20       (2.05 )     3.27       6.78  
Net asset value
                               
Beginning of period
    133.75       138.99       143.68       130.14  
End of period
  $ 146.95     $ 136.92     $ 146.95     $ 136.92  

 
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 this Annual Report on 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, 2011, filed with the SEC on June 10, 2011.  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 the Annual Report on Form 10-K for the year ended March 31, 2011.  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.

  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 the Company's 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. 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 nine months ended December 31, 2011, total investment income was $8,078,208, a $1,585,950, or 24%, increase from the $6,492,258 total investment income for the nine months ended December 31, 2010.  This comparable period increase was primarily attributable to a $1,288,050 or 27% increase in dividend income and partially offset by a $(68,500) or 14% decrease in management fees.

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 nine months ended December 31, 2011 and 2010, respectively the Company also had interest income of $35,421 and $45,862 from temporary cash investments.

 
The Company also receives management fees primarily from its controlled affiliates which aggregated $420,100 and $488,600 for the nine months ended December 31, 2011 and 2010, respectively.

During the nine months ended December 31, 2011 and 2010, the Company recorded dividend income from the following sources:

   
Nine Months Ended
December 31,
 
   
2011
   
2010
 
Alamo Group, Inc.
  $ 509,694     $ 509,454  
Balco, Inc.
          1,817,503  
CapitalSouth Partners Fund III
    79,459        
Encore Wire Corporation
    245,205       245,205  
The RectorSeal Corporation
    4,202,512       1,781,828  
TCI Holdings, Inc.
    60,953       60,953  
The Whitmore Manufacturing Company
    1,050,628       445,457  
    $ 6,148,451     $ 4,860,400  

Due to the nature of its business, the majority of the Company’s operating expenses are related to employee and director compensation, office expenses, legal, professional and accounting fees and the net pension benefit.  Total operating expenses, increased by $435,225 or 14% during the nine months ended December 31, 2011 and 2010.  The increase in 2011 is due primarily to higher salaries and bonuses paid, higher non-cash stock option expense, as well as increases in professional fees related to divestitures.

Net Realized Gain (Loss) on Investments

During the nine months ended December 31, 2011, we sold all of our shares of preferred stock (Series A, Series B and Series C) in Phi Health, Inc, generating net cash proceeds of $38,959 and a realized loss of $5,910,655; we sold all of our shares of Series A convertible preferred stock, along with warrants to purchase additional shares of common stock of All Components, Inc. in a management buy-out generating cash proceeds of $18,000,000 and a realized gain of $17,850,000; we received $500,000 in cash proceeds from Essex Capital Corporation as settlement for an unsecured promissory note generating a gain of $500,000, which was the by-product of an option exercise agreement; we sold all of our shares of common stock of Texas Capital BancShares, Inc., generating net cash proceeds of $13,416,341 and a realized gain of $9,866,335; we sold our warrants in PalletOne, Inc. generating cash proceeds of $459 and a realized loss of $45,287; and we recognized a loss of $10,820,624 when Palm Harbor Homes, Inc. was officially declared bankrupt.  In total, we recognized net realized gains of $11,328,436 for the nine months ended December 31, 2011.

During the nine months ended December 31, 2010, we sold all of our shares of common stock of Lifemark Group to NorthStar Memorial Group LLC resulting in net cash proceeds of $74,822,145 and $3,703,619 of real estate and assets, which were directly transferred to CapStar Holdings Corporation, our controlled affiliate created to hold assets transferred from Lifemark Group at time of sale. Transfer taxes in the amount of $1,218,855 related to the transfer of real estate were deducted from the realized gain on the Lifemark transaction. As a result of this transaction we recognized net realized gains on investments of $74,015,364 before taxes.
 
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 nine months ended December 31, 2011, we recognized a $163,937 increase in net change in unrealized appreciation of investments.  Total unrealized gains included in earnings that related to assets still held at report date was $10,243,394.  The largest increases in unrealized appreciation are attributable to Encore Wire Corporation, which increased $13,281,938, which is a reflection of an increase in its stock price; as well as The RectorSeal Corporation, which increased $9,000,000 and The Whitmore Manufacturing Company, which increased $5,400,000 attributable to increases in its respective earnings. Offsetting these increases were Heelys, Inc., which decreased $3,931,905 due to a decrease in its stock price, along with Cinatra Clean Technologies, Inc., which decreased $6,192,538 due to slowdowns in its business segment.

Set forth in the following table are the significant increases and decreases in unrealized appreciation by portfolio company:
 
     
Three Months Ended
December 31,
     
Nine Months Ended
December 31,
 
     
2011
     
2010
     
2011
     
2010
 
Alamo Group, Inc.
  $ 14,161,500     $ 11,604,230     $ (664,075 )   $ 16,557,255  
Balco, Inc.
    (300,000 )     (700,000 )     (1,100,000 )     (2,700,000 )
Cinatra Clean Technologies, Inc.
    (3,598,835 )           (6,192,538 )     2,185,065  
Encore Wire Corporation
    19,412,063       15,325,313       13,281,938       15,325,313  
Heelys, Inc.
    (1,677,116 )     2,142,981       (3,931,905 )     2,422,501  
KBI Biopharma, Inc.
    300,000             (2,300,000 )      
Media Recovery, Inc.
    2,200,000       2,900,000       500,000       5,600,000  
The RectorSeal Corporation
    12,400,000       (5,100,000 )     9,000,000       12,800,000  
The Whitmore Manufacturing Company
    1,400,000       2,400,000       5,400,000       4,300,000  

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, 2011 and March 31, 2011.”

Portfolio Investments

During the quarter ended December 31, 2011, we made investments of $1,577,150 in existing portfolio companies.

We have agreed, subject to certain conditions, to invest up to $9,658,215 in nine portfolio companies.

Financial Liquidity and Capital Resources

At December 31, 2011, the Company had cash and cash equivalents of approximately $63.2 million.  Pursuant to the SBA regulations, cash and cash equivalents of $5.6 million held by CSVC may not be transferred or advanced to CSC without the consent of 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.

 
Application of Critical Accounting Policies and Accounting Estimates

There have been no changes during the quarter ended December 31, 2011 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, 2011.

Item 3.
Quantitative and Qualitative Disclosures About Market Risk

We are subject to financial market risks, including changes in marketable equity security prices.  We do not use derivative financial instruments to mitigate any of these risks.

Our investment performance is a function of our portfolio companies’ profitability, which may be affected by economic cycles, competitive forces, foreign currency fluctuations and production costs including labor rates, raw material prices and certain basic commodity prices.  Most of the companies in our investment portfolio do not hedge their exposure to raw material and commodity price fluctuations.  However, the portfolio company with the greatest exposure to foreign currency fluctuations generally hedges its exposure.  All of these factors may have an adverse effect on the value of our investments and on our net asset value.

Our investment in portfolio securities includes fixed-rate debt securities which totaled $13,071,303 at December 31, 2011, equivalent to 2.7% of the value of our total investments.  Generally, these debt securities are below investment grade and have relatively high fixed rates of interest; therefore, minor changes in market yields of publicly traded debt securities have little or no effect on the values of debt securities in our portfolio and no effect on interest income.  Our investments in debt securities are generally held to maturity and their fair values are determined on the basis of the terms of the debt security and the financial condition of the issuer.

A portion of our investment portfolio consists of debt and equity securities of private companies.  We anticipate little or no effect on the values of these investments from modest changes in public market equity valuations.  Should significant changes in market valuations of comparable publicly traded companies occur, there may be a corresponding effect on valuations of private companies, which would affect the value and the amount and timing of proceeds eventually realized from these investments.  A portion of our investment portfolio also consists of restricted common stocks of publicly traded companies.  The fair values of these restricted securities are influenced by the nature of applicable resale restrictions, the underlying earnings and financial condition of the issuers of such restricted securities and the market valuations of comparable publicly traded companies.  A portion of our investment portfolio also consists of unrestricted, freely marketable common stocks of publicly traded companies.  These freely marketable investments, which are valued at the public market price, are directly exposed to equity price risks; in that a change in an issuer’s public market equity price would result in an identical change in the value of our investment in such security.


Item 4.
Controls and Procedures

As of the end of the period covered by this report, an evaluation was performed under the supervision and with the participation of our management, including the Chairman of the Board and President, and Chief Financial Officer, of the effectiveness of the design and operation of our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) of the Securities Exchange Act of 1934).  Based upon this evaluation, our Chairman of the Board and President, and Chief Financial Officer concluded that our disclosure controls and procedures are effective to ensure that the information required to be disclosed is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission’s rules and forms, and is accumulated and communicated to management, including the Chairman of the Board and President, and Chief Financial Officer, as appropriate, to allow timely decisions regarding such required disclosure.

During the fiscal quarter ended December 31, 2011, there were no changes to the internal controls over financial reporting that have materially affected, or are reasonably likely to materially affect our internal control over financial reporting.

PART II. – OTHER INFORMATION

Item 1.

We may, from time to time, be involved in litigation arising out of our operations in the normal course of business or otherwise.  Furthermore, third parties may try to seek to impose liability on us in connection with the activities of our portfolio companies.  We have no current pending legal proceedings to which we are party or to which any of our assets is subject.

Item 1A.

There have been no material changes to our risk factors disclosed in Item 1A. “Risk Factors”, in our Annual Report on Form 10-K for the fiscal year ended March 31, 2011.

Item 6.
Exhibits

Exhibit No.
Description
Certification of Chairman of the Board and President required by Rule 13a-14(a) or Rule 15d-14(a) of the Securities Exchange Act of 1934, as amended (the “Exchange Act”), filed herewith.
Certification of Chief Financial Officer required by Rule 13a-14(a) or Rule 15d-14(a) of the Exchange Act, filed herewith.
Certification of Chairman of the Board and President required by Rule 13a-14(b) or Rule 15d-14(b) of the Exchange Act and Section 1350 of Chapter 63 of Title 18 of the United States Code, furnished herewith.
Certification of Chief Financial Officer required by Rule 13a-14(b) or Rule 15d-14(b) of the Exchange Act and Section 1350 of Chapter 63 of Title 18 of the United States Code, furnished herewith.
101.INS
XBRL Instance Document
101.SCH
XBRL Taxonomy Extension Schema Document
101.CAL
XBRL Taxonomy Extension Calculation Linkbase Document
101.LAB
XBRL Taxonomy Extension Label Linkbase Document
101.PRE
XBRL Taxonomy Extension Presentation Linkbase Document
 
SIGNATURES

Pursuant to the requirements the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
 
 
CAPITAL SOUTHWEST CORPORATION
     
February 8, 2012
  By: 
/s/ Gary L. Martin
Date
  Gary L. Martin 
   
Chairman of the Board and President
     
February 8, 2012
  By: 
/s/ Tracy L. Morris
Date
 
Tracy L. Morris
    Chief Financial Officer
 
 
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