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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, 2013

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. Identification No.) Employer

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 definitions of “large accelerated filer,” “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.

15,285,544 shares of Common Stock, $0.25 par value, as of February 4, 2014

 

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TABLE OF CONTENTS

PART I		FINANCIAL INFORMATION	Page
Item 1.		Consolidated Financial Statements	3
		Consolidated Statements of Assets and Liabilities December 31, 2013 (Unaudited) and March 31, 2013	3
		Consolidated Statements of Operations (Unaudited) For the three and nine months ended December 31, 2013 and December 31, 2012	4
		Consolidated Statements of Changes in Net Assets (Unaudited) For the nine months ended December 31, 2013 and December 31, 2012	5
		Consolidated Statements of Cash Flows (Unaudited) For the three and nine months ended December 31, 2013 and December 31, 2012	6
		Consolidated Schedule of Investments December 31, 2013 (Unaudited) and March 31, 2013	7
		Notes to Consolidated Financial Statements	19
Item 2.		Management's Discussion and Analysis of Financial Condition and Results of Operations	33
Item 3.		Quantitative and Qualitative Disclosures About Market Risk	37
Item 4.		Controls and Procedures	38
PART II		OTHER INFORMATION
Item 1.		Legal Proceedings	38
Item 1A.		Risk Factors	38
Item 6.		Exhibits	38
Signatures			39

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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, 2013				March 31,  2013
Assets		(Unaudited)
Investments at market or fair value
Companies more than 25% owned (Cost: December 31, 2013 - $13,711; March 31, 2013 - $13,711)		$	370,879			$	344,790
Companies 5% to 25% owned (Cost: December 31, 2013 - $15,594; March 31, 2013 - $15,594)			245,896				157,394
Companies less than 5% owned (Cost: December 31, 2013 - $69,461; March 31, 2013 - $58,961)			77,227				72,003
Total investments (Cost: December 31, 2013 - $98,766, March 31, 2013 - $88,266)			694,002				574,187
Cash and cash equivalents			65,717				81,767
Receivables
Dividends and interest			10,366				2,465
Affiliates			656				291
Pension assets			8,981				8,762
Other assets			154				200
Total assets		$	779,876			$	667,672
Liabilities
Accounts payable and accrued expenses		$	3,826			$	3,102
Income taxes payable			4,110				-
Accrued pension cost			3,001				2,650
Deferred income taxes			1,088				2,143
Total liabilities			12,025				7,895
Net Assets
Common stock, $.25 par value: authorized, 25,000,000 shares; issued, 17,620,256 shares at December 31, 2013 and 17,576,776 at March 31, 2013			4,405				4,394
Additional capital			192,035				183,668
Accumulated net investment income(loss)			112				(706	)
Accumulated net realized gain			-				10,437
Unrealized appreciation of investments			595,236				485,921
Treasury stock - 2,339,512 shares, at cost			(23,937	)			(23,937	)
Total net assets			767,851				659,777
Total liabilities and net assets		$	779,876			$	667,672
Net asset value per share (on 15,280,744 shares outstanding at December 31, 2013 and 15,237,264 at March 31, 2013)		$	50.25			$	43.30

The accompanying Notes are an integral part of these Consolidated Financial Statements.

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CAPITAL SOUTHWEST CORPORATION AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF OPERATIONS

(Unaudited)

(In thousands)

		Three Months Ended  December 31								Nine Months Ended  December 31
		2013				2012				2013				2012
Investment income:
Interest		$	147			$	518			$	766			$	1,696
Dividends			8,072				6,308				9,162				7,548
Management and other income			144				146				467				523
			8,363				6,972				10,395				9,767
Operating expenses:
Salaries			2,236				2,357				5,103				3,720
Stock option expense			(2	)			62				347				334
Net pension expense(benefit)			45				(9	)			132				(26	)
Professional fees			251				191				664				767
Other operating expenses			273				272				1,064				935
			2,803				2,873				7,310				5,730
Income before income taxes			5,560				4,099				3,085				4,037
Income tax benefit			(700	)			(43	)			(782	)			(3	)
Net investment income		$	6,260			$	4,142			$	3,867			$	4,040
Proceeds from disposition of investments		$	-			$	11,023			$	55			$	78,528
Cost of investments sold			-				9,258				-				9,882
Realized gain on investments before income tax			-				1,765				55				68,646
Net increase (decrease) in unrealized appreciation of investments			53,308				22,296				109,315				(5,904	)
Net realized and unrealized gain on investments		$	53,308			$	24,061			$	109,370			$	62,742
Increase in net assets from operations		$	59,568			$	28,203			$	113,237			$	66,782

The accompanying Notes are an integral part of these Consolidated Financial Statements.

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CAPITAL SOUTHWEST CORPORATION AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CHANGES IN NET ASSETS

(Unaudited)

(In thousands)

		Nine Months Ended				Nine Months Ended
		December 31, 2013				December 31, 2012
Operations:
Net investment income		$	3,867			$	4,040
Net realized gain on investments			55				68,646
Net increase (decrease) in unrealized appreciation of investments			109,315				(5,904	)
Increase in net assets from operations			113,237				66,782
Distributions from:
Undistributed net investment income			(3,050	)			(3,025	)
Net realized gain distribution			-				(66,826	)
Taxes incurred in deemed capital gain distributions			(3,787	)			(1,125	)
Capital share transactions:
Exercise of employee stock options			1,327				3,243
Stock option expense			347				334
Increase(decrease) in net assets			108,074				(617	)
Net assets, beginning of period			659,777				628,706
Net assets, end of period		$	767,851			$	628,089

 

The accompanying Notes are an integral part of these Consolidated Financial Statements.

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CAPITAL SOUTHWEST CORPORATION AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited)

(In thousands)

		Three Months Ended  December 31								Nine Months Ended  December 31
		2013				2012				2013				2012
Cash flows from operating activities
Increase in net assets from operations		$	59,568			$	28,203			$	113,237			$	66,782
Adjustments to reconcile increase in net assets from operations to net cash (used in) provided by operating activities:
Net proceeds from disposition of investments			–				11,023				55				78,521
Return of Capital on Investment			–				511				–				768
Purchases of securities			(679	)			(2,482	)			(10,501	)			(9,278	)
Depreciation and amortization			5				7				16				25
Net pension expense (benefit)			44				(9	)			132				(26	)
Realized gain on investments before income tax			–				(1,765	)			(55	)			(68,646	)
Taxes incurred on deemed capital gain distribution			(3,787	)			(1,125	)			(3,787	)			(1,125	)
Net (increase) decrease in unrealized appreciation of investments			(53,308	)			(22,296	)			(109,315	)			5,904
Stock option expense			(2	)			62				347				334
Increase in dividend and interest receivable			(7,881	)			(5,586	)			(7,901	)			(6,462	)
Increase in receivables from affiliates			(136	)			(104	)			(365	)			(218	)
Decrease (Increase) in other assets			(13	)			22				31				32
Increase in taxes payable			4,110				1,125				4,110				1,125
Increase in other liabilities			1,295				1,687				724				1,591
(Decrease) Increase in deferred income taxes			(1,024	)			(43	)			(1,055	)			9
Net cash (used in) provided by operating activities			(1,808	)			9,230				(14,327	)			69,336
Cash flows from financing activities
Distributions from undistributed net investment income			(1,525	)			(1,520	)			(3,050	)			(3,025	)
Dividends paid from net realized capital gain			–				–				–				(66,826	)
Proceeds from exercise of employee stock options			868				226				1,327				3,243
Net cash used in financing activities			(657	)			(1,294	)			(1,723	)			(66,608	)
Net (decrease) increase in cash and cash equivalents			(2,465	)			7,936				(16,050	)			2,728
Cash and cash equivalents at beginning of period			68,182				59,687				81,767				64,895
Cash and cash equivalents at end of period		$	65,717			$	67,623			$	65,717			$	67,623

The accompanying Notes are an integral part of these Consolidated Financial Statements.

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CAPITAL SOUTHWEST CORPORATION AND SUBSIDIARIES

CONSOLIDATED SCHEDULE OF INVESTMENTS

(Unaudited)

December 31, 2013

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 and snow removal equipment for municipalities.			22.0	%		‡2,832,300 shares of common stock (acquired 4-1-73 thru 5-09-13)		$	2,190,937			$	171,831,597
ATLANTIC CAPITAL BANCSHARES, INC Atlanta, Georgia Holding company of Atlantic Capital Bank, a full service commercial bank.			1.9	%		300,000 shares of common stock (acquired 4-10-07)			3,000,000				3,656,000
¥BALCO, INC. Wichita, Kansas Specialty architectural products used in the construction and remodeling of commercial and institutional buildings.			95.7	%		445,000 shares of common stock and 60,920 shares Class B non-voting common stock (acquired 10-25-83 and 5-30-02)			624,920				4,600,000
*BOXX TECHNOLOGIES, INC. Austin, Texas Workstations for computer graphic imaging and design.			14.9	%		3,125,354 shares of 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				1,020,000
¥ CAPSTAR HOLDINGS CORPORATION Dallas, Texas Acquires holds and manages real estate for potential development and sale.			100	%		500 shares of common stock (acquired 6-10-10) and 1,000,000 shares of preferred stock (acquired 12-17-12)			4,703,619				7,572,000
CINATRA CLEAN TECHNOLOGIES, INC. Houston, Texas Cleans above ground oil storage tanks with a patented, automated system.			76.2	%		12% subordinated secured promissory note, due 5-9-16 (acquired 5-19-10 thru 10-20-10)			779,278				1
						12% subordinated secured promissory note, due 5-9-17 (acquired 5-9-11 thru 10-26-11)			2,285,700				1
						12% subordinated secured promissory note, due 3-31-17 (acquired 9-9-11 and 10-26-11)			1,523,800				1
						10% subordinated secured promissory note, due 5-9-17 (acquired 7-14-08 thru 4-28-10)			6,200,700				1
						12% subordinated secured promissory note, due 10-31-17 (acquired 10-19-12)			499,997				1
						12% subordinated secured promissory note, due 9-30-14 (acquired 7-25-13)			1,157,850				1
						3,033,410 shares of Series A Convertible Preferred Stock, convertible into 3,033,410 shares of common stock at $1.00 per share (acquired 7-14-08 thru 11-18-10)			3,033,410				1
						Warrants to purchase 1,436,499 shares of common stock at $1.00 per share, expiring 10-31-2027 (acquired 5-9-11 thru 10-19-12)			–				–
									15,480,735				7

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Company			Equity (a)			Investment (b)			Cost				Value (c)
DEEPWATER CORROSION SERVICES, INC. Houston, Texas Full-service corrosion control   company providing the oil and gas industry with expertise in cathodic protection and asset integrity management.			31.3	%		127,004 shares of Series A convertible preferred stock, convertible into 127,004 shares of common stock at $1.00 per shares (acquired 4-9-13)			8,000,000				8,000,000
¥DISCOVERY ALLIANCE, LLC Dallas, Texas Provides services related to intellectual property protection and development.			90	%		90.0% limited liability company interest (acquired  9-12-08 thru 10-15-12)			1,315,000				404,000
*†ENCORE WIRE CORPORATION McKinney, Texas Electric wire and cable for residential, commercial and industrial construction use.			6.2	%		‡1,312,500 shares of common stock (acquired 9-10-92 thru 10-15-98)			5,200,000				71,019,375
†HOLOGIC, INC. Bedford, Massachusetts Medical diagnostic products, imaging systems and surgical products serving the healthcare needs of women.			< 1	%		‡582,820 shares of common stock (acquired 8-27-99)			202,529				13,020,199
iMEMORIES, INC. Scottsdale, Arizona Enables online video and photo sharing and DVD creation for home movies and photos recorded in analog and digital formats.			23.3	%		17,391,304 shares of 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 of 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 1-21-21(acquired 9-13-10 thru 1-21-11)			–				–
						10% convertible notes, $308,000 principal due 7-31-14 (acquired  9-7-12)			308,000				308,000
						10% convertible notes, $880,000 principal due 7-31-14 (acquired  from 3-15-13 to 9-26-13)			880,000				880,000
									6,266,479				6,266,479
INSTAWARES HOLDING COMPANY, LLC Atlanta, Georgia Provides services and distributes equipment and supplies to the restaurant industry via its five subsidiary companies.			4.3	%		3,846,154 Class D Convertible Preferred Stock (acquired 5-20-11)			5,000,000				3,652,000

 

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Company			Equity (a)			Investment (b)			Cost				Value (c)
KBI BIOPHARMA, INC. Durham, North Carolina Provides fully-integrated, outsourced drug development and bio-manufacturing services.			17.1	%		10,204,082 shares of Series B-2 Convertible Preferred Stock, convertible into 10,204,802 shares of common stock at $0.49 per share (acquired 9-08-09)			5,000,000				6,900,000
						Warrants to purchase 94,510 shares of Series B preferred stock at $ 0.70 per share, acquired 1-26-12			-				-
									5,000,000				6,900,000
¥MEDIA RECOVERY, INC. Dallas, Texas Distributor of computer datacenter and office automation supplies and accessories; manufactures and distributes devices used to monitor and manage intransit inventory and dunnage products for protecting shipments.			97.9	%		800,000 shares of Series A Convertible Preferred Stock, convertible into 800,000 shares of common stock at $1.00 per share (acquired 11-4-97)			800,000				2,900,000
						4,000,002 shares of common stock (acquired 11-4-97)			4,615,000				14,300,000
									5,415,000				17,200,000
*PALLETONE, INC. Bartow, Florida Manufacturer of wooden pallets and pressure-treated lumber.			7.7	%		12.3% senior subordinated notes, $2,000,000 principal due 12-18-15 (acquired  9-25-06)			1,553,150				2,000,000
						150,000 shares of common stock (acquired 10-18-01)			150,000				2
									1,703,150				2,000,002
¥THE RECTORSEAL CORPORATION Houston, Texas Specialty chemicals, tools and products for plumbing, HVAC, electrical, construction, industrial, and oil field; smoke containment systems for building fires; also owns 20% of The Whitmore Manufacturing Company.			100.0	%		27,907 shares of common stock (acquired 1-5-73 and 3-31-73)			52,600				257,900,000
TITANLINER, INC. Midland, Texas Manufactures, installs and rents spill containment system for oilfield applications.			31.2	%		217,038 shares of Series A Convertible Preferred Stock convertible into 217,038 shares of Series A Preferred Stock at $14.76 per share (acquired 6-29-12)			3,203,000				-
						7%  senior subordinated secured promissory note, due 6-30-17 (acquired 6-29-12)			2,747,000				2,536,000
						Warrants to purchase 122,239 shares of Series A Preferred Stock at $ 0.01 per share, expiring 12-31-22			-				-
									5,950,000				2,536,000

 

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Company			Equity (a)			Investment (b)			Cost				Value (c)
TRAX HOLDINGS, INC. Scottsdale, Arizona Provides a comprehensive set of solutions to improve the  validation, accounting and payment of transportation-related invoices.			28.4	%		475,430 shares of Series B convertible Preferred Stock convertible into 475,430 shares of  common stock at $8.41 per share(acquired 12-5-12)			4,000,000				7,800,000
						1,061,279 shares of Series A Convertible Preferred Stock, convertible into 1,061,279 shares of common stock at $4.71 per share (acquired 12-8-08 and 2-17-09)			5,000,000				13,500,000
									9,000,000				21,300,000
*WELLOGIX, INC. Houston, Texas Formerly a developer and supporter of business process software used by the oil and gas industry.			19.0	%		4,788,371 shares of Series A-1 Convertible Participating Preferred Stock, convertible into 4,788,371 shares of common stock at $1.04 per share (acquired 8-19-05 thru 6-15-08)			5,000,000				25,000
¥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 of common stock (acquired 8-31-79)			1,600,000				83,000,000
MISCELLANEOUS			–			Ballast Point Ventures II, L.P. 2.2% limited partnership interest (acquired 8-4-08 thru 2-15-13)			1,959,790				2,757,000
			–			BankCap Partners Fund I, L.P. 5.5% limited partnership interest (acquired 7-14-06 thru 11-16-12)			6,000,000				5,249,000
			–			†Capitala Finance Corporation 108,105 shares of common stock (acquired 9-25-13)			1,363,799				2,151,290
			–			CapitalSouth Partners Fund III, L.P. 1.9% limited partnership interest (acquired 1-22-08 and 11-16-11)			467,457				237,000
			–			Diamond State Ventures, L.P. 1.4% limited partnership interest (acquired 10-12-99 thru 8-26-05)			-				16,000
			–			First Capital Group of Texas III, L.P. 3.0% limited partnership interest (acquired 12-26-00 thru 8-12-05)			778,895				169,000
			100	%		¥Humac Company 1,041,000 shares of common stock (acquired 1-31-75 and 12-31-75)			–				203,000

 

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Company

Equity (a)

Investment (b)

Cost

Value (c)

Miscellaneous (continued)

–

†North American Energy Partners, Inc. 77,194 shares of common stock (acquired 8-20-12)

236,986

448,498

–

STARTech Seed Fund II 3.2% limited partnership interest (acquired 4-28-00 thru 2-23-05)

754,327

161,000

–

TCI Holdings, Inc. 21 shares of 12% Series C Cumulative Compounding Preferred Stock (acquired 1-30-90)

–

708,000

TOTAL INVESTMENTS

$

98,766,223

$

694,002,447

 

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CAPITAL SOUTHWEST CORPORATION AND SUBSIDIARIES

CONSOLIDATED SCHEDULE OF INVESTMENTS

March 31, 2013

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 of common stock (acquired 4-1-73 thru 5-09-11)		$	2,190,937			$	108,278,100
ATLANTIC CAPITAL BANCSHARES, INC Atlanta, Georgia Holding company of Atlantic Capital Bank, a full service commercial bank.			1.9	%		300,000 shares of common stock (acquired 4-10-07)			3,000,000				2,950,000
¥BALCO, INC. Wichita, Kansas Specialty architectural products used in the construction and remodeling of commercial and institutional buildings.			95.7	%		445,000 shares of common stock and 60,920 shares Class B non-voting common stock (acquired 10-25-83 and 5-30-02)			624,920				4,500,000
*BOXX TECHNOLOGIES, INC. Austin, Texas Workstations for computer graphic imaging and design.			14.9	%		3,125,354 shares of 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				1,240,000
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 5-9-16 (acquired 5-19-10 thru 10-20-10)			779,278				81,000
						12% subordinated secured promissory note, due 5-9-17 (acquired 5-9-11 thru 10-26-11)			2,285,700				237,000
						12% subordinated secured promissory note, due 3-31-17 (acquired 9-9-11 and 10-26-11)			1,523,800				158,000
						10% subordinated secured promissory note, due 5-9-17 (acquired 7-14-08 thru 4-28-10)			6,200,700				643,000
						12% subordinated secured promissory note, due 10-31-17 (acquired 10-19-12)			499,997				52,000
						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 1,436,499 shares of common stock at $1.00 per share, expiring 10-31-2027 (acquired 5-9-11 thru 10-19-12)			–				–
									14,322,885				1,171,001

 

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Company			Equity (a)			Investment (b)			Cost				Value (c)
*†ENCORE WIRE    CORPORATION McKinney, Texas Electric wire and cable for residential, commercial and industrial construction use.			6.2	%		‡1,312,500 shares of common stock (acquired 9-10-92 thru 10-15-98)			5,200,000				45,950,625
†HOLOGIC, INC. Bedford, Massachusetts Medical instruments including bone densitometers, mammography devices and digital radiography systems.			< 1	%		‡582,820 shares of common stock (acquired 8-27-99)			202,529				13,165,904
iMEMORIES, INC. Scottsdale, Arizona Enables online video and photo sharing and DVD creation for home movies recorded in analog and new digital format.			23	%		17,391,304 shares of 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 of 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 1-21-21(acquired 9-13-10 thru 1-21-11)			–				–
						10% convertible notes, $308,000 principal due 7-31-14 (acquired  9-7-12)			308,000				308,000
						10% convertible notes, $400,000 principal due 7-31-14 (acquired  3-15-13			440,000				440,000
									5,826,479				5,826,479
INSTAWARES HOLDING COMPANY, LLC Atlanta, Georgia Provides services to the    restaurant industry via its five subsidiary companies.			4.5	%		3,846,154 shares of Class D Convertible Preferred Stock (acquired 5-20-11)			5,000,000				5,975,000
KBI BIOPHARMA, INC. Durham, North Carolina Provides fully-integrated, outsourced drug development and bio-manufacturing services.			17.1	%		10,204,082 shares of Series B-2 Convertible Preferred Stock, convertible into 10,204,802 shares of common stock at $0.49 per share (acquired 9-08-09)			5,000,000				5,200,000
						Warrants to purchase 94,510 shares of Series B Preferred stock at $ 0.70 per share, acquired 1-26-12			-				-
									5,000,000				5,200,000

 

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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 of Series A Convertible Preferred Stock, convertible into 800,000 shares of common stock at $1.00 per share (acquired 11-4-97)			800,000				2,000,000
						4,000,002 shares of common stock (acquired 11-4-97)			4,615,000				9,900,000
									5,415,000				11,900,000
*PALLETONE, INC. Bartow, Florida Manufacturer of wooden pallets and pressure-treated lumber.			7.7	%		12.3% senior subordinated notes, $2,000,000 principal due 12-18-15 (acquired  9-25-06)			1,553,150				1,900,000
						150,000 shares of common stock (acquired 10-18-01)			150,000				2
									1,703,150				1,900,002
¥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 of common stock (acquired 1-5-73 and 3-31-73)			52,600				238,900,000
TCI HOLDINGS, INC. Denver, Colorado Cable television systems and microwave relay systems.			–			21 shares of 12% Series C Cumulative Compounding Preferred Stock (acquired 1-30-90)			–				763,000
TITANLINER, INC. Midland, Texas Manufactures, installs and rents spill containment system for oilfield applications.			29.9	%		217,038 shares of Series A Convertible Preferred Stock convertible into 217,038 shares of Series A Preferred Stock at $14.76 per share (acquired 6-29-12)			3,203,000				3,203,000
						7%  senior subordinated secured promissory note, due 6-30-17 (acquired 6-29-12)			2,747,000				2,747,000
						Warrants to purchase 122,239 shares of Series A preferred stock at $ 0.01 per share, expiring 12-31-22			-				-
									5,950,000				5,950,000

 

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Company			Equity (a)			Investment (b)			Cost				Value (c)
TRAX HOLDINGS, INC. Scottsdale, Arizona Provides a comprehensive set of solutions to improve the transportation validation, accounting, payment and information management process.			25.4	%		475,430 shares of Series B convertible Preferred Stock convertible into 475,430 shares of  common stock at $8.41 per share(acquired 12-5-12)			4,000,000				7,000,000
						1,061,279 shares of Series A Convertible Preferred Stock, convertible into 1,061,279 shares of common stock at $4.71 per share (acquired 12-8-08 and 2-17-09)			5,000,000				12,400,000
									9,000,000				19,400,000
*WELLOGIX, INC. Houston, Texas Developer and supporter of software used by the oil and gas industry.			19.1	%		4,788,371 shares of Series A-1 Convertible Participating Preferred Stock, convertible into 4,788,371 shares of common stock at $1.04 per share (acquired 8-19-05 thru 6-15-08)			5,000,000				25,000
¥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 of common stock (acquired 8-31-79)			1,600,000				80,500,000
MISCELLANEOUS			–			Ballast Point Ventures II, L.P. 2.2% limited partnership interest (acquired 8-4-08 thru 2-15-13)			1,659,790				1,843,000
			–			BankCap Partners Fund I, L.P. 5.5% limited partnership interest (acquired 7-14-06 thru 11-16-12)			5,897,276				5,013,000
			–			CapitalSouth Partners Fund III, L.P. 1.9% limited partnership interest (acquired 1-22-08 and 11-16-11)			1,331,256				3,934,000
			100.0	%		¥CapStar Holdings   Corporation 500 shares common stock (acquired 6-10-10); 1,000,000 shares of preferred stock (acquired 12-17-12)			4,703,619				7,846,000

 

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Company			Equity (a)			Investment (b)			Cost				Value (c)
Miscellaneous (continued)			–			Diamond State Ventures, L.P. 1.4% limited partnership interest (acquired 10-12-99 thru 8-26-05)			-				120,000
			–			¥Discovery Alliance, LLC 90.0% limited liability company interest (acquired  9-12-08 thru 10-15-12)			1,315,000				956,000
			–			First Capital Group of Texas III, L.P. 3.0% limited partnership interest (acquired 12-26-00 thru 8-12-05)			778,895				190,000
			100	%		¥Humac Company 1,041,000 shares common stock (acquired 1-31-75 and 12-31-75)			–				188,000
			–			†North American Energy Partners, Inc. 77,194 shares of common stock (acquired 8-20-12)			236,986				350,461
			–			STARTech Seed Fund II 3.2% limited partnership interest (acquired 4-28-00 thru 2-23-05)			754,327				151,000
TOTAL INVESTMENTS								$	88,265,649			$	574,186,572

 

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Notes to Consolidated Schedule of Investments

 

a)

Equity

The percentages in the “Equity” column express equity interests held collectively 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 owned by the Company, or which the Company has the right to 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, 2013, restricted securities represented approximately 63.1% of the value of the consolidated investment portfolio and unrestricted securities represented 36.9% of the value of the consolidated investment portfolio. At March 31, 2013, restricted securities represented approximately 70.8% of the value of the consolidated investment portfolio and unrestricted securities represented 29.2% of the value of the consolidated investment portfolio.

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) 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; privately held securities are valued as determined in good faith by our Board of Directors.

ASC 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 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 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. For those securities without a principal market, our 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; and the proportion of the issuer’s securities owned by the Company.  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.

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Equity warrants are valued on the basis of the Black-Scholes model which defines the market value of a warrant in relation to the market price of the underlying 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 Company disposing of such 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, 2013 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 Humac Company and The Whitmore Manufacturing Company which are not obligated to bear registration costs.

(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.

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1.	ORGANIZATION AND BASIS OF PRESENTATION

Capital Southwest Corporation (“CSW”) was organized as a Texas corporation on April 19, 1961.  Until September 1969, CSW 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 registered under the Investment Company Act of 1940, as amended (the “1940 Act”).  Prior to March 30, 1988, CSW was registered as a closed-end, non-diversified investment company under the 1940 Act.  On that date, CSW 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 CSW wholly owns CSVC, the portfolios of both CSW and CSVC are referred to collectively as “our,” “we” and “us.”  Capital Southwest Management Company (“CSMC”), a wholly-owned subsidiary of CSW, is the management company for CSW 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 controlled affiliates, fund holdings, publicly-traded holdings, and other non-control holdings. 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.

The consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”).  Under the 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 CSMC, our management company.

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

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.”

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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 CSW, CSVC and CSMC.

Fair Value Measurements. We 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.  This topic 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.  This topic does not change existing accounting rules governing what can or what must be recognized and reported at fair value in our financial statements, or disclosed at fair value in our notes to 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 three investments comprising 57.7% of our net asset value at March 31, 2013.

We believe our investments at December 31, 2013 and March 31, 2013 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 the Notes to the Consolidated Schedule of Investments and Note 3 below.  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. We operate and manage our business in a singular segment.  As an investment company, we invest in portfolio 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.

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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 marketable securities and restricted securities.  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 generally will establish a reserve against the interest income. At that point, the loan or debt security’s status is on non-accrual basis, and we cease recognizing 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 its ability to service debt or, pay other obligations, it will be restored to accrual basis.

Federal Income Taxes.  CSW and CSVC have elected and intend to comply with the requirements of the Internal Revenue Code (“IRC”) necessary to qualify as regulated investment companies (“RIC”s).  By meeting these requirements, we 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 company taxable income, as defined by the IRC, each year.  Investment company taxable income generally differs from net income for financial reporting purposes due to temporary and permanent differences in the recognition of income and expenses.  Investment company taxable income generally excludes net unrealized appreciation or depreciation, as investment gains and losses are not included in investment company taxable income until they are realized.

In addition to the requirement that we must annually distribute at least 90% of our investment company taxable income, we may either distribute or retain our realized net capital gains from investments, but any net capital gains not distributed may be subject to corporate level tax. When we retain the capital gains, they are classified as a “deemed distribution” to our shareholders and are subject to our corporate tax rate of 35%.  As an investment company that qualifies as a RIC under the IRC, federal income taxes payable on security gains that we elect to retain are accrued only on the last day of our tax year, December 31.  Any capital gains actually distributed to shareholders are generally taxable to the shareholders as long-term capital gains. See Note 4 for further discussion.

CSMC, a wholly owned subsidiary of CSW, 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, 2013 and 2012.

 

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Defined Pension Benefits and Other Postretirement Plans.  We record annual amounts relating to our defined benefit pension plan based on calculations, which include various actuarial assumptions such as discount rates and assumed rates of return. Material changes in pension costs could occur due to changes in the discount rate, in the expected long-term rate of return, or in the 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 our 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 our fiscal year-end, which is March 31.

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. We have not experienced any losses in such accounts and do not believe we are subject to any significant credit risk.

 

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 we believe 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 we have 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 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.

·

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 used Level 3 inputs for measuring the fair value of approximately 62.8% of our investments as of December 31, 2013.

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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 inputs (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.

Unobservable inputs are those inputs for which little or no market data exists and, therefore, require an entity to develop its own assumptions. The fair value determination of each portfolio company requires one or more of the following unobservable inputs:

·

Financial information obtained from each portfolio company, including audited and unaudited statements of operations and balance sheets for the most recent period available as compared to budgeted numbers;

·

Current and projected financial condition of the portfolio company;

·

Current and projected ability of the portfolio company to service its debt obligations;

·

Projected operating results of the portfolio company;

·

Current information regarding any offers to purchase the investment or recent private sales transactions;

·

Current ability of the portfolio company to raise any additional financing as needed;

·

Change in the economic environment which may have a material impact on the operating results of the portfolio company;

·

Qualitative assessment of key management;

·

Contractual rights, obligations or restrictions associated with the investment; and

·

Other factors deemed relevant.

 

The significant unobservable inputs used in the fair value measurement of our equity securities are EBITDA multiples, revenue multiples, net book values, and tangible book value multiples. Generally, increases or decreases in EBITDA or revenue multiple inputs result in a higher or lower fair value measurement, respectively. However, due to the nature of certain investments, fair value measurements may be based on other criteria, such as third party-appraisals. For recent investments, we generally rely on our cost basis to determine the fair value unless fair value is deemed to have departed from this level.

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The significant unobservable inputs used in the fair value measurement of our debt securities are risk adjusted discount factors used in the yield valuation technique and probability of principal recovery. Significant increases or decreases in any of these valuation inputs in isolation would result in a significantly lower or higher fair value measurement. However, due to the nature of certain investments, fair value measurements may be based on other criteria, such as third party inputs.

For recent investments, we generally evaluate limited partnership or limited liability company interests at cost, which is deemed to represent fair value, unless or until there is substantive evidence that cost does not correspond to fair value. Thereafter, these securities are generally valued at our percentage interest of the fund or the company’s calculated net asset value, unless there is substantive evidence that the net asset value does not correspond to fair value. All investments of each fund are valued by each fund in accordance with ASC 820.

We generally use the Black-Scholes option pricing model to determine the fair value of warrants held in our portfolio. Option pricing models, including the Black-Scholes model, require the use of subjective inputs, including expected volatility, expected life, expected dividend rate, and expected risk-free rate of return. In the Black-Scholes model, variation in the expected volatility or expected term assumptions has a significant impact on fair value.

The table below presents the valuation technique and quantitative information about the significant unobservable inputs utilized by the Company to value our Level 3 investments as of December 31, 2013 and March 31, 2013. Unobservable inputs are those inputs for which little or no market data exists and therefore require an entity to develop its own assumptions. The table is not intended to be all inclusive, but instead captures the significant unobservable inputs relevant to our determination of fair value.

Type	Valuation  Technique		Fair Value at 12/31/2013  (in millions)			Unobservable  Input		Range				Weighted Average
Preferred & Common Equity	Market Approach		$	374.2		EBITDA Multiple			3.50x – 7.78	x			6.92	x
	Market Approach		$	26.3		Revenue Multiple			2.50x – 2.98	x			2.59	x
	Market Approach		$	7.6		Cash and Asset Value			NA				NA
	Income Approach		$	0.7		Discount Rate			2.86	%			2.86	%
	Market Approach		$	3.7		Multiple of Tangible Book Value			1.47	x			1.47	x
	Market Approach		$	8.0		Recent Transaction Price			NA				NA
	Market Approach		$	0.2		Market Value of Held Securities			NA				NA
			$	420.7
Debt	Income Approach		$	4.6		Discount Rate			11.69% -13.02	%			12.28	%
	Recent Transaction Price		$	1.2		Recent Transaction Price			NA				NA
			$	5.8
Partnership Interests	Net Asset Value*		$	9.0		Fund Value		NA				NA
	Total		$	435.5

 

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Type	Valuation Technique		Fair Value at 3/31/2013  (in millions)			Unobservable  Input		Range				Weighted Average
Preferred & Common Equity	Market Approach		$	342.2		EBITDA Multiple			3.25x – 7.00	x			6.45	x
	Market Approach		$	11.1		Revenue Multiple			0.25x – 1.82	x			0.97	x
	Market Approach		$	7.9		Cash and Asset Value			NA				NA
	Income Approach		$	0.7		Discount Rate			1.75	%			1.75	%
	Market Approach		$	3.0		Multiple of Tangible Book Value			1.22	x			1.22	x
	Market Approach		$	22.6		Recent Transaction Price			NA				NA
	Market Approach		$	0.2		Market Value of Held Securities			NA				NA
			$	387.7
Debt	Income Approach		$	3.1		Discount Rate			10.02% -12.00	%			10.77	%
	Recent Transaction Price		$	3.5		Recent Transaction Price			NA				NA
			$	6.6
Partnership Interests	Net Asset Value*		$	12.2		Fund Value		NA				NA
	Total		$	406.5

 

*All funds are valued in accordance with ASC 820.

             As of December 31, 2013 and March 31, 2013, 62.8% and 70.8%, 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, 2013 and March 31, 2013 (in millions):

						Fair Value Measurements at 12/31/13 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		$	5.8			$	−			$	−			$	5.8
Partnership Interests			9.0				−				−				9.0
Preferred Equity			51.2				−				−				51.2
Common Equity			628.0				256.3				2.2				369.5
Total Investments		$	694.0			$	256.3			$	2.2			$	435.5

 

						Fair Value Measurements at 3/31/13 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		$	6.6			$	−			$	−			$	6.6
Partnership Interests			12.2				−				−				12.2
Preferred Equity			44.6				−				−				44.6
Common Equity			510.8				167.7				−				343.1
Total Investments		$	574.2			$	167.7			$	−			$	406.5

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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, 2013 (in millions):

		Fair  Value  3/31/13				Net  Unrealized Appreciation (Depreciation)				New  Investments				Distribution				Net Changes  from  Unrealized  to  Realized				Conversion  of Security  from Debt to Equity				Fair Value at  12/31/13
Debt		$	6.6			$	(2.4	)		$	1.6			$	−			$	−			$	−			$	5.8
Partnership Interests			12.2				(2.7	)			0.9				(1.4	)			−				−				9.0
Preferred Equity			44.6				(1.4	)			8.0				−				−				−				51.2
Common Equity			343.1				26.4				−				−				−				−				369.5
Total Investments		$	406.5			$	19.9			$	10.5			$	(1.4	)		$	−			$	−			$	435.5

 

4.	INCOME TAXES

We operate to qualify as a RIC under Subchapter M of the IRC and have a calendar tax year end of December 31.  In order to qualify as a RIC, we must annually distribute at least 90% of our investment company taxable ordinary income, based on our tax year, to our shareholders in a timely manner.  Investment company 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.  As permitted by the IRC, 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 distributed or intend to distribute sufficient dividends to eliminate any 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 years ended December 31, 2013 and 2012, we declared and paid ordinary dividends in the amounts of $3,049,614 and $3,025,032, 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, 2013 and 2012, 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, 2013 and 2012.

A RIC may elect to retain its long-term capital gains by designating them as a “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 they 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.

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           During our tax year ended December 31, 2013, we sold 9,317,310 shares of common stock of Heelys, Inc. to Sequential Brands Group, Inc. and generated cash proceeds of $20,963,948 and a capital gain of $20,861,458. Subsequently, we distributed and paid $0.69 per share or $10,474,932 of Heely’s gain to our shareholders on March 28, 2013. For the tax year ended December 31, 2013, we had net long-term capital gains of $10,819,079 for tax purposes and $10,491,526 for book purposes, which we elected to retain and treat as deemed distributions to our shareholders. During the tax year ended December 31, 2012, we distributed capital gains dividends in the amount of $4.40 per share or $66,825,782 to our shareholders; we also had net long-term capital gains of $3,214,547 for tax purposes and $2,319,012 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 $3,786,678 for the tax year ended December 31, 2013.  For the tax year ended December 31, 2012, we incurred federal taxes on behalf of our shareholders in the amount of $1,125,092.

For the quarter ended December 31, 2013 and 2012, CSW and CSVC qualified to be taxed as RICs.  We intend to continue meet the applicable qualifications to be taxed as a RIC.  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 CSW, is not a RIC and is required to pay taxes at the current corporate rate.  CSMC sponsors a qualified defined benefit pension plan which covers its employees and employees of certain wholly owned portfolio companies.  In addition, CSMC records phantom stock option and bonus accruals on a quarterly basis. Deferred taxes related to the qualified defined benefit pension plan and phantom stock option and bonus accruals are recorded as incurred. As of December 31, 2013, CSMC has a net deferred tax liability of $1,087,981.

5.	ACCUMULATED NET REALIZED GAINS (LOSSES) ON INVESTMENTS

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 of the difference 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. We had $10,491,526 and $10,436,526 of accumulated long term capital gains, as of December 31, 2013 and March 31, 2013, respectively. In accordance with the RIC rules, we elected to retain our long-term capital gains for the tax year ended December 31, 2013, incur the applicable income taxes of $3,786,678, and designate the after-tax gain as “deemed distributions” to shareholders. “Deemed distributions” are reclassified from accumulated net realized gains into additional paid in capital at the end of December.

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6.	EMPLOYEE STOCK BASED COMPENSATION PLANS

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

Stock Options

On July 20, 2009, shareholders approved our 2009 Stock Incentive Plan (the “2009 Plan”), which provides for the granting of stock options to employees and officers  and authorizes the issuance of common stock upon exercise of such options for up to 560,000 shares.  All options are granted at or above market price, generally expire up to 10 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.  Options to purchase 155,000 shares at a price of $19.19 per share (market price at the time of grant) were granted on October 19, 2009. Additionally, options to purchase 80,000 shares at a price of $23.95 per share (market price at time of grant) were granted on March 22, 2010, options to purchase 60,000 shares at a price of $22.05 per share were granted on July 19, 2010 and options to purchase 40,000 shares at a price of $24.23 per share were granted on July 18, 2011. During the nine months ended December 31, 2013, options to purchase 30,000 shares at a price of $37.02 per share (market price at the time of grant) were granted on July 15, 2013. Additionally, 13,720 options were exercised and 47,000 options were forfeited during the nine months ended December 31, 2013 and thus leaving 140,188 options outstanding and 298,000 options available to grant under the 2009 Plan as of December 31, 2013.

We previously granted stock options under our 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 our 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 10 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. During the nine months ended December 31, 2013, 38,000 options were exercised, thus leaving 208,000 options outstanding under the 1999 Plan.

We recognize compensation expense over the straight-line method for all share-based payments granted on or after that date and for all awards granted to employees prior to April 1, 2006 that remain unvested on that date.  The fair value of stock options is determined on the date of grant using the Black-Scholes pricing model and are expensed over the vesting period of the related stock options. Share-based compensation cost for restricted stock is measured based on the closing fair market value of our Company’s common stock on the date of the grant.  Accordingly, for the quarters ended December 31, 2013 and 2012, we recognized stock option compensation expense of $8,044 and  $33,769, respectively. For the nine months ended December 31, 2013 and 2012, we recognized stock option compensation expense of $283,341 and $ 262,785, respectively. Changes in stock option compensation expense for 2013 versus 2012 is due to forfeitures of unexercised stock options that occurred with the departures of employees during the quarter ended December 31, 2013.

As of December 31, 2013, the total remaining unrecognized compensation expense related to non-vested stock options was $691,754, which will be amortized over the weighted-average service period of approximately 0.9 years.

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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		$	8.27				0.83	%			1.45	%			40.0	%			5
July 19, 2010		$	7.15				0.91	%			1.73	%			37.5	%			5
March 22, 2010		$	8.14				0.84	%			2.43	%			37.8	%			5
October 19, 2009		$	6.34				1.04	%			2.36	%			37.6	%			5
July 15, 2013		$	14.80				0.54	%			1.40	%			46.6	%			5
1999 Plan
July 30, 2008		$	7.48				0.62	%			3.36	%			20.2	%			5
July 21, 2008		$	6.84				0.67	%			3.41	%			20.2	%			5
July 16, 2007		$	10.44				0.39	%			4.95	%			19.9	%			5
July 17, 2006		$	8.26				0.61	%			5.04	%			21.2	%			7
May 15, 2006		$	7.82				0.64	%			5.08	%			21.1	%			7

 

The following table summarizes activity in the 2009 Plan and the 1999 Plan as of December 31, 2013:

 

		Number of Shares				Weighted Average  Exercise  Price
2009 Plan
Balance at March 31, 2011			295,000			$	21.06
Granted			40,000				24.23
Exercised			–				–
Canceled/Forfeited			–				–
Balance at March 31, 2012			335,000				21.44
Granted			–				–
Exercised			(108,092	)			19.96
Canceled/Forfeited			(56,000	)			21.44
Balance at March 31, 2013			170,908				22.37
Granted			30,000				37.02
Exercised			(13,720	)			22.71
Canceled/Forfeited			(47,000	)			22.10
Balance at December 31, 2013			140,188			$	25.55

 

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1999 Plan
Balance at March 31, 2011			386,000			$	28.70
Granted			–				–
Exercised			(6,000	)			16.43
Canceled/Forfeited			–				–
Balance at March 31, 2012			380,000				28.41
Granted			–				–
Exercised			(76,420	)			23.83
Canceled/Forfeited			(57,580	)			27.79
Balance at March 31, 2013			246,000				33.00
Granted			–				–
Exercised			(38,000	)			26.69
Canceled/Forfeited			–				–
Balance at December 31, 2013			208,000			$	34.16
Combined Balance at December 31, 2013			348,188			$	30.69

 

December 31, 2013	Weighted Average Aggregate Intrinsic Remaining Contractual Term		Value
Outstanding	0.9 years		$	3,068,087
Exercisable	0.3 years		$	2,260,194

At December 31, 2013, the range of exercise prices was $19.19 to $38.25 and the weighted-average remaining contractual life of outstanding options was 0.9 years. The total number of options exercisable under both the 2009 Plan and the 1999 Plan at December 31, 2013 and 2012, was 264,188 shares with a weighted-average exercise price of $31.58 and 272,600 shares with a weighted-average exercise price of $31.10, respectively. During the nine months ended December 31, 2013, 47,000 options were forfeited and 51,720 options were exercised. During the nine months ended December 31, 2012, 113,580 options were forfeited, and 148,820 options were exercised.

Stock Awards

 

Pursuant to the Capital Southwest Corporation 2010 Restricted Stock Award Plan, our Board of Directors reserved for issuance 188,000 shares of restricted stock to certain key employees. A restricted stock award is an award of shares of our common stock (which have full voting and dividend rights but are restricted with regard to sale or transfer), the restrictions on which lapse ratably over a specified period of time (generally five years). Restricted stock awards are independent of stock grants and are subject to forfeiture if employment terminates prior to these restrictions lapsing. These shares vest over a five-year period from the grant date and are expensed over the five-year service period starting on the grant date. On January 16, 2012, the Board of Directors granted 38,600 shares of restricted stock to key employees of the Company. On January 22, 2013, the Board of Directors granted 8,000 shares of restricted stock to officers of the Company. On July 15, 2013, The Board of Directors granted 5,000 shares of restricted stock to a key officer of the Company. During the nine months ended December 31, 2013, 13,240 shares of restricted stock were forfeited. The following table summarizes the restricted stock available for issuance as of December 31 2013:

Restricted stock available for issuance as of March 31, 2013			153,400
Restricted stock granted during the nine Months ended December 31, 2013			(5,000	)
Restricted stock forfeited during the nine Months ended December 31, 2013			13,240
Restricted stock available for issuance as of December 31, 2013			161,640

 

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We expense the cost of the restricted stock awards, which is determined to equal the fair value of the restricted stock award at the date of grant on a straight-line basis over the vesting period in which the restrictions on these stock awards lapse. For these purposes, the fair value of the restricted stock award is determined based on the closing price of our common stock on the date of grant. For the quarters ended December 2013 and 2012, we recognized total share based compensation expense of $(9,930) and $27,797, respectively, related to the restricted stock issued to our employees and officers.  For the nine months ended December 31, 2013 and 2012, we recognized share based compensation expense of $64,050 and $70,851, respectively, related to restricted stock issued to employees and officers. Changes in stock option compensation expense for 2013 versus 2012 are due to forfeitures of unvested restricted stock that occurred with the departures of employees during the quarter ended December 31, 2013.

As of December 31, 2013, the total remaining unrecognized compensation expense related to non-vested restricted stock awards was $443,979, which will be amortized over the weighted-average service period of approximately 3.6 years.

            The following table represents a summary of the activity for our restricted stock awards for the nine months ended December 31, 2013:

Restricted Stock Awards		Number of  Shares				Weighted  Average Fair  Value Per  Share				Weighted Average  Remaining Vesting Term  (in Years)
Unvested at March 31, 2013			29,280			$	22.32				4.1
Granted			5,000				37.02				4.5
Vested			−				−				−
Forfeited			(13,240	)			22.08				−
Unvested at December 31, 2013			21,040			$	25.96				3.6