Twelve Largest Investments - March 31, 1998
Palm Harbor Homes, Inc. $138,250,000
--------------------------------------------------------------------------------
Palm Harbor Homes, Dallas, Texas, is an integrated manufactured housing
company, building, retailing, financing and insuring homes produced in 16 plants
in Alabama, Arizona, Florida, Georgia, North Carolina, Ohio, Oregon and Texas
and sold in 34 states by over 300 independent dealers and 94 company-owned
retail superstores. Palm Harbor manufactures high-quality, energy-efficient
homes designed to meet the need for affordable housing, particularly among
retirees and newly-formed families.
During the year ended March 27, 1998, Palm Harbor earned $31,854,000 ($1.69
per share) on net sales of $637,268,000, compared with earnings of $24,739,000
($1.34 per share) on net sales of $563,192,000 in the previous year. The March
31, 1998 closing Nasdaq bid price of Palm Harbor's common stock was $36.625 per
share.
At March 31, 1998, the $10,931,955 investment in Palm Harbor by Capital
Southwest and its subsidiary was valued at $138,250,000 ($22.00 per share)
consisting of 6,284,096 restricted shares of common stock, representing a
fully-diluted equity interest of 33.2%.
--------------------------------------------------------------------------------
Skylawn Corporation $42,000,000
--------------------------------------------------------------------------------
Skylawn Corporation owns and operates cemeteries, mausoleums and mortuaries.
Skylawn's operations, all of which are in California, include a mausoleum and an
adjacent mortuary in Oakland and cemeteries and mausoleums in San Mateo,
Hayward, Sacramento and Napa, the latter three of which also have mortuaries at
the cemetery sites. All of these entities are well established and have provided
funeral services to their respective communities for many years.
For the fiscal year ended March 31, 1998, Skylawn Corporation earned
$4,031,000 on revenues of $22,156,000. In the previous year, Skylawn earned
$3,822,000 on revenues of $20,602,000.
At March 31, 1998, Capital Southwest owned 100% of Skylawn Corporation's
common stock, which had a cost of $4,510,400 and was valued at $42,000,000.
--------------------------------------------------------------------------------
The RectorSeal Corporation $38,500,000
--------------------------------------------------------------------------------
The RectorSeal Corporation, with plants in Houston, Texas and Mount Vernon,
New York, manufactures specialty chemical products including pipe thread
sealants, firestop sealants, plastic solvent cements and other formulations for
plumbing and industrial applications. RectorSeal's subsidiary, Jet-Lube, Inc.,
with plants in Houston, England and Canada, produces anti-seize compounds,
specialty lubricants and other products used in industrial and oil field
applications. RectorSeal also owns a 20% equity interest in The ▇▇▇▇▇▇▇▇
Manufacturing Company (described subsequently).
During the year ended March 31, 1998, RectorSeal earned $3,917,000 on
revenues of $42,218,000, compared with earnings of $3,116,000 on revenues of
$37,988,000 in the previous year. RectorSeal's earnings do not reflect its 20%
equity in The ▇▇▇▇▇▇▇▇ Manufacturing Company.
At March 31, 1998, Capital Southwest owned 100% of RectorSeal's common stock
having a cost of $52,600 and a value of $38,500,000.
--------------------------------------------------------------------------------
Alamo Group Inc. $37,240,000
--------------------------------------------------------------------------------
Alamo Group Inc. is a leading designer, manufacturer and distributor of
heavy-duty, tractor-mounted mowing and vegetation maintenance equipment. Founded
in 1969, Alamo Group operates 12 manufacturing facilities and serves
agricultural, governmental and commercial markets in the U.S. and Europe.
For the year ended December 31, 1997, ▇▇▇▇▇ reported consolidated earnings of
$13,600,000 ($1.41 per share) on net sales of $203,092,000, compared with
earnings of $8,762,000 ($0.91 per share) on net sales of $183,595,000 in the
previous year. The March 31, 1998 closing NYSE market price of Alamo's common
stock was $18.125 per share.
At March 31, 1998, the $575,000 investment in Alamo by Capital Southwest and
its subsidiary was valued at $37,240,000, consisting of 2,660,000 restricted
shares of common stock valued at $37,240,000 ($14.00 per share) and warrants for
62,500 shares, representing a fully-diluted equity interest of 27.0% at an
anticipated cost of $1,575,000.
6
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Encore Wire Corporation $33,660,000
--------------------------------------------------------------------------------
Encore Wire Corporation, McKinney, Texas, manufactures a broad line of copper
electrical wire and cable including non-metallic sheathed cable, underground
feeder cable and THHN cable for residential, commercial and industrial
construction. Encore's products are sold through large-volume distributors and
building materials retailers.
For the year ended December 31, 1997, Encore reported net income of
$21,693,000 ($1.97 per share) on net sales of $254,640,000, compared with net
income of $7,159,000 ($0.68 per share) on net sales of $179,132,000 in the
previous year. The March 31, 1998 closing Nasdaq bid price of Encore's common
stock was $32.25 per share.
At March 31, 1998, the $4,100,000 investment in 1,683,000 shares of Encore's
restricted common stock by Capital Southwest and its subsidiary was valued at
$33,660,000 ($20.00 per share), representing a fully-diluted equity interest of
14.6%.
--------------------------------------------------------------------------------
Mail-Well, Inc. $24,986,000
--------------------------------------------------------------------------------
Mail-Well, Inc., Englewood, Colorado, is a leading consolidator in the
fragmented printing industry, specializing in the following market segments:
customized envelopes, high-impact printing, consumer products labels and
business communications documents. Mail-Well has 9,000 employees and operates 75
plants and numerous sales offices throughout North America.
For the year ended December 31, 1997, Mail-Well reported earnings of
$22,176,000 ($1.18 per share) on net sales of $897,560,000, compared with
earnings of $16,927,000 ($0.95 per share) on net sales of $778,524,000 in the
previous year. The March 31, 1998 closing NYSE price of Mail-Well's common stock
was $37.875 per share.
At March 31, 1998, the $2,889,010 investment in Mail-Well by Capital
Southwest was valued at $24,986,000 ($24.00 per share) consisting of 1,041,094
restricted shares of common stock, representing a fully-diluted equity interest
of 3.8%.
--------------------------------------------------------------------------------
American Homestar Corporation $16,992,710
--------------------------------------------------------------------------------
American Homestar Corporation, League City, Texas, builds, retails and
finances manufactured housing, producing homes from its 11 plants and retailing
its products through 83 company-owned retail sales centers and more than 400
independent dealers in 28 states.
For the year ended May 31, 1997, American Homestar reported net income of
$14,692,000 ($0.87 per share) on net sales of $339,979,000. Unaudited earnings
for the nine months ended February 28, 1998 were $11,120,000 ($0.62 per share)
compared with $10,445,000 ($0.60 per share) during the same period in the prior
year. The March 31, 1998 closing Nasdaq bid price of American Homestar's stock
was $22.625 per share.
At March 31, 1998, Capital Southwest and its subsidiary owned 751,059
unrestricted shares of American Homestar common stock, having a cost of
$3,405,824 and a market value of $16,992,710 ($22.625 per share), representing a
fully-diluted equity interest of 4.1%.
--------------------------------------------------------------------------------
PETsMART, Inc. $6,991,976
--------------------------------------------------------------------------------
PETsMART, Inc., Phoenix, Arizona, is the largest operator of stores specializing
in pet foods, supplies and grooming and veterinary services. PETsMART currently
operates 468 stores in North America and the United Kingdom.
For the year ended February 1, 1998, PETsMART reported a net loss of
$34,430,000 ($0.30 per share) on net sales of $1,790,599,000, compared with net
income of $20,591,000 ($0.17 per share) on net sales of $1,501,017,000 in the
previous year. The March 31, 1998 closing Nasdaq bid price of PETsMART's common
stock was $10.6875 per share.
At March 31, 1998, Capital Southwest and its subsidiary owned 654,220
unrestricted shares of PETsMART common stock, having a cost of $2,878,733 and a
market value of $6,991,976 ($10.6875 per share).
7
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The ▇▇▇▇▇▇▇▇ Manufacturing Company $6,000,000
--------------------------------------------------------------------------------
The ▇▇▇▇▇▇▇▇ Manufacturing Company, with plants in Rockwall, Texas and
Cleveland, Ohio, manufactures specialty lubricants for heavy equipment used in
surface mining and other industries, and produces transit coatings for the
automobile industry. ▇▇▇▇▇▇▇▇'▇ subsidiary, ▇▇▇▇▇▇-▇▇▇▇▇ Company, Inc., Buena
Park, California, produces floor-finishing compounds, supplies and equipment for
supermarkets.
During the year ended March 31, 1998, ▇▇▇▇▇▇▇▇ reported net income of
$118,424 on net sales of $12,901,000, compared with net income of $971,000 on
net sales of $12,300,000 (restated) in the previous year. The company is owned
80% by Capital Southwest and 20% by Capital Southwest's subsidiary, The
RectorSeal Corporation (described on a previous page).
At March 31, 1998, the direct investment in ▇▇▇▇▇▇▇▇ by Capital Southwest was
valued at $6,000,000 and had a cost of $1,600,000. Our Company's direct and
indirect equity in ▇▇▇▇▇▇▇▇'▇ income for the year ended March 31, 1998 was
$118,424.
--------------------------------------------------------------------------------
SDI Holding Corp. $6,000,000
--------------------------------------------------------------------------------
SDI Holding Corp., Greenville, South Carolina, through its subsidiary,
Sterling Diagnostic Imaging, Inc., manufactures and markets, on a world-wide
basis, x-ray imaging film, intensifying screens, cassettes, film development
chemicals and related equipment and services. A subsidiary, Direct Radiography
Corp., recently developed and obtained FDA approval of a system which is the
technological leader in capturing, storing and transmitting conventional x-ray
images in a digital format.
The net assets of the Diagnostic Imaging business were purchased from ▇. ▇.
▇▇▇▇▇▇ de Nemours for approximately $315 million in March 1996. The operations
acquired by SDI recorded 1997 sales of $527 million and 1996 sales of $500
million.
At March 31, 1998, Capital Southwest's $6,000,000 investment in the common
stock of SDI Holding Corp. was valued at cost and represents a fully-diluted
equity interest of 11.1%.
--------------------------------------------------------------------------------
Media Recovery, Inc. $5,093,000
--------------------------------------------------------------------------------
Media Recovery, Inc., ▇▇▇▇▇▇, Texas, distributes computer and office
automation supplies and accessories to corporate customers through its direct
sales force with 22 offices in 14 states and also manufactures and sells impact
and tilt monitoring devices used to detect mishandled shipments.
The net assets of Media Recovery were acquired for approximately $23,320,000
in November 1997, by Varix Corporation, which subsequently changed its name to
Media Recovery. The acquired operations recorded sales of $57,042,000 and
$43,388,000 during the fiscal years ended September 30, 1997 and 1996,
respectively.
At March 31, 1998, the $5,708,000 investment by Capital Southwest and its
subsidiary consisted of $293,000 in a 12% promissory note and $5,415,000 in
Series A convertible preferred stock, valued at an aggregate of $5,093,000 and
representing a fully-diluted equity interest of 68.4%. The $615,000 difference
between the cost and value of our investment is attributable to the investment
in Varix in earlier years.
--------------------------------------------------------------------------------
Amfibe, Inc. $4,000,000
--------------------------------------------------------------------------------
Amfibe, Inc., Ridgeway, Virginia, manufactures and markets nylon monofilament
yarns for the textile industry. Key market segments for Amfibe's yarns include
(1) warp knit (fabric used in very sheer specialty fabrics for bras, lingerie
lace and bridal veils), (2) very sheer nylon hosiery, and (3) textile weaving
(filtration fabrics and selvage yarns). Amfibe's new manufacturing facility in
Ridgeway, Virginia enlarges the company's production capacity.
During the year ended May 31, 1997, Amfibe reported net sales of $9,565,000,
compared with $6,779,000 in the previous year.
At March 31, 1998, Capital Southwest's subsidiary owned 2,000 shares of
Amfibe Class B non-voting common stock, which had a cost of $200,000 and was
valued at $4,000,000, representing a 40.0% fully-diluted equity interest.
8
Portfolio of Investments - March 31, 1998
Company Equity (a) Investment (b) Cost Value (c)
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AIRFORMED COMPOSITES, INCORPORATED 51.8% 10% subordinated debentures, due 2007
Charleston, South Carolina (acquired 12-12-97) $ 1,800,000 $ 1,800,000
Airformed composite materials for use in 425,000 shares Series A convertible
absorbent specialty products. preferred stock, convertible into
425,000 shares of common stock at
$1.00 per share (acquired 12-12-97) 425,000 425,000
----------- -----------
2,225,000 2,225,000
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+ALAMO GROUP INC. 27.0% 2,660,000 shares common stock (acquired
San Antonio, Texas 4-1-73 and 7-18-78) 575,000 37,240,000
Heavy-duty, tractor-mounted mowing Warrant to purchase 62,500 shares of common
and vegetation maintenance equipment stock at $16.00 per share, expiring 2000
for agricultural and governmental markets. (acquired 11-25-91) - -
----------- -----------
575,000 37,240,000
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ALL COMPONENTS, INC. 29.3% 14% subordinated debenture, due 1999
Dallas, Texas (acquired 9-16-94) 600,000 600,000
Distribution and production of memory 150,000 shares Series A convertible preferred
and other components to personal computer stock, convertible into 600,000 shares of
manufacturers, retailers and value-added common stock at $0.25 per share
resellers. (acquired 9-16-94) 150,000 2,100,000
450,000 shares Series B preferred stock
(acquired 9-16-94) 450,000 450,000
----------- -----------
1,200,000 3,150,000
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+AMERICAN HOMESTAR CORPORATION 4.1% ++751,059 shares common stock (acquired
League City, Texas 8-31-93, 7-12-94 and 3-28-96) 3,405,824 16,992,710
Integrated manufacturing, retailing
and financing of manufactured
housing produced in 11 plants.
------------------------------------------------------------------------------------------------------------------------------------
AMFIBE, INC. 40.0% 2,000 shares Class B non-voting common stock
Ridgeway, Virginia (acquired 6-15-94) 200,000 4,000,000
Nylon monofilament yarns for the textile industry.
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BALCO, INC. 85.0% 14% subordinated debentures, payable 1998 to
Wichita, Kansas 2002 (acquired 8-13-91) 400,000 400,000
Specialty architectural products used in 14% subordinated debenture, payable 1998 to
the construction and remodeling of 2002, last maturing $250,000 convertible into
commercial and institutional buildings. 250,000 shares of common stock at $1.00 per
share (acquired 6-1-91) 800,000 800,000
110,000 shares common stock and 60,920 shares
Class B non-voting common stock
(acquired 10-25-83) 170,920 170,920
Warrants to purchase 85,000 shares of common
stock at $2.40 per share, expiring 2001
(acquired 8-13-91) - -
---------- -----------
1,370,920 1,370,920
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+Publicly-owned company ++Unrestricted securities as defined in Note (b)
9
Company Equity (a) Investment (b) Cost Value (c)
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CDC TECHNOLOGIES, INC. 8.8% 1,694 shares Series C convertible preferred
Oxford, Connecticut stock, convertible into 1,694 shares of
Hematology and blood chemistry analyzers common stock at $737.65 per share
for medical and veterinary applications. (acquired 10-15-97) $ 1,249,579 $ 1,249,579
Warrants to acquire 339 shares of
Series C convertible preferred stock at
$737.65 per share (acquired 12-17-97) - -
----------- -----------
1,249,579 1,249,579
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▇▇▇▇▇▇ TOOL COMPANY 43.9% 98,687 shares common stock (acquired 3-7-94) 330,000 2,800,000
Houston, Texas
Polycrystalline diamond compacts (PDCs)
used in oil field drill bits and in
mining and industrial applications.
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+ENCORE WIRE CORPORATION 14.6% 1,683,000 shares common stock (acquired
McKinney, Texas 7-16-92, 3-15-94 and 4-28-94) 4,100,000 33,660,000
Electrical wire and cable for residential
and commercial use.
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+FMC CORPORATION <1% ++6,430 shares common stock (acquired 6-6-86) 123,777 504,754
Chicago, Illinois
Machinery and chemicals in diversified
product areas.
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+FRONTIER CORPORATION <1% ++31,338 shares common stock (acquired 12-20-95) 78,346 1,020,444
Rochester, New York
Diversified telecommunications company.
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INTELLIGENT REASONING SYSTEMS, INC. 15.3% 8.5%subordinated promissory note, convertible
Austin, Texas into 352,565 shares of Series B convertible
Machine vision systems for automatic preferred stock at $0.60 per share
inspection of electronic circuit boards. (acquired 11-21-97 and 2-3-98) 211,539 211,539
705,128 shares Series B convertible preferred
stock, convertible into 705,128 shares of
common stock at $0.60 per share
(acquired 5-28-97) 423,077 423,077
Warrant to acquire 70,513 shares of Series B
convertible preferred stock at $.60 per
share (acquired 11-21-97) - -
------------ -----------
634,616 634,616
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+▇▇▇▇▇▇▇▇-▇▇▇▇▇ CORPORATION (formerly Tecnol <1% ++77,180 shares common stock
Medical Products, Inc.) (acquired 12-18-97) 2,396,926 3,868,648
Irving, Texas
Household and personal care products.
------------------------------------------------------------------------------------------------------------------------------------
+MAIL-WELL, INC. 3.8% 1,041,094 shares common stock (acquired
Englewood, Colorado 2-18-94, 12-14-94 and 7-27-95) 2,889,010 24,986,000
Customized envelopes, labels and
high-impact printing.
------------------------------------------------------------------------------------------------------------------------------------
+Publicly-owned company ++Unrestricted securities as defined in Note (b)
10
Company Equity (a) Investment (b) Cost Value (c)
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MEDIA RECOVERY, INC. (formerly Varix Corporation) 68.4% 12% promissory note, due 1998
▇▇▇▇▇▇, Texas (acquired 11-4-97) $ 293,000 $ 293,000
Computer and office automation supplies 4,800,000 shares Series A convertible
and accessories;impact and tilt monitoring preferred stock, convertible into
devices to detect mishandled 4,800,000 shares of common stock at $1.00
shipments. per share (acquired 11-4-97) 5,415,000 4,800,000
--------- ---------
5,708,000 5,093,000
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+MYLAN LABORATORIES INC. <1% ++128,286 shares common stock
Pittsburgh, Pennsylvania (acquired 11-20-91) 400,000 2,950,578
Proprietary and generic pharmaceutical
products.
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+PALM HARBOR HOMES, INC. 33.2% 6,284,096 shares common stock
Dallas, Texas (acquired 1-3-85, 3-31-88 and 7-31-95) 10,931,955 138,250,000
Integrated manufacturing, retailing,
financing and insuring of manufactured
housing produced in 16 plants.
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+PETSMART, INC. <1% ++654,220 shares common stock
Phoenix, Arizona (acquired 6-1-95) 2,878,733 6,991,976
Retail chain of 468 stores selling pet
foods, supplies and services.
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THE RECTORSEAL CORPORATION 100.0% 27,907 shares common stock
Houston, Texas (acquired 1-5-73 and 3-31-73) 52,600 38,500,000
Chemical specialty products for industrial,
construction and oil field applications;
owns 20% of ▇▇▇▇▇▇▇▇ Manufacturing.
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REWIND HOLDINGS, INC. 40.7% 12% subordinated notes, payable 1998
Sugar Land, Texas to 2003 (acquired 10-21-96 and 8-13-97) 3,225,000 3,225,000
Owns ▇▇▇▇ ▇▇▇▇▇ Productions, Inc., 375 shares 8% Series A convertible
a producer of radio and television preferred stock, convertible into 1,500
commercials and music videos. shares of common stock at $250.00
per share (acquired 10-21-96) 375,000 375,000
----------- -----------
3,600,000 3,600,000
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SDI HOLDING CORP. 11.1% 60,000 shares common stock (acquired 3-26-96) 6,000,000 6,000,000
Greenville, South Carolina
Owns Sterling Diagnostic Imaging,
a manufacturer of medical x-ray imaging
film and direct radiography systems.
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SKYLAWN CORPORATION 100.0% 1,449,026 shares common stock
Hayward, California (acquired 7-16-69) 4,510,400 42,000,000
Cemeteries, mausoleums and mortuaries
located in northern California.
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+Publicly-owned company ++Unrestricted securities as defined in Note (b)
11
Company Equity (a) Investment (b) Cost Value (c)
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+SPRINT CORPORATION <1% ++36,000 shares common stock
Westwood, Kansas (acquired 6-20-84) $ 503,645 $ 2,436,750
Diversified telecommunications company.
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+TELE-COMMUNICATIONS, INC.-Liberty Media Group <1% ++101,250 shares Series A common stock
Englewood, Colorado (acquired 8-4-95) - 3,474,141
Production and distribution of cable
television programming services.
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+TELE-COMMUNICATIONS, INC. - TCI Group <1% ++114,516 shares Series A common stock
Englewood, Colorado (acquired 6-3-69) 43 3,557,153
Operation of the nation's largest cable
television system.
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+TELE-COMMUNICATIONS, INC. - TCI Ventures Group <1% ++130,968 shares Series A common stock
Englewood, Colorado (acquired 9-17-97) 25 2,300,126
Wireless and wireline communications services.
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TEXAS PETROCHEMICAL HOLDINGS, INC. 5.4% 30,000 shares common stock
Houston, Texas (acquired 6-27-96) 3,000,000 1,500,000
Butadiene for synthetic rubber, MTBE for
gasoline octane enhancement and
butylenes for varied applications.
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TEXAS SHREDDER, INC. 45.7% 14% subordinated debentures, payable 1999
San Antonio, Texas (acquired 3-6-91) 562,500 562,500
Design and manufacture of heavy-duty shredder 3,000 shares Series A preferred stock (acquired
systems for recycling steel and other 3-6-91) 300,000 300,000
materials from junk automobiles. 750 shares Series B convertible preferred stock,
convertible into 7,500 shares of common stock
at $10.00 per share (acquired 3-6-91) 75,000 2,625,000
----------- ----------
937,500 3,487,500
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+TRITON ENERGY CORPORATION <1% ++6,022 shares common stock (acquired 12-15-86) 144,167 221,309
Dallas, Texas
Oil and gas exploration and development.
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WESTMARC COMMUNICATIONS, INC. - 21 shares 12% Series C cumulative compounding pre- - 508,000
Denver, Colorado ferred stock (acquired 1-3-90)
Cable television systems and microwave
relay systems.
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+Publicly-owned company ++Unrestricted securities as defined in Note (b)
12
Company Equity (a) Investment (b) Cost Value (c)
------------------------------------------------------------------------------------------------------------------------------------
THE ▇▇▇▇▇▇▇▇ MANUFACTURING COMPANY 80.0% 80 shares common stock (acquired 8-31-79) $ 1,600,000 $ 6,000,000
Rockwall, Texas
Specialized mining and industrial
lubricants; automotive transit coatings;
floor-finishing compounds and equipment.
------------------------------------------------------------------------------------------------------------------------------------
MISCELLANEOUS 98.8% Humac Company-1,041,000 shares common stock
(acquired 1-31-75 and 12-31-75) - 210,000
<1% +360 Communications Company-++12,000 shares
common stock (acquired 3-7-96) 108,355 375,000
<1% +TCI Satellite Entertainment, Inc.-++18,000
shares Series A common stock
(acquired 12-4-96) - 128,250
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TOTAL INVESTMENTS $61,154,421 $401,286,454
=========== ============
------------------------------------------------------------------------------------------------------------------------------------
+Publicly-owned company ++Unrestricted securities as defined in Note (b)
Notes to Portfolio of Investments
(a) 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 shares, plus shares reserved
for all outstanding warrants, convertible securities and employee stock options.
The symbol "<1%" indicates that the Company holds a potential equity interest of
less than one percent.
(b) 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 March 31, 1998, restricted securities represented
approximately 89% of the value of the consolidated investment portfolio.
(c) Under the valuation policy of the Company, unrestricted securities are
valued at the closing sale price for listed securities and at the closing bid
price for over-the-counter securities on the valuation date. Restricted
securities, including securities of publicly-owned companies which are subject
to restrictions on resale, are valued at fair value as determined by the Board
of Directors. Fair value is considered to be the amount which the Company may
reasonably expect to receive for portfolio securities if such securities were
sold on the valuation date. Valuations as of any particular date, however, are
not necessarily indicative of amounts which may ultimately be realized as a
result of future sales or other dispositions of securities.
Among the factors considered by the Board of Directors in determining the
fair value of restricted securities are 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
13
Notes to Portfolio of Investments (continued)
values of similar securities issued by companies in similar businesses, the
proportion of the issuer's securities owned by the Company, 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.
(d) Agreements between certain issuers and the Company provide that the issuers
will bear substantially all costs in connection with the disposition of common
stocks, including those costs involved in registration under the Securities Act
of 1933 but excluding underwriting discounts and commissions. These agreements,
which cover common stocks owned at March 31, 1998 and common stocks which may be
acquired thereafter through exercise of warrants and conversion of debentures
and preferred stocks, 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, Skylawn
Corporation and The ▇▇▇▇▇▇▇▇ Manufacturing Company.
(e) The descriptions of the companies and ownership percentages shown in the
portfolio of investments were obtained from published reports and other sources
believed to be reliable, are supplemental and are not covered by the report of
independent auditors. Acquisition dates indicated are the dates specific
securities were acquired. Certain securities were received in exchange for or
upon conversion or exercise of other securities previously acquired.
Portfolio Changes During the Year
New Investments and Additions to Previous Investments
Amount
-----------
Airformed Composites, Incorporated........................ $ 2,225,000
CDC Technologies, Inc..................................... 1,449,579
Intelligent Reasoning Systems, Inc........................ 634,616
Media Recovery, Inc....................................... 4,800,000
Rewind Holdings, Inc...................................... 600,000
-----------
$ 9,709,195
===========
Dispositions
Amount
Cost Received
---------- ------------
Cherokee Communications, Inc............ $ - $ 515,020
Data Race, Inc.......................... 574,814 2,193,902
Dymetrol Company, Inc................... 199,115 199,115
LiL' Things, Inc........................ 3,990,894 -
MESC Holdings, Inc...................... - 553,745
PTS Holdings, Inc....................... 2,000,000 13,208,110
---------- ------------
$6,764,823 $ 16,669,892
========== ============
Repayments Received..................... $ 1,697,866
============
14
Capital Southwest Corporation and Subsidiary
Consolidated Statements of Financial Condition
March 31
---------------------------
Assets 1998 1997
------------ ------------
Investments at market or fair value (Notes 1
and 2)
Companies more than 25% owned
(Cost: 1998 - $19,370,874,
1997 - $20,552,361)................... $266,370,919 $203,399,920
Companies 5% to 25% owned
(Cost: 1998 - $14,984,195,
1997 - $19,979,904)................... 43,044,195 35,747,002
Companies less than 5% owned
(Cost: 1998 - $26,799,352,
1997 - $19,375,650)................... 91,871,340 54,144,104
------------- ------------
Total investments
(Cost: 1998 - $61,154,421,
1997 - $59,907,915)................... 401,286,454 293,291,026
Cash and cash equivalents.................. 117,047,920 14,009,481
Receivables................................ 332,873 279,815
Other assets (Note 8)...................... 3,656,308 3,180,171
------------ -----------
Totals.................................. $522,323,555 $310,760,493
============ ============
March 31
---------------------------
Liabilities and Shareholders' Equity 1998 1997
-------- --------
Note payable to bank (Note 4) ............. $100,000,000 $ -
Accrued interest and other liabilities
(Note 8) 1,961,382 1,735,372
Income taxes payable....................... - 3,184,373
Deferred income taxes (Note 3)............. 119,339,357 81,868,628
Subordinated debenture (Note 5)............ 5,000,000 5,000,000
------------ ------------
Total liabilities ..... 226,300,739 91,788,373
------------ ------------
Shareholders' equity (Notes 3 and 6)
Common stock, $1 par value: authorized,
5,000,000 shares; issued, 4,225,316
shares at March 31, 1998 and 4,204,416
shares at March 31, 1997.............. 4,225,316 4,204,416
Additional capital...................... 5,512,409 4,813,121
Undistributed net investment
income................................ 5,261,898 4,804,205
Undistributed net realized gain on
investments........................... 66,598,460 60,113,568
Unrealized appreciation of investments -
net of deferred income taxes.......... 221,458,035 152,070,112
Treasury stock - at cost
(437,365 shares)...................... (7,033,302) (7,033,302)
------------ ------------
Net assets at market or fair value,
equivalent to $78.15 per share on the
3,787,951 shares outstanding at
March 31, 1998, and $58.13 per share
on the 3,767,051 shares outstanding at
March 31, 1997........................ 296,022,816 218,972,120
------------ ------------
Totals.............. $522,323,555 $310,760,493
============ ============
See Notes to Consolidated Financial Statements
15
Capital Southwest Corporation and Subsidiary
Consolidated Statements of Operations
Years Ended March 31
--------------------------------------------
1998 1997 1996
------------ ------------ ------------
Investment income (Note 9):
Interest..................................................................... $ 2,025,024 $ 1,371,802 $ 2,018,308
Dividends.................................................................... 2,237,293 2,774,321 3,597,004
Management and directors' fees............................................... 569,900 586,900 561,950
------------ ------------ ------------
4,832,217 4,733,023 6,177,262
------------ ------------ ------------
Operating expenses:
Interest..................................................................... 426,962 634,667 1,700,003
Salaries..................................................................... 1,206,478 1,147,294 1,112,640
Net pension expense (benefit) (Note 8)....................................... (313,511) (349,903) (208,701)
Other operating expenses (Note 7)............................................ 674,466 599,578 642,955
------------- ------------ ------------
1,994,395 2,031,636 3,246,897
------------ ------------ ------------
Income before income taxes...................................................... 2,837,822 2,701,387 2,930,365
Income tax expense (Note 3)..................................................... 111,678 127,325 75,448
------------ ------------ ------------
Net investment income .......................................................... $ 2,726,144 $ 2,574,062 $ 2,854,917
============ ============ ============
Proceeds from disposition of investments........................................ $ 16,669,892 $ 14,177,580 $ 21,470,173
Cost of investments sold (Note 1)............................................... 6,764,823 3,619,369 4,938,933
------------ ------------ ------------
Realized gain on investments before income taxes (Note 9)....................... 9,905,069 10,558,211 16,531,240
Income tax expense ............................................................. 3,420,177 3,752,425 5,357,215
------------ ------------ ------------
Net realized gain on investments................................................ 6,484,892 6,805,786 11,174,025
------------ ------------ ------------
Increase in unrealized appreciation of investments before income taxes and
distributions................................................................. 106,748,923 34,996,750 54,619,668
Increase in deferred income taxes on appreciation of investments (Note 3)....... 37,361,000 12,192,000 15,874,000
------------ ------------ ------------
Net increase in unrealized appreciation of investments before distributions..... 69,387,923 22,804,750 38,745,668
------------ ------------ ------------
Net realized and unrealized gain on investments before distributions............ $ 75,872,815 $ 29,610,536 $ 49,919,693
============ ============ ============
Increase in net assets from operations before distributions..................... $ 78,598,959 $ 32,184,598 $ 52,774,610
============ ============ ============
See Notes to Consolidated Financial Statements
16
Capital Southwest Corporation and Subsidiary
Consolidated Statements of Changes in Net Assets
Years Ended March 31
--------------------------------------------
1998 1997 1996
------------ ------------ -------------
Operations
Net investment income........................................................ $ 2,726,144 $ 2,574,062 $ 2,854,917
Net realized gain on investments............................................. 6,484,892 6,805,786 11,174,025
Net increase in unrealized appreciation of investments before distributions.. 69,387,923 22,804,750 38,745,668
------------ ------------- -------------
Increase in net assets from operations before distributions.................. 78,598,959 32,184,598 52,774,610
Distributions from:
Undistributed net investment income.......................................... (2,268,451) (2,260,231) (2,253,831)
Undistributed net realized gain on investments............................... - - (153,376)
Unrealized appreciation of investments....................................... - - (9,264,304)
Capital share transactions
Exercise of employee stock options........................................... 720,188 - 574,750
------------ ------------- -------------
Increase in net assets....................................................... 77,050,696 29,924,367 41,677,849
Net assets, beginning of year................................................... 218,972,120 189,047,753 147,369,904
------------- ------------- -------------
Net assets, end of year ........................................................ $296,022,816 $218,972,120 $189,047,753
============ ============ ============
See Notes to Consolidated Financial Statements
17
Capital Southwest Corporation and Subsidiary
Consolidated Statements of Cash Flows
Years Ended March 31
------------------------------------------------
1998 1997 1996
------------- ------------ ------------
Cash flows from operating activities
Increase in net assets from operations before distributions..................... $ 78,598,959 $ 32,184,598 $ 52,774,610
Adjustments to reconcile increase in net assets from operations before
distributions to net cash provided by
operating activities:
Depreciation and amortization................................................ 23,770 31,240 33,439
Net pension benefit.......................................................... (313,511) (349,903) (208,701)
Net realized and unrealized gain on investments.............................. (75,872,815) (29,610,536) (49,919,693)
(Increase) decrease in receivables........................................... (53,058) 5,187 (41,369)
(Increase) decrease in other assets.......................................... (7,035) (17,812) 28,950
Increase (decrease) in accrued interest and other liabilities................ 46,649 (66,361) 48,075
Deferred income taxes........................................................ 109,729 122,500 72,640
------------- ------------ ------------
Net cash provided by operating activities....................................... 2,532,688 2,298,913 2,787,951
------------- ------------ ------------
Cash flows from investing activities
Proceeds from disposition of investments........................................ 16,669,892 14,177,580 21,470,173
Purchases of securities......................................................... (9,709,195) (6,023,684) (19,406,816)
Maturities of securities........................................................ 1,697,866 1,040,500 5,515,824
Income taxes paid on realized gain on investments............................... (6,604,549) (6,268,782) -
------------- ------------ ------------
Net cash provided by investing activities....................................... 2,054,014 2,925,614 7,579,181
------------- ------------ ------------
Cash flows from financing activities
Increase (decrease) in note payable to bank..................................... 100,000,000 (50,000,000) 50,000,000
Repayment of subordinated debenture............................................. - (6,000,000) -
Distributions from undistributed net investment income.......................... (2,268,451) (2,260,231) (2,253,831)
Distributions from undistributed net realized gain on investments............... - - (15,842)
Proceeds from exercise of employee stock options................................ 720,188 - 574,750
------------- ------------ ------------
Net cash provided (used) by financing activities................................ 98,451,737 (58,260,231) 48,305,077
------------- ------------- ------------
Net increase (decrease) in cash and cash equivalents............................ 103,038,439 (53,035,704) 58,672,209
Cash and cash equivalents at beginning of year.................................. 14,009,481 67,045,185 8,372,976
------------- ------------ ------------
Cash and cash equivalents at end of year........................................ $ 117,047,920 $ 14,009,481 $ 67,045,185
============= ============ ============
Supplemental disclosure of cash flow information:
Cash paid during the year for: Interest ...................................... $ 400,000 $ 691,397 $ 1,653,277
Income taxes................................... $ 6,621,499 $ 6,270,291 $ 483
Supplemental disclosure of financing activities:
On July 31, 1995, Capital Southwest Corporation distributed to its shareholders
1,175,230 shares of common stock of Palm Harbor Homes, Inc., which had a cost of
$137,534 and a fair market value of $8.00 per share, or $9,401,838, as adjusted
for 5-for-4 stock splits on August 2, 1996 and July 21, 1997.
See Notes to Consolidated Financial Statements
18
Notes to Consolidated Financial Statements
1. Summary of Significant Accounting Policies
Capital Southwest Corporation ("CSC") is a business development company
subject to regulation under the Investment Company Act of 1940. Capital
Southwest Venture Corporation ("CSVC"), a wholly-owned subsidiary of CSC, is a
Federal licensee under the Small Business Investment Act of 1958. The following
is a summary of significant accounting policies followed in the preparation of
the consolidated financial statements of CSC and CSVC (together, the "Company"):
Principles of Consolidation. The consolidated financial statements have
been prepared on the value method of accounting in accordance with generally
accepted accounting principles for investment companies. All significant
intercompany accounts and transactions have been eliminated in consolidation.
Cash and Cash Equivalents. All temporary cash investments having a maturity
of three months or less when purchased are considered to be cash equivalents.
Portfolio Security Valuations. Investments are stated at market or fair
value determined by the Board of Directors as described in the Notes to
Portfolio of Investments and Note 2 below. The average cost method is used in
determining cost of investments sold.
2. Valuation of Investments
The consolidated financial statements as of March 31, 1998 and 1997 include
securities valued at $356,464,614 (89% of the value of the consolidated
investment portfolio) and $257,914,916 (88% of the value of the consolidated
investment portfolio), respectively, whose values have been determined by the
Board of Directors in the absence of readily ascertainable market values.
Because of the inherent uncertainty of valuation, these values may differ
significantly from the values that would have been used had a ready market for
the securities existed, and the differences could be material.
3. Income taxes
For the tax years ended December 31, 1997, 1996 and 1995, CSC and CSVC
qualified to be taxed as regulated investment companies ("RICs") under
applicable provisions of the Internal Revenue Code. As RICs, CSC and CSVC must
distribute at least 90% of their taxable net investment income (investment
company taxable income) and may either distribute or retain their taxable net
realized gain on investments (capital gains). Both CSC and CSVC intend to meet
the applicable qualifications to be taxed as RICs in future years; however,
either company's ability to meet certain portfolio diversification requirements
of RICs in future years may not be controllable by such company.
No provision was made for Federal income taxes on the investment company
taxable income of CSC and CSVC for the 1998, 1997 and 1996 fiscal years. Such
income was distributed to shareholders in the form of cash dividends for which
CSC and CSVC receive a tax deduction. With respect to net investment income, the
income tax expense for each of the three years ended March 31, 1998 includes a
deferred tax provision related to the net pension benefit.
With respect to the net increase in unrealized appreciation of investments
before distributions during fiscal 1996, the increase in deferred income taxes
on appreciation of investments at the Federal statutory rate of 35% differs from
the amount reported in the financial statements due to the distribution of
appreciated securities with no associated tax liability.
CSC and CSVC may not qualify or elect to be taxed as RICs in future years.
Therefore, consolidated deferred Federal income taxes of $118,674,000 and
$81,313,000 have been provided on net unrealized appreciation of investments of
$340,132,033 and $233,383,111 at March 31, 1998 and 1997, respectively. Such
appreciation is not included in taxable income until realized. Deferred income
taxes on net unrealized appreciation of investments have been provided at the
then currently effective maximum Federal corporate tax rate on capital gains of
35% at March 31, 1998 and 1997.
19
4. Note Payable to Bank
The note payable to bank at March 31, 1998 was an unsecured note with
interest payable at 6.51%. The note was paid in full on April 1, 1998.
5. Subordinated Debenture
The subordinated debenture of $5,000,000 outstanding at March 31, 1998 and
1997 is payable to others and guaranteed by the Small Business Administration
("SBA"), bears interest at 8.0% and matures in 2002.
6. Employee Stock Option Plan
Under the 1984 Incentive Stock Option Plan, options to purchase 69,100
shares of the Company's common stock at $35.625 per share (the adjusted market
price at the time of grant) were outstanding at March 31, 1998. Options on
49,725 shares were exercisable at March 31, 1998. During the year ended March
31, 1998, options for 20,900 shares were exercised. Outstanding options expire
2000 through 2003. The 1984 Incentive Stock Option Plan expired in 1994 and no
options have been authorized or granted since that date. At March 31, 1998 and
1997, the dilution of net assets per share arising from options outstanding was
not material.
7. Employee Stock Ownership Plan
The Company and one of its wholly-owned subsidiaries sponsor a qualified
employee stock ownership plan ("ESOP") in which certain employees participate.
Contributions to the plan, which are invested in Company stock, are made at the
discretion of the Company's Board of Directors. A participant's interest in
contributions to the ESOP fully vests after five years of active service. During
the three years ended March 31, the Company made contributions to the ESOP,
which were charged against net investment income, of $67,763 in 1998, $54,104 in
1997 and $76,341 in 1996.
8. Retirement Plan
The Company sponsors a qualified defined benefit pension plan which covers
its employees and employees of certain of its wholly-owned subsidiaries. The
following information about the plan represents amounts and information related
to the Company's participation in the plan and is presented as though the
Company sponsored a single-employer plan. Benefits are based on years of service
and an average of the highest five consecutive years of compensation during the
last ten years of employment. The funding policy of the plan is to contribute
annual amounts that are currently deductible for tax reporting purposes. No
contribution was made to the plan during the three years ended March 31, 1998.
Components of net pension benefit related to the qualified plan include the
following:
Years Ended March 31
------------------------------------
1998 1997 1996
---------- --------- ----------
Service cost - benefits earned during
the year............................ $ 52,388 $ 47,662 $ 42,184
Interest cost on projected benefit
obligation.......................... 204,328 174,792 165,906
Actual return on assets.................. (3,563,399) (961,831) (1,421,745)
Net amortization and deferral............ 2,813,811 257,580 873,696
---------- --------- ----------
Net pension expense (benefit) from
qualified plan...................... $ (492,872) $(481,797) $ (339,959)
========== ========= ==========
20
The following table sets forth the qualified plan's funded status and
amounts recognized in the Company's consolidated statements of financial
condition:
March 31
-------------------------
1998 1997
Actuarial present value of benefit ----------- -----------
obligations: Accumulated benefit obligation,
including vested benefits of $2,602,654 in
1998 and $2,017,257 in 1997.................... $(2,665,123) $(2,082,399)
=========== ===========
Projected benefit obligation for service rendered to
date........................................... $(3,059,555) $(2,376,257)
Plan assets at fair value*.......................... 11,314,714 7,820,401
----------- -----------
Excess of plan assets over the projected benefit
obligation..................................... 8,255,159 5,444,144
Unrecognized net (gain) loss from past experience
different from that assumed and effects of
changes in assumptions......................... (4,214,675) (1,819,422)
Prior service costs not yet recognized.............. (36,440) (39,719)
Unrecognized net assets being amortized over
19 years...................................... (516,801) (590,632)
----------- -----------
Prepaid pension cost included in other assets $ 3,487,243 $ 2,994,371
=========== ===========
--------------
*Primarily equities and bonds including approximately 29,700 shares of common
stock of the Company.
The weighted-average discount rate and rate of increase in future
compensation levels used in determining the actuarial present value of the
projected benefit obligation were 7.0% and 5.0%, respectively, at March 31,
1998, 8.0% and 5.0%, respectively, at March 31, 1997 and 7.75% and 5.25%,
respectively, at March 31, 1996. The expected long-term rate of return used to
project estimated earnings on plan assets was 8.5% for the years ended March 31,
1998, 1997 and 1996. The calculations also assume retirement at age 65, the
normal retirement age.
The Company also sponsors an unfunded Retirement Restoration Plan, which is
a nonqualified plan that provides for the payment, upon retirement, of the
difference between the maximum annual payment permissible under the qualified
retirement plan pursuant to Federal limitations and the amount which would
otherwise have been payable under the qualified plan.
The following table sets forth the status of the Retirement Restoration
Plan and the amounts recognized in the consolidated statements of financial
condition:
March 31
-------------------------
1998 1997
----------- -----------
Projected benefit obligation....................... $(2,051,899) $(1,474,701)
Unrecognized net (gain) loss from past ex-
perience different from that assumed
and effects of changes in assumptions......... 406,217 (11,453)
Unrecognized net obligation........................ 59,489 79,322
----------- -----------
Accrued pension cost included in other liabilities. $(1,586,193) $(1,406,832)
=========== ===========
The Retirement Restoration Plan expenses recognized during the years ended
March 31, 1998, 1997 and 1996 of $179,361, $131,894 and $131,258, respectively,
are offset against the net pension benefit from the qualified plan.
21
9. Sources of Income
Income was derived from the following sources:
Investment Income Realized Gain
----------------------------------
(Loss) on
Years Ended Investments
March 31 Other Before Income
--------
1998 Interest Dividends Income Taxes
---- ---------------------------------- -------------
Companies more than
25% owned........... $ 168,000 $1,985,200 $518,900 $ -
Companies 5% to 25%
owned............... 8,706 - 35,500 (3,990,894)
Companies less than
5% owned............ 609,187 252,093 15,500 13,895,963
Other sources,
including temporary
investments......... 1,239,131 - - -
------------------------------------------------
$2,025,024 $2,237,293 $569,900 $ 9,905,069
================================================
1997
----
Companies more than
25% owned........... $ 237,600 $2,454,895 $531,400 $ -
Companies 5% to 25%
owned............... - - 55,500 2,844,272
Companies less than
5% owned............ 496,847 319,426 - 7,713,939
Other sources,
including temporary
investments......... 637,355 - - -
------------------------------------------------
$1,371,802 $2,774,321 $586,900 $10,558,211
================================================
1996
----
Companies more than
25% owned........... $ 755,146 $3,101,219 $545,200 $ -
Companies 5% to 25%
owned............... 2,730 - 16,750 17,954,600
Companies less than
5% owned............ 568,915 495,785 - (1,423,360)
Other sources,
including temporary
investments......... 691,517 - - -
------------------------------------------------
$2,018,308 $3,597,004 $561,950 $16,531,240
================================================
10. Summarized Financial Information of Unconsolidated
Subsidiaries
The Company has three significant wholly-owned subsidiaries - The
RectorSeal Corporation, The ▇▇▇▇▇▇▇▇ Manufacturing Company and Skylawn
Corporation which are neither investment companies nor business development
companies. Accordingly, the accounts of such subsidiaries are not included with
those of the Company. Summarized combined financial information of the three
subsidiaries is as follows:
(all figures in thousands) March 31
-----------------------------
1998 1997
-------- -------
Condensed Balance Sheet Data
Assets
Cash and temporary
investments........................$ 13,496 $11,240
Receivables.......................... 21,769 22,762
Inventories.......................... 34,452 32,825
Property, plant and equipment........ 29,223 19,252
Other assets......................... 12,316 11,553
-------- -------
Totals............................. $111,256 $97,632
======== =======
Liabilities and Shareholder's Equity
Long-term debt.......................$ 5,540 $ 681
Other liabilities.................... 12,836 11,486
Shareholder's equity................. 92,880 85,465
--------- ---------
Totals.............................$ 111,256 $97,632
========= =========
Condensed Statements of Income 1998 1997 1996
-------- ------- -------
Revenues.............................$ 77,275 $70,890 $69,058
Costs and operating expenses.........$ 66,223 $61,760 $60,050
Net income...........................$ 8,066 $ 7,909 $ 6,865
11. Commitments
The Company leases office space under an operating lease which requires
base annual rentals of approximately $58,000 through February, 2003. For the
three years ended March 31, total rental expense charged to investment income
was $44,285 in 1998, $43,844 in 1997 and $43,449 in 1996.
22
Selected Per Share Data and Ratios
Years Ended March
--------------------------------------------
1998 1997 1996 1995 1994
--------------------------------------------
Investment income.................................................................$ 1.28 $ 1.26 $ 1.64 $ 1.37 $ 1.48
Operating expenses................................................................ (.42) (.37) (.41) (.32) (.30)
Interest expense.................................................................. (.11) (.17) (.45) (.37) (.39)
Income taxes...................................................................... (.03) (.03) (.02) (.01) (.02)
--------------------------------------------
Net investment income............................................................. .72 .69 .76 .67 .77
Distributions from undistributed net investment income............................ (.60) (.60) (.60) (.60) (.60)
Net realized gain (loss) on investments........................................... 1.71 1.81 2.97 .04 (.13)
Distributions from undistributed net realized gain on investments................. - - (.04) - -
Net increase in unrealized appreciation of investments before distributions....... 18.32 6.05 10.28 3.64 3.00
Distributions from unrealized appreciation of investments......................... - - (2.46) - -
Exercise of employee stock options*............................................... (.13) - (.19) (.10) (.22)
--------------------------------------------
Increase in net asset value....................................................... 20.02 7.95 10.72 3.65 2.82
Net asset value:
Beginning of year............................................................... 58.13 50.18 39.46 35.81 32.99
--------------------------------------------
End of year..................................................................... $78.15 $58.13 $50.18 $39.46 $35.81
===========================================
Ratio of operating expenses to average net assets................................. .6% .7% .9% .9% .9%
Ratio of net investment income to average net assets.............................. 1.1% 1.2% 1.7% 1.8% 2.3%
Portfolio turnover rate........................................................... 2.5% 1.6% 4.5% 1.3% 1.3%
Shares outstanding at end of period (000s omitted)................................ 3,788 3,767 3,767 3,735 3,715
---------------
*Net decrease is due to exercise of employee stock options at less than
beginning of period net asset value.
23
Independent Auditors' Report
The Board of Directors and Shareholders of
Capital Southwest Corporation:
We have audited the accompanying consolidated statements of financial
condition of Capital Southwest Corporation and subsidiary as of March 31, 1998
and 1997, including the portfolio of investments as of March 31, 1998, and the
related consolidated statements of operations, changes in net assets, and cash
flows for each of the years in the three-year period ended March 31, 1998 and
the selected per share data and ratios for each of the years in the five-year
period ended March 31, 1998. These financial statements and per share data and
ratios are the responsibility of the Company's management. Our responsibility is
to express an opinion on these financial statements and per share data and
ratios based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements and per share data
and ratios are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. Our procedures included verification of securities owned as of March
31, 1998 and 1997, by examination of such securities held by the custodian. An
audit also includes assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall financial
statement presentation. We believe that our audits provide a reasonable basis
for our opinion.
In our opinion the consolidated financial statements and selected per share
data and ratios referred to above present fairly, in all material respects, the
financial position of Capital Southwest Corporation and subsidiary as of March
31, 1998 and 1997, and the results of their operations, the changes in their net
assets and their cash flows for each of the years in the three-year period ended
March 31, 1998, and the selected per share data and ratios for each of the years
in the five-year period ended March 31, 1998, in conformity with generally
accepted accounting principles.
KPMG PEAT MARWICK LLP
Dallas, Texas
April 24, 1998
24
Management's Discussion and Analysis of
Financial Condition and Results of Operations
Results of Operations
The composite measure of the Company's financial performance in the
Consolidated Statements of Operations is captioned "Increase in net assets from
operations before distributions" and consists of three elements. The first is
"Net investment income", which is the difference between the Company's income
from interest, dividends and fees and its combined operating and interest
expenses, net of applicable income taxes. The second element is "Net realized
gain 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. The third element is the "Net increase in unrealized
appreciation of investments before distributions", which is the net change in
the market or fair value of the Company's investment portfolio, compared with
stated cost, net of an increase or decrease in deferred income taxes which would
become payable if the unrealized appreciation was realized through the sale or
other disposition of the investment portfolio. It should be noted that the "Net
realized gain on investments" and "Net increase in unrealized appreciation of
investments before distributions" 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
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 three
years ended March 31, the Company had interest income from temporary cash
investments of $1,239,000 in 1998, $637,000 in 1997 and $687,000 in 1996. The
Company also receives management fees from its wholly-owned subsidiaries which
aggregated $494,400 in the year ended March 31, 1998, $506,400 in the year ended
March 31, 1997 and $523,200 in the year ended March 31, 1996. During the three
years ended March 31, 1998, the Company recorded dividend income from the
following sources:
Years Ended March 31
----------------------------------
1998 1997 1996
---------- ---------- -----------
Alamo Group Inc. ................... $1,064,000 $1,064,000 $ 1,064,000
Cherokee Communications, Inc. ...... - 108,789 144,000
Humac Company....................... - - 208,200
The RectorSeal Corporation.......... 501,200 940,895 1,529,019
Skylawn Corporation................. 300,000 450,000 300,000
Texas Shredder, Inc. ............... 37,500 37,500 178,125
The ▇▇▇▇▇▇▇▇ Manufacturing Company.. 120,000 - -
Other............................... 214,593 173,137 173,660
---------- ---------- ----------
$2,237,293 $2,774,321 $3,597,004
========== ========== ==========
Total operating expenses, excluding interest expense, increased by $170,464
or 12.2% and decreased by $149,925 or 9.7% during the years ended March 31, 1998
and 1997, respectively. 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 and accounting fees and the net pension benefit. Interest
expense, the majority of which is related to the SBA-guaranteed subordinated
debentures, decreased by $207,705 and $1,065,336 during the years ended March
31, 1998 and 1997, respectively.
Net Realized Gain on Investments
Net realized gain on investments was $6,484,892 (after income tax expense of
$3,420,177) during the year ended March 31, 1998, compared with a gain of
$6,805,786 (after income tax expense of $3,752,425) during 1997 and a gain of
$11,174,025 (after income tax expense of $5,357,215) during 1996. Management
does not attempt to maintain a comparable 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 through the disposition of certain
portfolio investments.
25
Net Increase in Unrealized Appreciation of Investments
For the three years ended March 31, the Company recorded an increase in
unrealized appreciation of investments before income taxes and distributions of
$106,748,923, $34,996,750 and $54,619,668 in 1998, 1997 and 1996, respectively.
As explained in the first paragraph of this discussion and analysis, the
realization of gains or losses results in a corresponding decrease or increase
in unrealized appreciation of investments. Set forth in the following table are
the significant increases and decreases in unrealized appreciation (before the
related change in deferred income taxes and distributions and excluding the
effect of gains or losses realized during the year) by portfolio company for
securities held at the end of each year.
Years Ended March 31
---------------------------------------
1998 1997 1996
----------- ----------- -----------
Alamo Group Inc. .............. $ 5,463,000 $(6,432,000) $ 3,652,000
American Homestar Corporation.. 8,480,708 550,792 3,834,276
Amfibe, Inc.................... 2,400,000 1,400,000 -
Encore Wire Corporation....... 17,279,000 9,782,000 (5,812,000)
Mail-Well, Inc. ............... 14,020,000 6,830,000 1,246,990
Mylan Laboratories, Inc........ 1,042,324 (785,752) (21,381)
Palm Harbor Homes, Inc......... 53,792,000 13,372,000 39,931,777
PETsMART, Inc. ................ (6,092,424) 1,226,663 7,059,004
The RectorSeal Corporation..... 3,500,000 7,000,000 3,000,000
Tele-Communications, Inc.
LM Group.................... 2,132,578 165,938 1,175,625
TCI Group................... 1,419,678 (1,192,500) (450,000)
TCI Ventures Group.......... 2,300,101 - -
Texas Shredder, Inc............ 1,125,000 250,000 1,175,000
A description of the investments listed above and other material components
of the investment portfolio is included elsewhere in this report under the
caption "Portfolio of Investments - March 31, 1998."
Deferred Taxes on Unrealized Appreciation of Investments
The Company provides for deferred Federal income taxes on net unrealized
appreciation of investments. Such taxes would become payable at such time as
unrealized appreciation is realized through the sale or other disposition of
those components of the investment portfolio which would result in taxable
transactions. At March 31, 1998, consolidated deferred Federal income taxes of
$118,674,000 were provided on net unrealized appreciation of investments of
$340,132,033 compared with deferred taxes of $81,313,000 on net unrealized
appreciation of $233,383,111 at March 31, 1997. Deferred income taxes at March
31, 1998 and 1997 were provided at the then currently effective maximum Federal
corporate tax rate on capital gains of 35%.
Portfolio Investments
During the year ended March 31, 1998, the Company invested $9,709,195 in
various portfolio securities listed elsewhere in this report under the caption
"Portfolio Changes During the Year," which also lists dispositions of portfolio
securities. During the 1997 and 1996 fiscal years, the Company invested a total
of $6,023,684 and $19,406,816, respectively.
Financial Liquidity and Capital Resources
At March 31, 1998, the Company had net cash equivalent assets (cash and
cash equivalents less the note payable to bank) of $17.0 million. Pursuant to
Small Business Administration ("SBA") regulations, cash and cash equivalents of
$7.2 million held by CSVC may not be transferred or advanced to CSC without the
consent of the SBA. Under current SBA regulations and subject to SBA's approval
of its credit application, CSVC would be entitled to borrow up to $48.2 million
in addition to the $5 million presently outstanding. Approximately $44.8 million
of the Company's investment portfolio is represented by unrestricted
publicly-traded securities, which have an ascertainable market value and
represent a primary source of liquidity.
26
Funds to be used by the Company for operating or investment purposes may be
transferred in the form of dividends, management fees or loans from Skylawn
Corporation, The RectorSeal Corporation and The ▇▇▇▇▇▇▇▇ Manufacturing Company,
wholly-owned subsidiaries of the Company, to the extent of their available cash
reserves and borrowing capacities.
Management believes that the Company's cash and cash equivalents 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.
Impact of Inflation
The Company does not believe that its business is materially affected by
inflation, other than the impact which inflation may have on the securities
markets, the valuations of business enterprises and the relationship of such
valuations to underlying earnings, all of which will influence the value of the
Company's investments.
Risks
Pursuant to Section 64(b)(1) of the Investment Company Act of 1940, a
business development company is required to describe the risk factors involved
in an investment in the securities of such company due to the nature of the
company's investment portfolio. Accordingly the Company states that:
The Company's objective is to achieve capital appreciation through
investments in businesses believed to have favorable growth potential. Such
businesses are often undercapitalized small companies which lack management
depth and have not yet attained profitability. The Company's venture investments
often include securities which do not yield interest or dividends and are
subject to legal or contractual restrictions on resale, which restrictions
adversely affect the liquidity and marketability of such securities.
Because of the speculative nature of the Company's investments and the lack
of any market for the securities initially purchased by the Company, there is a
significantly greater risk of loss than is the case with traditional investment
securities. The high-risk, long-term nature of the Company's venture investment
activities may prevent shareholders of the Company from achieving price
appreciation and dividend distributions.
27
Selected Consolidated Financial Data
(all figures in thousands except per share data)
1988 1989 1990 1991 1992 1993 1994
--------------------------------------------------------------------------------------------------------
Financial Position (as of March 31)
Investments at cost.......... $ 28,478 $ 29,665 $ 32,212 $ 31,593 $ 34,929 $ 33,953 $ 41,993
Unrealized appreciation...... 89,512 97,134 99,903 107,120 100,277 113,153 132,212
--------- --------- ---------- --------- -------- -------- --------
Investments at market or
fair value................ 117,990 126,799 132,115 138,713 135,206 147,106 174,205
Total assets................. 183,941 131,365 185,231 149,975 208,871 176,422 270,874
Subordinated debentures...... 15,000 15,000 15,000 15,000 11,000 15,000 15,000
Deferred taxes on
unrealized appreciation... 30,073 32,619 33,608 36,063 33,761 38,112 45,932
Net assets................... 78,376 83,124 94,610 97,139 107,522 121,455 133,053
Shares outstanding*.......... 3,563 3,563 3,617 3,617 3,644 3,681 3,715
--------------------------------------------------------------------------------------------------------
Changes in Net Assets (years ended March 31)
Net investment income........ $ 22 $ 716 $ 1,737 $ 2,090 $ 2,363 $ 2,189 $ 2,870
Net realized gain (loss) on
investments............... 497 27 12,722 (2,515) 14,313 5,099 (475)
Net increase (decrease) in
unrealized appreciation
before distributions...... 15,986 5,075 1,780 4,762 (4,541) 8,524 11,160
--------- --------- --------- --------- -------- --------- ---------
Increase in net assets
from operations before
distributions............. 16,505 5,818 16,239 4,337 12,135 15,812 13,555
Cash dividends paid.......... (378) (1,069) (5,197) (1,809) (2,181) (2,202) (2,228)
Securities dividends......... - - - - - - -
Treasury stock acquired...... (4,118) - - - - - -
Employee stock options
exercised................. - - 444 - 429 322 272
--------- --------- --------- --------- -------- --------- ---------
Increase in net assets....... 12,009 4,749 11,486 2,528 10,383 13,932 11,599
--------------------------------------------------------------------------------------------------------
Per Share Data (as of March 31)*
Deferred taxes on
unrealized appreciation... $ 8.44 $ 9.15 $ 9.29 $ 9.97 $ 9.27 $ 10.35 $ 12.36
Net assets................... 22.00 23.33 26.16 26.86 29.51 32.99 35.81
% Increase................ 25.1% 6.0% 12.1% 2.7% 9.9% 11.8% 8.5%
Closing market price......... 17.125 18.25 21.375 20.75 24.25 36.50 38.125
Cash dividends paid.......... 0.10 0.30 1.44 .50 .60 .60 .60
Securities dividends......... - - - - - - -
--------------
* Shares outstanding and per share amounts have been restated to give effect to
a two-for-one stock split in September 1987.
Selected Consolidated Financial Data
(all figures in thousands except per share data)
1995 1996 1997 1998
-----------------------------------------------------------------------
Financial Position (as of March 31)
Investments at cost.......... $ 49,730 $ 58,544 $ 59,908 $ 61,154
Unrealized appreciation...... 153,031 198,386 233,383 340,132
-------- -------- -------- --------
Investments at market or
fair value................ 202,761 256,930 293,291 401,286
Total assets................. 213,811 326,972 310,760 522,324
Subordinated debentures...... 11,000 11,000 5,000 5,000
Deferred taxes on
unrealized appreciation... 53,247 69,121 81,313 118,674
Net assets................... 147,370 189,048 218,972 296,023
Shares outstanding*.......... 3,735 3,767 3,767 3,788
-----------------------------------------------------------------------
Changes in Net Assets (years ended March 31)
Net investment income........ $ 2,447 $ 2,855 $ 2,574 $ 2,726
Net realized gain (loss) on
investments............... 142 11,174 6,806 6,485
Net increase (decrease) in
unrealized appreciation
before distributions...... 13,584 38,746 22,804 69,388
-------- -------- -------- --------
Increase in net assets
from operations before
distributions............. 16,173 52,775 32,184 78,599
Cash dividends paid.......... (2,241) (2,270) (2,260) (2,268)
Securities dividends......... - (9,402) - -
Treasury stock acquired...... - - - -
Employee stock options
exercised................. 385 575 - 720
-------- -------- ------- --------
Increase in net assets....... 14,317 41,678 29,924 77,051
-----------------------------------------------------------------------
Per Share Data (as of March 31)*
Deferred taxes on
unrealized appreciation... $ 14.26 $ 18.35 $ 21.59 $ 31.33
Net assets................... 39.46 50.18 58.13 78.15
% Increase................ 10.2% 27.2% 15.8% 34.4%
Closing market price......... 38.00 60.00 67.875 94.00
Cash dividends paid.......... .60 .60 .60 .60
Securities dividends......... - 2.50 - -
--------------
* Shares outstanding and per share amounts have been restated to give effect to
a two-for-one stock split in September 1987.
28
Shareholder Information
Stock Transfer Agent
American Stock Transfer & Trust Company, ▇▇ ▇▇▇▇ ▇▇▇▇▇▇, ▇▇▇ ▇▇▇▇, ▇▇ ▇▇▇▇▇
(telephone ▇▇▇-▇▇▇-▇▇▇▇) serves as transfer agent for the Company's common
stock. Certificates to be transferred should be mailed directly to the transfer
agent, preferably by registered mail.
Shareholders
The Company had approximately 900 record holders of its common stock at March
31, 1998. This total does not include an estimated 1,700 shareholders with
shares held under beneficial ownership in nominee name or within clearinghouse
positions of brokerage firms or banks.
Market Prices
The common stock of Capital Southwest Corporation is traded in the
over-the-counter market through the National Association of Securities Dealers
Automated Quotation ("Nasdaq") National Market System under the symbol CSWC. The
following high and low selling prices for the shares during each quarter of the
last two fiscal years were taken from quotations provided to the Company by the
National Association of Securities Dealers, Inc.
Quarter Ended High Low
------------------------------------------------------------------------
June 30, 1996.................................... $66 $57 1/2
September 30, 1996............................... 73 63 1/2
December 31, 1996............................... 72 1/2 67 1/4
March 31, 1997................................... 72 65 3/8
Quarter Ended High Low
------------------------------------------------------------------------
June 30, 1997.................................... $73 $65
September 30, 1997............................... 76 68
December 31, 1997................................ 94 73 1/2
March 31, 1998................................... 100 82
Dividends
The payment dates and amounts of cash dividends per share since April 1, 1996
are as follows:
Payment Date Cash Dividend
-----------------------------------------------------------------------
May 31, 1996.............................................. $0.20
November 29, 1996......................................... 0.40
May 30, 1997.............................................. 0.20
November 28, 1997......................................... 0.40
May 29, 1998.............................................. 0.20
The amounts and timing of cash dividend payments have generally been dictated
by requirements of the Internal Revenue Code regarding the distribution of
taxable net investment income of regulated investment companies.
Automatic Dividend Reinvestment and Optional Cash Contribution Plan
As a service to its shareholders, the Company offers an Automatic Dividend
Reinvestment and Optional Cash Contribution Plan for shareholders of record who
own a minimum of 25 shares. The Company pays all costs of administration of the
Plan except brokerage transaction fees. Upon request, shareholders may obtain
information on the Plan from the Company, ▇▇▇▇▇ ▇▇▇▇▇▇▇ ▇▇▇▇, ▇▇▇▇▇ ▇▇▇, ▇▇▇▇▇▇,
▇▇▇▇▇ ▇▇▇▇▇. Telephone (▇▇▇) ▇▇▇-▇▇▇▇. Questions and answers about the Plan are
on the next page.
Annual Meeting
The Annual Meeting of Shareholders of Capital Southwest Corporation will be
held on Monday, July 20, 1998, at 10:00 a.m. in the North Dallas Bank Tower
Meeting Room (first floor), ▇▇▇▇▇ ▇▇▇▇▇▇▇ ▇▇▇▇, ▇▇▇▇▇▇, ▇▇▇▇▇.
29