Capital Southwest
Annual Report 2010

Plain-text annual report

To Our Shareholders Net Asset Value at March 31, 2010 was $486,925,586, equivalent to $130.14 per share. Assuming reinvestment of all dividends and tax credits on long-term capital gains, the March 31, 2010 net asset value was 18.5% greater than the March 31, 2009 net value of $110.98 per share and 6.7% above the December 31, 2009 net asset value of $121.99 per share. The following table identifies significant sources of the changes in net asset value of each share of Capital Southwest stock during the past year: Increases (decreases) in unrealized gains: Alamo Group, Inc ....................................................................... The RectorSeal Corporation ........................................................ The Whitmore Manufacturing Company ..................................... All Components, Inc ................................................................... Heelys, Inc ................................................................................. Encore Wire Corporation ............................................................. Media Recovery, Inc. .................................................................. Palm Harbor Homes, Inc ............................................................. Other increases .......................................................................... Net realized gains.......................................................................... Net investment income ................................................................. Dividends ..................................................................................... Year End March 31, 2010 $ 5.30 3.47 3.07 2.48 1.57 0.55 (0.37) (0.80) 3.61 0.22 0.56 (0.80) Other changes in net assets .......................................................... 0.30 Increases in net asset value........................................................... Net asset value beginning of period ............................................... Net asset value end of period ........................................................ 19.16 110.98 $130.14 Moving Parts During the year ended March 31, 2010, net unrealized appreciation of investments rose to $377,920,063 ($101.00 per share), an increase of 23.0% from $307,295,832 ($82.12 per share) at March 31, 2009. This notable positive change in overall portfolio appreciation of $70,624,231 ($18.88 per share) was fairly evenly distributed during the year, as $37,262,293 ($9.96 per share) was reported at Septem- ber 30, 2009, and the balance, $33,361,938 ($8.92 per share) oc- curred during the six months ended March 31, 2010. As reflected elsewhere within this report, net realized gain on investments for the year ended March 31, 2010 was $825,491, which produced a slight decrease in net unrealized appreciation of investments during the year of $538,037 ($0.14 per share). During the year ended March 31, 2010, investments classified as Controlled Affiliates increased $23,100,000 in net unrealized apprecia- tion, which was 32.7% of the total $70,624,231 increase in net unrea- lized appreciation in investments. The Major Publicly Traded Invest- ments category experienced a net increase in appreciation of $24,740,433, which represented 35.0% of the total increase in net unrealized appreciation of $70,624,231. March 31, 2010 March 31, 2009 Market % of Total Market % of Total Value Investments Value Investments Controlled Affiliates (mainly) The RectorSeal Corporation $120,200,000 Lifemark Group 71,000,000 The Whitmore Manufacturing Co. 47,500,000 Media Recovery, Inc 13,400,000 Major Publicly Traded Investments 25.1 14.9 9.9 2.8 $107,200,000 71,000,000 36,000,000 14,800,000 27.0 17.9 9.1 3.7 Encore Wire Corporation 67,431,375 14.1 65,388,000 16.5 Alamo Group, Inc Heelys, Inc 42,454,500 19,845,870 Palm Harbor Homes, Inc 6,833,955 8.9 4.2 1.4 22,642,400 13,975,965 9,818,901 5.7 3.5 2.5 Venture Capital Assets 68,262,428 14.3 42,023,841 10.6 Marketable Securities 21,014,929 4.4 13,785,916 3.5 Total $477,943,057 100.0 $396,635,023 100.0 In addition to a complete list of our investments, this report includes a description of our twelve largest holdings (see pages 6 through 8). 1 These twelve investments had a combined cost of $33,542,228 and a combined value of $431,648,324, representing 90.3% of the value of our investment portfolio at March 31, 2010. Regardless of its classification or current form, every security we currently hold originated as a venture capital investment in a private company. Investments in growing, private companies have always been, and continue to be, the essential source of our present holdings. Measure of Performance and Value The following table reflects our Company’s performance compared to the S&P 500 Index for the past 5 and 10 years: Investment Returns Period Ended March 31, 2010 5 years 10 years *Capital Southwest 6.0% 5.4% **S&P 500 Stock Index 2.0% (0.7)% __________ * Compounded annual return for Capital Southwest based on net asset value per share assuming reinvestment of all dividends and tax credits. ** Compounded annual return for the S&P 500 Stock Index assuming reinvestment of all dividends. Investment Activities A total of $17,234,456 was invested during the twelve months ended March 31, 2010 including $9,000,000 in new holdings and $8,234,456 in existing holdings. New venture investments include: iMemories, Inc. - $4,000,000. The company provides a convenient means for consumers to maintain and share their home videos, tapes, reels and photos via a complete digitizing process. The resulting online for- mats can be accessed by family and friends with links to www.imemories.com. The service is sold online and in selected retail outlets. The investment is in the form of convertible preferred stock representing a fully diluted potential ownership of 26.2%. 2 KBI Biopharma, Inc. - $5,000,000. This fully inte- grated contract biopharmaceutical development and manufacturing organization serves large pharmaceuti- cal biotechnology clients. The investment is via Series B convertible preferred stock representing 14.8% of the fully diluted ownership. Additions to existing investments include contracted capital calls from Ballast Point Ventures II, LP in the amount of $300,000; BankCap Partners Fund I, LP for $1,747,156; Cina- tra Clean Technologies, Inc. for $1,737,300; CMI Holding Company, Inc. for $1,150,000; Discovery Alliance, LLC for $300,000; and development financing for Palm Harbor Homes, Inc. of $3,000,000, which was repaid during the period. Future commitments in these holdings, subject to specific conditions are $2,325,000 for Ballast Point Ventures II, LP; $486,163 for BankCap Partners I, LP; $1,270,000 for Capital- South Partners Fund III, LP; $200,400 for Cinatra Clean Tech- nologies, Inc.; $600,000 for CMI Holding Company, Inc.; $150,000 for Discovery Alliance, LLC; and $486,900 for Ster- ling Group Partners I, LP. Within the Controlled Affiliates category of our portfolio, The RectorSeal Corporation made two strategic acquisitions total- ing $5,200,000 and All Components, Inc. divested its EMS di- vision for $6,770,000 during the year ended March 31, 2010. Additionally, in the Major Publicly Traded Investment category, Alamo Group, Inc. acquired the assets of Bush Hog, LLC for $23,950,000 during the year ended March 31, 2010. Our management and directors think like shareholders be- cause we are. Every $1.00 we directly invest includes approx- imately $0.24 owned by our management and directors. Ac- cordingly our investment decisions are very thoughtful and our monitoring duties are thorough. Highlights within the Portfolio Sale of Lifemark Group In the spring of 1969, we invested $600,000 in a shell cor- poration named Douglass Industries that was created to ac- quire Engler Manufacturing Co. Engler was a small, slightly emerging organization producing mowers to maintain difficult areas such as highway right-of-ways. As is the case in our typical investment today, the investment was heavily predi- cated upon the belief that the aspiring entrepreneur, in this case named Don Douglass, could acquire and grow the busi- ness. The initial $600,000 investment and $200,000 second- ary infusion a few months later launched Douglass’ business plan and paved the way for Engler of Houston to then become Terrain King Corporation and subsequently become The Alamo Group, Inc. During the next several years we continued to participate as needed in the emerging capitalization of Alamo, which increased our investment to $2,191,000 as Alamo me- thodically grew its manufacturing business across the U.S., Canada, Europe and Australia. Today Alamo, headquartered in Seguin, Texas, is a NYSE company with more than 2,300 employees, operating 18 man- ufacturing plants with annual sales nearing $500 million. In the fourth quarter of 2009, Alamo purchased the assets of Bush Hog, the U.S. market leader for commercial sized rotary mowing systems. The combination of Bush Hog with Alamo’s Rhino brand of rotary mowers provides a commanding market presence. Furthermore, Alamo’s campaigns of aggressive cost containment, synchronization of inventory to demand levels, and labor efficiency have produced a streamlined operating platform. These systems should allow Alamo to extract higher operating profits from the historical base of business, plus pro- vide impressive earnings from the newly acquired Bush Hog business. On a fully diluted basis, Alamo reported first quarter 2010 earnings of $0.34 per share compared to earnings of $0.15 per share during the first quarter of 2009. On April 29, 2010, we announced that a Stock Purchase Agreement had been executed with NorthStar Memorial Group, LLC whereby NorthStar would acquire 100% of the outstanding common stock of Lifemark Group for $84.75 million. The transaction is only contingent upon regulatory approval from the licensing and permitting department of the State of Cali- fornia, which is expected to occur during the quarter ended June 30, 2010. We will retain certain real estate previously owned by Lifemark that was held for long term investment purposes, pay the professional transaction costs and retire cer- tain debt owed by Lifemark. We estimate that $46.2 million of the cash proceeds will be retained for future investment activi- ties and $24.4 million will be paid in long-term capital gains tax on behalf of our shareholders. Based on an individual tax rate of 15%, it is estimated that individual shareholders will receive a net tax credit of $3.73 per share effective December 31, 2010 from this transaction. Any additional capital gains or losses we experience during the course of 2010 will alter this amount. Preparing for the Future Glenn Neblett recently joined the Company as a vice presi- dent. Glenn received both an accounting degree and an MBA from Baylor University, accumulated public accounting expe- rience with Ernst & Young and spent 13 years in investment banking, with the last ten years as a director with Houlihan Lokey in Dallas and Los Angeles. Glenn’s focus will include on- going business development activities with the Company, se- curing and executing new venture transactions and providing investment monitoring support at the director level. Glenn will be filling the position vacated by Jeff Peterson, who was repo- sitioned as the CEO of The Whitmore Manufacturing Company in 2009. 3  Marquez Bela was recruited to a newly created vice president position that will manage the strategic acquisitions of our Con- trolled Affiliate portfolio companies. Four of our six Controlled Affiliates are judged well positioned to further energize their acquisition programs. Marquez received Bachelors degrees from the University of Texas within the Plan II Honors Program and the Business Honors Program. He began his twelve year investment banking and private equity career with Goldman, Sachs & Co. and gained additional experience with a middle market fund and two boutique investment firms. These staff additions combined with the expected proceeds from the Lifemark sale, should position Capital Southwest to invest into an improved deal flow during a venture capital cycle that remains depressed. As reported by the National Venture Capital Association in April 2010, venture capital firms across the United States raised 31% less in the first quarter of 2010 than they raised in the first quarter of 2009, representing the slowest quarter since 1993.In May 2010, Mergers and Ac- quisitions Report indicated that the average length of time General Partners of traditional private equity firms spent fun- draising continued to increase. Funds that had closed on fund raises thus far in 2010 took an average of 19 months to final- ize the transactions, more than double the timeframe expe- rienced in 2004. While all this may translate into opportunity for us as fewer dollars are chasing increasingly attractive pri- vate companies, it also highlights the benefit of our structure that allows our investment staff to focus on investing versus fundraising. Our philosophy and approach allow us to general- ly operate more efficiently than our peers and pursue superior returns with minimal distraction. June 7, 2010 Chairman of the Board and President 4 Business Capital Southwest Corporation is one of the nation’s largest publicly- owned venture capital investment companies. Since its formation in 1961 and its designation as a business development company in 1988, the Company and its wholly-owned small business investment company subsidiary have provided capital to support the growth of small and medium-sized businesses in varied industries throughout the United States. Investments are focused on opportunities for capital appreciation derived from expansion financings, management buyouts, recapitali- zations, industry consolidations and early-stage financings. The port- folio is a composite of companies in which Capital Southwest Corpora- tion has major interests, as well as a number of developing companies and marketable securities of established publicly traded companies. Our Investment Philosophy We invest in enterprises believed to have exceptional growth po- tential. We finance those managers who have a proven record of achieve- ment, focused determination, and unquestionable integrity. We invest for the long term, which to us means building companies that will lead their industries for many years. Unlike most venture capitalists, we do not have an exit strategy that causes successful managers to sell their companies or go pub- lic. These and other investment principles have been forged by our Company’s 49 years of experience in providing patient capital and management assistance to those entrepreneurs judged to be capable of building successful businesses with enduring value. A significant cornerstone of our investment philosophy is our long- term perspective, which has enabled us to hold positions in enterprises destined to achieve accelerating growth after 10, 20 or 30 years. Cur- rently, investments held over 20 years represent approximately 26% of the cost and 76% of the value of our portfolio. 5 The RectorSeal Corporation $120,200,000 Lifemark Group $71,000,000 Twelve Largest Investments – March 31, 2010 The RectorSeal Corporation, Houston, Texas, with facilities in Texas, New York and Idaho, manufactures specialty chemical products including pipe thread sealants, firestop sealants, plastic cements and other formulations for plumbing, HVAC, electrical and industrial applications. The company also makes special tools for plumbers and systems for containing smoke from building fires. RectorSeal’s subsidiary, Jet-Lube, Inc., with plants in Texas, England and Canada, produces anti-seize compounds, specialty lubri- cants and other products used in industrial and oil field applications. Anoth- er subsidiary produces and sells automotive chemical products. RectorSeal also owns a 20% equity interest in The Whitmore Manufacturing Company (described on this page). During the year ended March 31, 2010, RectorSeal earned $9,571,000 on revenues of $102,075,000, compared with earnings of $10,170,000 on rev- enues of $112,762,000 in the previous year. RectorSeal’s earnings do not reflect its 20% equity in The Whitmore Manufacturing Company. At March 31, 2010, Capital Southwest owned 100% of RectorSeal’s com- mon stock having a cost of $52,600 and a value of $120,200,000. Lifemark Group, Hayward, California, owns and operates cemeteries, mausoleums and mortuaries. Lifemark’s operations, all of which are in Cali- fornia, include a major cemetery and funeral home in San Mateo, a mauso- leum and an adjacent mortuary in Oakland and cemeteries, mausoleums and mortuaries in Hayward and Sacramento. Its funeral and cemetery trusts enable Lifemark’s clients to make pre-need arrangements. The com- pany’s assets also include excess real estate holdings. For the fiscal year ended March 31, 2010, Lifemark reported earnings of $716,000 on revenues of $25,298,000, compared with earnings of $635,000 on revenues of $28,193,000 in the previous year. At March 31, 2010, Capital Southwest owned 100% of Lifemark Group’s common stock, which had a cost of $4,510,400 and was valued at $71,000,000. Encore Wire Corporation $67,431,375 The Whitmore Manufacturing Company $47,500,000 Encore Wire Corporation, McKinney, Texas, manufactures a broad line of copper electrical building wire and cable including non-metallic sheathed, underground feeder and THHN wire and cable, as well as armored cable for residential, commercial and industrial construction. Encore’s products are sold through distributors and building materials retailers. For the year ended December 31, 2009, Encore reported net income of $3,636,000 ($0.16 per share) on net sales of $649,613,000, compared with income of $39,771,000 ($1.70 per share) on net sales of net $1,081,132,000 in the previous year. The March 31, 2010 closing Nasdaq bid price of Encore’s common stock was $20.80 per share. At March 31, 2010, the $5,800,000 investment in 4,086,750 shares of Encore’s restricted common stock by Capital Southwest and its subsidiary was valued at $67,431,375 ($16.50 per share), representing a fully-diluted equity interest of 17.3%. 6 The Whitmore Manufacturing Company, Rockwall, Texas, manufactures specialty lubricants for heavy equipment used in surface mining, railroads and other industries, and produces water-based coatings for the automotive and primary metals industries. Whitmore’s Air Sentry division manufactures fluid contamination control devices. The company’s assets also include sev- eral commercial real estate interests. During the year ended March 31, 2010, Whitmore reported net income of $3,661,000 on net sales of $26,777,000, compared with net income of $3,209,000 on net sales of $28,163,000 in the previous year. The company is owned 80% by Capital Southwest and 20% by Capital Southwest’s sub- sidiary, The RectorSeal Corporation (described on this page). At March 31, 2010, the direct investment in 80% of Whitmore by Capital Southwest was valued at $47,500,000 and had a cost of $1,600,000. Alamo Group Inc. $42,454,500 Heelys, Inc. $19,845,870 Alamo Group Inc., Seguin, Texas, is a leading designer, manufacturer and distributor of heavy-duty, tractor and truck mounted mowing and other vegetation maintenance equipment, mobile excavators, street-sweeping and snow removal equipment and replacement parts. Founded in 1969, Alamo Group operates 18 manufacturing facilities and serves governmental, indus- trial and agricultural markets in North America, Europe, and Australia. For the year ended December 31, 2009, Alamo reported net income of $17,091,000 ($1.65 per share) on net sales of $446,487,000, compared with net income of $10,999,000 ($1.11 per share) on net sales of $557,135,000 in the previous year. The March 31, 2010 closing NYSE mar- ket price of Alamo’s common stock was $19.99 per share. At March 31, 2010, the $2,190,937 investment in Alamo by Capital Southwest and its subsidiary was valued at $42,454,500 ($15.00 per share), consisting of 2,830,300 restricted shares of common stock, representing a fully-diluted equity interest of 22.0%. Heelys, Inc., Carrollton, Texas, designs, markets and distributes branded footwear, equipment and accessories. The company imports its products from China and Korea and distributes them through domestic and interna- tional sporting goods chains, department and lifestyle stores and specialty footwear retailers. During the year ended December 31, 2009, Heelys reported net loss of $5,125,000 (-$0.19 per share) on net sales of $43,777,000, compared with net loss of $5,924,000 (-$0.22 per share) on net sales of $70,741,000 in the previous year. The March 31, 2010 closing Nasdaq bid price of Heely’s common stock was $2.37 per share. At March 31, 2010, the $102,490 investment in Heelys by Capital South- west’s subsidiary was valued at $19,845,870 ($2.13 per share), consisting of 9,317,310 restricted shares of common stock, representing a fully-diluted equity interest of 31.1%. Media Recovery, Inc. $13,400,000 All Components, Inc. $12,276,650 Media Recovery, Inc. (MRI), Dallas, Texas, is the holding company of DataSpan, ShockWatch and Damage Prevention Company. DataSpan pro- vides datacenter supplies and services to corporate customers through a direct sales force. ShockWatch manufactures and distributes devices used to detect mishandled shipments and devices for monitoring material han- dling equipment. Media Recovery’s subsidiary, The Damage Prevention Company, Denver, Colorado, manufactures dunnage products used to pre- vent damage in trucking, rail and export container shipments. During the year ended September 30, 2009, Media Recovery reported net loss of $2,626,000 on net sales of $110,311,000, compared with net income of $4,354,000 on net sales of $132,864,000 in the previous year. At March 31, 2010, the $5,415,000 investment in Media Recovery by Cap- ital Southwest and its subsidiary was valued at $13,400,000, consisting of 800,000 shares of Series A Convertible Preferred Stock and 4,000,002 shares of common stock, representing a fully-diluted equity interest of 97.5%. All Components, Inc., Pflugerville, Texas, distributes and produces memo- ry and other electronic components for personal computer manufacturers, retailers, value-added resellers and other corporate customers. Through its sales and distribution center near Austin, Texas and its distribution center in Miami, Florida, the company serves over 2,000 customers throughout the United States and Latin America. During the year ended August 31, 2009, All Components reported net income of $1,863,000 on net sales of $186,188,000, compared with net income of $1,167,000 on net sales of $200,673,000 in the previous year. At March 31, 2010, the $6,150,000 investment in All Components by Capital Southwest and its subsidiary was valued at $12,276,650 consisting of an 8.25% Subordinated Note valued at $6,454,925 and 150,000 shares of Series A Convertible Preferred Stock valued at $5,821,725, representing a 80.4% fully-diluted equity interest. 7 Hologic, Inc. $11,726,155 Texas Capital Bancshares, Inc. $9,288,774 Hologic, Inc., Bedford, Massachusetts, is a leading developer, manufac- turer and supplier of bone densitometers, mammography and breast biopsy devices, direct-to-digital x-ray systems and other x-ray based imaging sys- tems. These products are generally targeted to address women’s health- care and general radiographic applications. For the year ended September 26, 2009, Hologic reported net loss of $2,176,237,000 (-$8.48 per share) on net sales of $1,637,134,000 com- pared with net loss of $385,617,000 (-$1.57 per share) on net sales of $1,674,499,000 in the previous year. The March 31, 2010 closing Nasdaq bid price of Hologic’s common stock was $18.53 per share. At March 31, 2010, Capital Southwest and its subsidiary owned 632,820 unrestricted shares of common stock, having a cost of $220,000 and a mar- ket value of $11,726,155 ($18.53 per share). Texas Capital Bancshares, Inc. of Dallas, Texas, formed in 1998, has total assets of approximately $5.7 billion. With branch banks in Austin, Dallas, Fort Worth, Houston, Plano and San Antonio, Texas Capital Bancshares con- ducts its business through its subsidiary, Texas Capital Bank, N.A., which targets middle market commercial and wealthy private client customers in Texas. For the year ended December 31, 2009, Texas Capital reported net in- come of $18,769,000 ($0.55 per share), compared with net income of $24,266,000 ($0.87 per share) in the previous year. The March 31, 2010 closing Nasdaq bid price of Texas Capital’s common stock was $18.97 per share. At March 31, 2010, Capital Southwest owned 489,656 unrestricted shares of common stock, having a cost of $3,550,006 and a market value of $9,288,774 ($18.97 per share). Extreme International, Inc. $8,525,000 Balco, Inc. $8,000,000 Extreme International, Inc., Sugar Land, Texas, owns Bill Young Produc- tions, Texas Video and Post, and Extreme Communications and Vanilla Goril- la which produce radio and television commercials and corporate communi- cations videos. During the year ended September 30, 2009, Extreme reported net income of $1,205,000 on net sales of $11,272,000, compared with net income of $1,435,000 on net sales of $11,545,000 in the previous year. At March 31, 2010, Capital Southwest and its subsidiary owned 39,359 shares of Series C Convertible Preferred Stock, 3,750 shares of 8% Series A Convertible Preferred Stock and 13,035 shares of common stock, having a cost of $3,325,875 and a market value of $8,525,000, representing a fully- diluted equity interest of 53.6%. Balco, Inc., Wichita, Kansas, designs and manufactures innovative archi- tectural products used in the construction and remodeling of educational facilities, commercial and industrial buildings, airports, hotels, hospitals, parking garages and high-end residential condominiums. Company prod- ucts include an extensive line of high quality, standard or custom- engineered expansion joint covers, floor grids and mats, stair nosings, grates and frames and trench and access covers. During the year ended May 31, 2009, Balco reported net income of $952,000 on net sales of $14,651,000, compared with net income of $841,000 on net sales of $13,675,000 in the previous year. At March 31, 2010, the $624,920 investment in Balco by Capital South- west was valued at $8,000,000 consisting of 445,000 shares of common stock and 60,920 shares of Class B non-voting common stock, representing a fully-diluted equity interest of 90.9%. 8 Consolidated Schedule of Investments – March 31, 2010 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. ALL COMPONENTS, INC. Pflugerville, Texas Electronics contract manufacturing; distribution and production of memory and other components for computer manufacturers, retailers and value-added resellers. 22.0% 2,830,300 shares common stock (acquired 4-1-73 thru 5-25-07) $ 2,190,937 $ 42,454,500 80.4% 8.25% Subordinated Note, $6,000,000 principal due 2012 (acquired 6-27-07) 150,000 shares Series A Convertible Preferred Stock, con- vertible into 600,000 shares of common stock at $0.25 per share (acquired 9-16-94) Warrants to purchase 350,000 shares of common stock at $11.00 per share, expiring 2017 (acquired 6-27-07) 6,000,000 6,454,925 150,000 5,821,725 – 6,150,000 – 12,276,650 ATLANTIC CAPITAL BANCSHARES, INC. Atlanta, Georgia Holding company of Atlantic Capital Bank, a full service commercial bank. ¥BALCO, INC. 90.9% Wichita, Kansas Specialty architectural products used in the construction and 1.9% remodeling of commercial and institutional buildings. BOXX TECHNOLOGIES, INC. Austin, Texas Workstations for computer graphic imaging and design. ¥CMI HOLDING COMPANY, INC. Richardson, Texas Owns Chase Medical, which develops and sells devices used in cardiac surgery to relieve congestive heart failure; develops and supports cardiac imaging systems. 15.2% 22.4% 300,000 shares common stock (acquired 4-10-07) 3,000,000 3,150,000 445,000 shares common stock and 60,920 shares Class B non-voting common stock (acquired 10-25-83 and 5-30-02) 624,920 8,000,000 3,125,354 shares Series B Convertible Preferred Stock, convertible into 3,125,354 shares of common stock at $0.50 per share (acquired 8-20-99 thru 8-8-01) 10% convertible promissory note, due 2013 (acquired 2-23-10) 1,631,516 shares Series C-1 Convertible Preferred Stock, convertible into 1,631,516 shares of common stock at $2.15 per share (acquired 7-10-09) 2,327,658 shares Series A Convertible Preferred Stock, convertible into 2,327,658 shares of common stock at $1.72 per share (acquired 8-21-02 and 6-4-03) Warrants to purchase 109,012 shares of common stock at  1,500,000 650,000 2 1,300,000 2,863,347 2,857,759 4,000,000 2 $1.72 per share, expiring 2012 (acquired 4-7-04) – – †Publicly-owned company; ¥ Control investment ‡Unrestricted securities as defined in Note (b) Warrants to purchase 636,151 shares of Series A-1 Convertible Preferred Stock at $1.72 per share expiring 2017 and 2019 (acquired 7-2-07 and 6-9-09) Warrant to purchase 90,698 shares of Series D or D-1 Convertible Preferred Stock at $1.72 per share expiring 2017 (acquired 2-23-10) – – – 7,513,347 – 4,157,761 9 Consolidated Schedule of Investments – March 31, 2010 Company CINATRA CLEAN TECHNOLOGIES, INC. Houston, Texas Cleans above ground oil storage tanks with a patented, automated system. Equity (a) 59.2% Investment (b) Cost Value (c) 10% Subordinated Secured Promissory Note, $6,200,000 principal due 2013 (acquired 7-14-08 thru 3-23-10) 1,128,649 shares Series A Convertible Preferred Stock, convertible into 1,128,649 shares of common stock at $1.00 per share (acquired 7-14-08 and 11-19-08) $ 6,000,300 $ 3,815,235 1,128,649 7,128,949 1,128,649 4,943,884 †ENCORE WIRE CORPORATION McKinney, Texas Electric wire and cable for residential, commercial and industrial construction use. 17.3% 4,086,750 shares common stock (acquired 7-16-92 thru 10-7-98) 5,800,000 67,431,375 EXTREME INTERNATIONAL, INC. Sugar Land, Texas Owns Bill Young Productions, Texas Video and Post, and Extreme Communications, which produce radio and television commercials and corporate communications videos. 53.6% 13,035 shares Series A Common Stock (acquired 9-26-08 and 12-18-08) 39,359.18 shares Series C Convertible Preferred Stock, convertible into 157,437.72 shares of common stock at $25.00 per share (acquired 9-30-03) 3,750 shares 8% Series A Convertible Preferred Stock, convertible into 15,000 shares of common stock at $25.00 per share (acquired 9-30-03) 325,875 600,000 2,625,000 7,236,000 375,000 3,325,875 689,000 8,525,000 ¥, †HEELYS, INC. Carrollton, Texas Heelys stealth skate shoes, equipment and apparel sold through sporting goods chains, department stores and footwear retailers. †HOLOGIC, INC. Bedford, Massachusetts Medical instruments including bone densitometers, mammography devices and digital radiography systems. iMEMORIES, INC. Scottsdale, AZ Enables online video and photo sharing and DVD creation for home movies recorded in analog and new digital format. KBI BIOPHARMA, INC. Durham, NC Provides fully-integrated, outsourced drug development and bio-manufacturing services. 31.1% 9,317,310 shares common stock (acquired 5-26-00) 102,490 19,845,870 <1% ‡632,820 shares common stock (acquired 8-27-99) 220,000 11,726,155 26.2% 14.8% 17,391,304 shares Series B Convertible Preferred Stock, convertible into 17,391,304 shares of common stock at $0.23 per share (acquired 7-10-09) 7,142,857 shares Series B-2 Convertible Preferred Stock, convertible into 7,142,857 shares of common stock at $0.70 per share (acquired 9-08-09) 4,000,000 4,000,000  5,000,000 5,000,000  †Publicly-owned company; ¥ Control investment ‡Unrestricted securities as defined in Note (b) 10 Company Equity (a) Investment (b) Cost Value (c) Consolidated Schedule of Investments – March 31, 2010 ¥ LIFEMARK GROUP Hayward, California Cemeteries, mausoleums and mortuaries located in northern California. 100.0% 1,449,026 shares common stock (acquired 7-16-69) $ 4,510,400 $ 71,000,000 ¥ MEDIA RECOVERY, INC. Dallas, Texas Computer datacenter and office automation supplies and accessories; impact, tilt monitoring and temperature sensing devices to detect mishandled shipments; dunnage for protecting shipments. 97.5% PALLETONE, INC. Bartow, Florida Manufacturer of wooden pallets and pressure-treated 8.4% lumber. 800,000 shares Series A Convertible Preferred Stock, convertible into 800,000 shares of common stock at $1.00 per share (acquired 11-4-97) 4,000,002 shares common stock (acquired 11-4-97) 12.3% senior subordinated notes, $2,000,000 principal due 2012 (acquired 9-25-06) 150,000 shares common stock (acquired 10-18-01) Warrant to purchase 15,294 shares of common stock at $1.00 per share, expiring 2011 (acquired 2-17-06) ¥, †PALM HARBOR HOMES, INC. Dallas, Texas Integrated manufacturing, retailing, financing and insuring of manufactured housing and modular homes. 30.5% 7,855,121 shares common stock (acquired 1-3-85 thru 7-31-95) Warrant to purchase 286,625 shares of common stock at $3.14 per share, expiring 2019 800,000 4,615,000 5,415,000 2,200,000 11,200,000 13,400,000 1,553,150 2,000,000 2 150,000 45,746 1,748,896 – 2,000,002 10,931,955 6,833,955 ¥ 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. TCI HOLDINGS, INC. Denver, Colorado Cable television systems and microwave relay systems. †TEXAS CAPITAL BANCSHARES, INC. Dallas, Texas Regional bank holding company with banking operations in six Texas cities. (acquired 4-24-09) 100.0% 27,907 shares common stock (acquired 1-5-73 and 3-31-73) – 10,931,955 – 6,833,955 52,600 120,200,000 – 21 shares 12% Series C Cumulative Compounding Preferred Stock (acquired 1-30-90) – 677,250 1.6% ‡489,656 shares common stock (acquired 5-1-00) 3,550,006 9,288,774 †Publicly-owned company; ¥ Control investment ‡Unrestricted securities as defined in Note (b) 11 Company Equity (a) Investment (b) Cost Value (c) Consolidated Schedule of Investments – March 31, 2010 TRAX HOLDINGS, INC. Scottsdale, Arizona Provides a comprehensive set of solutions to improve the trans- portation validation, accounting, payment and information management process. 31.1% 1,061,279 shares Series A Convertible Preferred Stock, convertible into 1,061,279 common stock at $4.71 per share (acquired 12-8-08 and 2-17-09) $ 5,000,000 $ 5,687,669 VIA HOLDINGS, INC. Sparks, Nevada Designer, manufacturer and distributor of high-quality office seating. 28.1% 9,118 shares Series B Preferred Stock (acquired 9-19-05) 4,559,000 1,118 shares Series C Preferred Stock (acquired 11-1-07) 281,523 4,840,523 2 2 4 WELLOGIX, INC. Houston, Texas Developer and supporter of software used by the oil and gas 19.6% 4,788,371 shares Series A-1 Convertible Participating Preferred Stock, convertible into 4,788,371 shares of common stock at $1.0441 per share (acquired industry. 8-19-05 thru 6-15-08) ¥ THE WHITMORE MANUFACTURING COMPANY Rockwall, Texas Specialized surface mining, railroad and industrial lubricants; coatings for automobiles and primary metals; fluid contamination control devices. 80.0% 80 shares common stock (acquired 8-31-79) 5,000,000 2 1,600,000 47,500,000 MISCELLANEOUS – – – – – – – 100.0% – – – Ballast Point Ventures II, L.P. – 2.6% limited partnership interest (acquired 8-4-08 thru 11-3-09) 675,000 675,000 BankCap Partners Fund I, L.P. – 6.0% limited partnership interest (acquired 7-14-06 thru 6-18-09) 5,513,837 5,179,842 CapitalSouth Partners Fund III, L.P. – 2.0% limited partnership interest (acquired 1-22-08 and 2-12-09) 831,256 831,256 Diamond State Ventures, L.P. – 1.8% limited partnership interest (acquired 10-12-99 thru 8-26-05) ¥ Discovery Alliance, LLC – 90.0% limited liability company (acquired 9-12-08 thru 3-12-10) Essex Capital Corporation – 10% unsecured promissory note due 8-19-11 (acquired 8-16-09) First Capital Group of Texas III, L.P. – 3.0% limited partnership interest (acquired 12-26-00 thru 8-12-05) ¥ Humac Company – 1,041,000 shares common stock (acquired 1-31-75 and 12-31-75) STARTech Seed Fund I – 12.1% limited partnership interest (acquired 4-17-98 thru 1-5-00) STARTech Seed Fund II – 3.2% limited partnership interest (acquired 4-28-00 thru 2-23-05) Sterling Group Partners I, L.P. – 1.6% limited partnership interest (acquired 4-20-01 thru 1-24-05) 76,000 186,852 750,000 750,000 – 1,000,000 778,895 451,208 – 163,000 178,066 950,000 1 1 1,064,042 607,044 $100,022,994 $477,943,057 TOTAL INVESTMENTS †Publicly-owned company; ¥ Control investment 12 ‡Unrestricted securities as defined in Note (b) Consolidated Schedule of Investments – March 31, 2009 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. 26.0% 2,830,300 shares common stock (acquired 4-1-73 thru 5-25-07) $ 2,190,937 $ 22,642,400 ALL COMPONENTS, INC. Austin, Texas Electronics contract manufacturing; distribution and production of memory and other components for computer manufacturers, 80.0% retailers and value-added resellers. 8.25% Subordinated Note due 2012 (acquired 6-27-07) 150,000 shares Series A Convertible Preferred Stock, con- vertible into 600,000 shares of common stock at $0.25 per share (acquired 9-16-94) Warrants to purchase 350,000 shares of common stock at $11.00 per share, expiring 2017 (acquired 6-27-07) 6,000,000 3,000,000 150,000 1 – 6,150,000 – 3,000,001 ATLANTIC CAPITAL BANCSHARES, INC. Atlanta, Georgia Holding company of Atlantic Capital Bank a full service commercial bank. ¥ BALCO, INC. Wichita, Kansas Specialty architectural products used in the construction and remodeling of commercial and institutional buildings. 2.0% 300,000 shares common stock (acquired 4-10-07) 3,000,000 3,000,000 90.9% 445,000 shares common stock and 60,920 shares Class B non-voting common stock (acquired 10-25-83 and 5-30-02) 624,920 6,600,000 BOXX TECHNOLOGIES, INC. Austin, Texas Workstations for computer graphics imaging and design. 15.2% 3,125,354 shares Series B Convertible Preferred Stock, convertible into 3,125,354 shares of common stock at $0.50 per share (acquired 8-20-99 thru 8-8-01) 1,500,000 ¥ CMI HOLDING COMPANY, INC. Richardson, Texas Owns Chase Medical, which develops and sells devices used in cardiac surgery to relieve congestive heart failure; develops and supports cardiac imaging systems. 15.3% 10% Convertible Subordinated Note, due 2009 (acquired 7-2-07 thru 10-9-07) 2,363,347 1,000,000 2,327,658 shares Series A Convertible Preferred Stock, convertible into 2,327,658 shares of common stock at $1.72 per share (acquired 8-21-02 and 6-4-03) Warrants to purchase 109,012 shares of common stock at 4,000,000 2 $1.72 per share, expiring 2012 (acquired 4-7-04) – – Warrant to purchase 431,982 shares of Series A-1 Convertible Preferred Stock at $1.72 per share expiring 2017 (acquired 7-2-07) – 6,363,347 – 1,000,002 †Publicly-owned company; ¥ Control investment ‡Unrestricted securities as defined in Note (b) 13  2 Company Equity (a) Investment (b) Cost Value (c) Consolidated Schedule of Investments – March 31, 2009 CINATRA CLEAN TECHNOLOGIES, INC. Houston, Texas Cleans above ground oil storage tanks with a patented, automated system. 59.2% 10% subordinated secured promissory note (acquired 7-14-08 thru 12-8-08) $ 4,263,000 $ 4,263,000 1,128,649 shares Series A Convertible Preferred Stock, convertible into 1,128,649 shares of common stock at $1.00 per share (acquired 7-14-08 and 11-19-08) 1,128,649 5,391,649 1,128,649 5,391,649 999,981 2,329,963 3,329,944 999,981 2,868,000 3,867,981 ¥ DENNIS TOOL COMPANY Houston, Texas Polycrystalline diamond compacts (PDCs) used in oil field drill bits and in mining and industrial applications. 67.4% 20,725 shares 5% Convertible Preferred Stock, convertible into 20,725 shares of common stock at $48.25 per share (acquired 8-10-98) 140,137 shares common stock (acquired 3-7-94 and 8-10-98) †ENCORE WIRE CORPORATION McKinney, Texas Electric wire and cable for residential, commercial and industrial construction use. 17.2% 4,086,750 shares common stock (acquired 7-16-92 thru 10-7-98) 5,800,000 65,388,000 EXTREME INTERNATIONAL, INC. Sugar Land, Texas Owns Bill Young Productions, Texas Video and Post, and Extreme Communications, which produce radio and television commercials and corporate communications videos. 53.6% 13,035 shares Series A common stock (acquired 9-26-08 and 12-18-08) 39,359.18 shares Series C Convertible Preferred Stock, convertible into 157,436.72 shares of common stock at $25.00 per share (acquired 9-30-03) 3,750 shares 8% Series A Convertible Preferred Stock, convertible into 15,000 shares of common stock at $25.00 per share (acquired 9-30-03) 325,875 463,850 2,625,000 5,602,376 375,000 3,325,875 533,774 6,600,000 ¥, †HEELYS, INC. Carrollton, Texas Heelys stealth skate shoes, equipment and apparel sold through sporting goods chains, department stores and footwear retailers. †HOLOGIC, INC. Bedford, Massachusetts Medical instruments including bone densitometers, mammography devices and digital radiography systems. ¥ LIFEMARK GROUP Hayward, California Cemeteries, mausoleums and mortuaries located in northern California. 31.1% 9,317,310 shares common stock (acquired 5-26-00) 102,490 13,975,965 <1% ‡632,820 shares common stock (acquired 8-27-99) 220,000 8,277,286 100.0% 1,449,026 shares common stock (acquired 7-16-69) 4,510,400 71,000,000 †Publicly-owned company; ¥ Control investment ‡Unrestricted securities as defined in Note (b) 14 Company Equity (a) Investment (b) Cost Value (c) Consolidated Schedule of Investments – March 31, 2009 ¥ MEDIA RECOVERY, INC. Dallas, Texas Computer datacenter and office automation supplies and accessories; impact, tilt monitoring and temperature sensing devices to detect mishandled shipments; dunnage for protecting shipments. 97.1% PALLETONE, INC. Bartow, Florida Manufacturer of wooden pallets and pressure-treated 8.5% lumber. 800,000 shares Series A Convertible Preferred Stock, con- vertible into 800,000 shares of common stock at $1.00 per share (acquired 11-4-97) 4,000,002 shares common stock (acquired 11-4-97) 12.3% Senior Subordinated Notes due 2012 (acquired 9-25-06) 150,000 shares common stock (acquired 10-18-01) Warrant to purchase 15,294 shares of common stock at $1.00 per share, expiring 2011 (acquired 2-17-06) 31.5% 7,855,121 shares common stock (acquired 1-3-85 thru 7-31-95) $ 800,000 4,615,000 5,415,000 $ 2,500,000 12,300,000 14,800,000 1,553,150 150,000 2 2 45,746 1,748,896 – 4 10,931,955 9,818,902 ¥, †PALM HARBOR HOMES, INC. Dallas, Texas Integrated manufacturing, retailing, financing and insuring of manufactured housing and modular homes. ¥ 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. TCI HOLDINGS, INC. Denver, Colorado Cable television systems and microwave relay systems. †TEXAS CAPITAL BANCSHARES, INC. Dallas, Texas Regional bank holding company with banking operations in six Texas cities. TRAX HOLDINGS, INC. Scottsdale, Arizona Provides a comprehensive set of solutions to improve the trans- portation validation, accounting, payment and information management process. VIA HOLDINGS, INC. Sparks, Nevada Designer, manufacturer and distributor of high-quality office seating. †Publicly-owned company; ¥ Control investment 100.0% 27,907 shares common stock (acquired 1-5-73 and 3-31-73) 52,600 107,200,000 – 21 shares 12% Series C Cumulative Compounding Preferred Stock (acquired 1-30-90) – 677,250 1.6% ‡489,656 shares common stock (acquired 5-1-00) 3,550,006 5,508,630 32.5% 1,061,279 shares Series A Convertible Preferred Stock, convertible into 1,061,279 common stock at $4.71 per share (acquired 12-8-08 and 2-17-09) 5,000,000 5,000,000 28.1% 9,118 shares Series B Preferred Stock (acquired 9-19-05) 1,118 shares Series C Preferred Stock (acquired 11-1-07) 4,559,000 281,523 4,840,523 2 2 4 ‡Unrestricted securities as defined in Note (b) 15 Consolidated Schedule of Investments – March 31, 2009 Equity (a) 19.9% Investment (b) Cost Value (c) 4,788,371 shares Series A-1 Convertible Participating Preferred Stock, convertible into 4,788,371 shares of common stock at $1.0441 per share (acquired 8-19-05 thru 6-15-08) $ 5,000,000 $ 2 80.0% 80 shares common stock (acquired 8-31-79) 1,600,000 36,000,000 Company WELLOGIX, INC. Houston, Texas Developer and supporter of software used by the oil and gas industry. ¥ THE WHITMORE MANUFACTURING COMPANY Rockwall, Texas Specialized surface mining, railroad and industrial lubricants; coatings for automobiles and primary metals; fluid contamina- tion control devices. MISCELLANEOUS – – – – – – 100.0% – – – Ballast Point Ventures II, L.P. – 2.6% limited partnership interest (acquired 8-4-08 thru 10-24-08) 375,000 375,000 BankCap Partners Fund I, L.P. – 6.0% limited partnership interest (acquired 7-14-06 thru 10-10-08) 3,766,681 3,766,681 CapitalSouth Partners Fund III, L.P. – 2.8% limited partnership interest (acquired 1-22-08 and 2-12-09) 831,256 831,256 Diamond State Ventures, L.P. – 1.9% limited partnership interest (acquired 10-12-99 thru 8-26-05) ¥ Discovery Alliance, LLC – 90.0% limited liability company (acquired 9-12-08 thru 3-1-09) First Capital Group of Texas III, L.P. – 3.0% limited partnership interest (acquired 12-26-00 thru 8-12-05) ¥ Humac Company – 1,041,000 shares common stock (acquired 1-31-75 and 12-31-75) STARTech Seed Fund I – 12.1% limited partnership interest (acquired 4-17-98 thru 1-5-00) STARTech Seed Fund II – 3.2% limited partnership interest (acquired 4-28-00 thru 2-23-05) Sterling Group Partners I, L.P. – 1.7% limited partnership interest (acquired 4-20-01 thru 1-24-05) 111,000 111,000 450,000 450,000 964,604 840,260 – 133,000 178,066 950,000 1 1 1,064,042 379,746 $89,339,191 $396,635,023 TOTAL INVESTMENTS †Publicly-owned company; ¥ Control investment ‡Unrestricted securities as defined in Note (b) 16 Notes to Consolidated Schedule of Investments (a) Equity The percentages in the ―Equity‖ column express the potential equity interests held by Capital Southwest Corporation and Capital Southwest Venture Corporation (together, the ―Company‖) in each issuer. Each percentage represents the amount of the issuer’s common stock the Company owns or can acquire as a percentage of the issuer’s total outstanding common stock, plus stock reserved for all warrants, con- vertible securities and employee stock options. The symbol ―<1%‖ indicates that the Company holds a potential equity interest of less than 1%. (b) Investments Unrestricted securities (indicated by ‡) are freely marketable securities having readily available market quotations. All other securi- ties are restricted securities which are subject to one or more re- strictions on resale and are not freely marketable. At March 31, 2010, restricted securities represented approximately 95.6% of the value of the consolidated investment portfolio. Our investments are carried at fair value in accordance with the In- vestment Company Act of 1940 (the ―1940 Act‖) and FASB Accounting Standards Codification™ (ASC) Topic 820, Fair Value Measurements and Disclosures. In accordance with the 1940 Act, unrestricted minor- ity-owned publicly traded securities, for which the market quotations are readily available, are valued at the closing sale price for the NYSE listed securities and the lower of the closing bid price or the last sale price for NASDAQ securities on the valuation date; and restricted pub- licly traded securities and other privately held securities are valued as determined in good faith by our Board of Directors. We adopted FASB ASC Topic 820 on April 1, 2008 (see footnote 1 in ―Notes to Consolidated Financial Statements,‖ page 25). ASC Topic 820 provides a framework for measuring the fair value of assets and liabilities along with guidance regarding a fair value hierarchy, which prioritizes information used to measure fair value and the effect of fair value measurements on earnings and provides for enhanced disclo- sures determined by the level within the hierarchy of information used for valuation. ASC Topic 820 applies whenever other standards require (or permit) assets or liabilities to be measured at fair value but does not expand the use of fair value in any new circumstances. ASC Topic 820 defines fair value in terms of the price that would be received upon the sale of an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date (the ―exit price‖) and excludes transaction costs. Under ASC Topic 820, the fair value mea- surement also assumes that the transaction to sell an asset occurs in the principal market for the asset or, in the absence of a principal mar- ket, the most advantageous market for the asset. The principal mar- ket 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, it is assumed that the reporting entity has access to the market as of the measurement date. Our Board of Directors retained Duff & Phelps to provide limited scope third party valuation services on eight invest- ments comprising 81.3% of our net asset value at March 31, 2010. Please refer to our Form 10-K for full disclosure of Duff & Phelps’ ser- vices. (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 equiv- alent 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 major 17 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, which are valued at the closing sale price for the NYSE listed securities and the lower of the closing bid price or the last sale price for NASDAQ securities on the valuation date, and restricted marketable securities for which there is a public market, are valued at the closing sale price for the NYSE listed securities and the lower of the closing bid price or the last sale price for NASDAQ securities on the valuation date, adjusted in good faith by our Board of Directors if they deem a discount or premium would be likely or obtainable upon a sale or transfer of our interest. For those without a principal market, the Board of Directors considers the financial condi- tion and operating results of the issuer; the long-term potential of the business of the issuer; the market for and recent sales prices of the issuer’s securities; the values of similar securities issued by companies in similar businesses; the proportion of the issuer’s securities owned by the Company; protective put analysis based on the Black-Scholes option pricing model; the nature and duration of resale restrictions; and the nature of any rights enabling the Company to require the is- suer to register restricted securities under applicable securities laws. In determining the fair value of restricted securities, the Board of Di- rectors considers the inherent value of such securities without regard to the restrictive feature and adjusts for any diminution in value result- ing from restrictions on resale. Investments, in certain entities that calculate net asset value per share (or its equivalent) and for which fair market value is not readily determinable, are valued using the net asset value per share (or its equivalent, such as member units or ownership interest in partners’ capital to which a proportionate share of net assets is attributed) of the investment. Equity Warrants are valued on the basis of accepted formulas de- rived from empirical studies which define the market value of a war- 18 rant in relation to the market price of its common stock. These formu- las measure the ―option value‖ of a warrant as well as its ―exercise value‖ (the amount, if any, by which the value of the stock exceeds the exercise price of the warrant). In applying such formulas, the market price of the stock is usually discounted to reflect the fact that the stock is restricted and the calculated value is of the warrant itself may be discounted (if deemed appropriate) to reflect its restrictive nature. Generally, the option value is excluded if the formula indicates (i) the warrant expires within six months, (ii) the market price of the stock (discounted) is less than one-half of the exercise price of the warrant, or (iii) the market price of the stock (discounted) is more than two times the amount of the exercise price of the warrant. (d) Agreements between certain issuers and the Company provide that the issuers will bear substantially all costs in connection with the disposition of common stock, including those costs involved in registra- tion under the Securities Act of 1933, but excluding underwriting dis- counts and commissions. These agreements cover common stock owned at March 31, 2010 and common stock which may be acquired thereafter through the exercise of warrants and conversion of deben- tures and preferred stock. They apply to restricted securities of all issuers in the investment portfolio of the Company except securities of the following issuers, which are not obligated to bear registration costs: Humac Company, Lifemark Group and The Whitmore Manufac- turing 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 our independent registered public accounting firm. Acquisition dates indicated are the dates specific se- curities were acquired, which may differ from the original investment dates. Certain securities were received in exchange for or upon con- version or exercise of other securities previously acquired. New Investments and Additions to Previous Investments Dispositions Portfolio Changes During the Year Ballast Point Ventures II, L.P. ..................................... BankCap Partners Fund I, L.P. ................................... Cinatra Clean Technologies, Inc.. ............................... CMI Holding Company, Inc. ........................................ Discovery Alliance, LLC .............................................. iMemories, Inc. ........................................................... KBI Biopharma, Inc..................................................... Palm Harbor Homes, Inc. ........................................... Amount $ 300,000 1,747,156 1,737,300 1,150,000 300,000 4,000,000 5,000,000 3,000,000 $17,234,456 $3,329,944 Dennis Tool Company ...................................... 35,000 Diamond State Ventures ................................... Essex Capital Corporation ................................. - First Capital Group of Texas .............................. 185,709 Cost ............................ Amount Received $4,763,416 35,000 206,522 185,709 Repayments Received .................................... $3,000,000 $3,550,653 $5,190,647 19 Capital Southwest Corporation and Subsidiaries Consolidated Statements of Assets and Liabilities Assets 2010 2009 Liabilities March 31 March 31 2010 2009 Investments at market or fair value Companies more than 25% owned (Cost: 2010 – $26,178,302, 2009 - $29,208,246) ...................................... $330,147,325 $286,488,248 Other liabilities ................................................... ...... Pension liability .................................................. Deferred income taxes ....................................... ...... Total liabilities................................. $ 1,070,540 1,082,941 2,095,518 4,248,999 $ 253,294 934,427 1,092,427 2,280,148 66,388,010 Net Assets Companies 5% to 25% owned (Cost: 2010 – $21,562,243, 2009 - $20,412,243) ............................... 73,589,142 Companies less than 5% owned (Cost: 2010 – $52,282,449, 2009 - $39,718,702) ............................... 74,206,590 43,758,765 Total investments (Cost: 2010 – $100,022,994, 2009 – $89,339,191) .............................. Cash and cash equivalents ...................... Receivables Dividends and interest .................. Affiliates ....................................... ......... Pension assets ........................................ Other assets ............................................ ......... 477,943,057 4,093,508 1,012,782 864,943 7,068,957 191,338 396,635,023 14,721,730 498,506 16,706 5,468,861 202,313 Total assets ................................. $491,174,585 $417,543,139 Common stock, $1 par value: authorized, 5,000,000 shares; issued, 4,326,516 shares at March 31, 2010 and March 31, 2009 .............................................. ...... Additional capital ................................................ ...... Undistributed net investment income .. .............. Undistributed net realized gain on 4,326,516 126,554,546 2,061,109 4,326,516 124,571,029 2,963,640 Investments .................................................... ...... - Unrealized appreciation of investments ............. 377,920,063 Treasury stock – at cost 584,878 shares at March 31, 2010 and March 31,2009 .......... (23,936,648) (23,936,648) Total net assets ................................................. 486,925,586 42,622 307,295,832 415,262,991 Total liabilities and net assets ............................ ...... Net assets value per share $491,174,585 $417,543,139 (on the 3,741,638 shares outstanding) ......... $ 130.14 $ 110.98 The accompanying Notes are an integral part of these Consolidated Financial Statements 20 Capital Southwest Corporation and Subsidiaries Consolidated Statements of Operations Years Ended March 31 2010 2009 2008 Investment income (see note 9): Interest .................................................................................................................................................................................... Dividends ................................................................................................................................................................................. Management and directors’ fees ............................................................................................................................ $ 1,044,867 3,788,680 1,275,759 6,109,306 Operating expenses: Salaries ................................................................................................................................................................. Net pension benefit ................................................................................................................................................ Stock option expense ............................................................................................................................................ Professional fees .................................................................................................................................................. Other operating expenses...................................................................................................................................... Income before income taxes ................................................................................................................................... Income tax expense ................................................................................................................................................ $ 1,375,215 11,533,878 1,076,039 13,985,132 $ 2,255,550 3,656,833 882,300 6,794,683 2,294,187 (253,229) 503,645 689,425 431,473 3,665,501 10,319,631 136,176 1,619,008 (327,345) 263,664 798,172 614,824 2,968,323 3,826,360 111,160 2,839,070 (369,108) 675,210 551,112 207,224 3,903,508 2,205,798 115,017 Net investment income ........................................................................................................................................ $ 2,090,781 $ 10,183,455 $ 3,715,200 Proceeds from disposition of investments ............................................................................................................... $ 5,190,647 Cost of investments sold ......................................................................................................................................... 3,550,653 $ 20,697,647 4,718,381 $ 1,433,891 1,193,867 Net realized gain on investments before income taxes............................................................................................ Income tax expense ................................................................................................................................................ 1,639,994 814,503 15,979,266 5,222,964 Net realized gain on investments ......................................................................................................................... 825,491 10,756,302 240,024 - 240,024 Net increase (decrease) in unrealized appreciation of investments ................................................................. 70,624,231 (159,247,203) (142,969,698) Net realized and unrealized gain (loss) on investments .................................................................................... $71,449,722 $(148,490,901) $(142,729,674) Increase (decrease) in net assets from operations ............................................................................................ $73,540,503 $(138,307,446) $(139,014,474) The accompanying Notes are an integral part of these Consolidated Financial Statements 21 Capital Southwest Corporation and Subsidiaries Consolidated Statements of Changes in Net Assets Years Ended March 31 2010 2009 2008 Operations: Net investment income ............................................................................................................................................ Net realized gain on investments ............................................................................................................................. Net increase (decrease) in unrealized appreciation of investments ......................................................................... Increase (decrease) in net assets from operations .................................................................................................. $ 2,090,781 825,491 70,624,231 73,540,503 $ 3,715,200 $ 10,183,455 10,756,302 (159,247,203) (142,969,698) (139,014,474) (138,307,446) 240,024 ................................. Distributions from: Undistributed net investment income ....................................................................................................................... Net realized gains deemed distribution to shareholders .......................................................................................... (2,993,310) (12,256,745) (868,114) (8,646,560) (2,333,291) - Capital share transactions: Allocated increase in share value for deemed distribution ....................................................................................... Exercise of employee stock options......................................................................................................................... Change in pension plan funded status, net of tax .................................................................................................... Stock option expense .............................................................................................................................................. Treasury stock ......................................................................................................................................................... Increase (decrease) in net assets ............................................................................................................................ 868,114 - 440,192 675,210 - 71,662,595 8,646,560 - 231,390 - (1,178,764) (1,473,329) 503,645 263,664 (16,903,346) - (142,031,475) (168,437,221) Net assets, beginning of year .................................................................................................................................... 415,262,991 583,700,212 725,731,689 Net assets, end of year .......................................................................................................................................... $486,925,586 $415,262,991 $583,700,214 The accompanying Notes are an integral part of these Consolidated Financial Statements 22 Capital Southwest Corporation and Subsidiaries Consolidated Statements of Cash Flows Cash flows from operating activities Increase (decrease) in net assets from operations ............................................................... Adjustments to reconcile increase (decrease) in net assets from operations ........................ to net cash provided by (used in) operating activities: Proceeds from disposition of investments .......................................................................... Proceeds from repayment of debt securities ....................................................................... Purchases of securities ....................................................................................................... Maturities of securities......................................................................................................... Depreciation and amortization ............................................................................................. Net pension benefit ............................................................................................................. Net realized (gain) loss on investments before income taxes .............................................. Net (increase) decrease in unrealized appreciation of investments ..................................... Stock option expense .......................................................................................................... Increase in dividend and interest receivable ....................................................................... (Increase) decrease in receivables from affiliates ................................................................ Increase in other assets ...................................................................................................... Increase (decrease) in other liabilities ................................................................................. Decrease in accrued pension cost ...................................................................................... Increase in deferred income taxes ...................................................................................... Net cash provided by (used in) operating activities ............................................................... Cash flows from financing activities Distributions from undistributed net investment income ........................................................ Proceeds from exercise of employee stock options .............................................................. Purchase of treasury stock ................................................................................................... Payment of federal income tax for deemed capital gains distribution .................................... Net cash used in financing activities ..................................................................................... Net (decrease) in cash and cash equivalents ....................................................................... Cash and cash equivalents at beginning of year ................................................................... Cash and cash equivalents at end of year ............................................................................ Supplemental disclosure of cash flow information: Cash paid during the year for: Interest .................................................................................. Income taxes ......................................................................... 2010 Years Ended March 31 2009 2008 $ 73,540,503 $(138,307,446) $(139,014,474) 5,190,647 3,000,000 (17,234,456) - 33,130 (369,108) (825,491) (70,624,231) 675,210 (514,278) (617,026) (22,155) 817,246 - 129,600 (6,820,409) (2,993,310) - - (814,503) (3,807,813) (10,628,222) 14,721,730 $ 4,093,508 20,697,647 - (13,030,107) - 40,478 (253,229) (10,756,302) 159,247,203 503,645 (364,160) 5,270 (33,358) 7,620 (68,934) 88,700 17,777,027 1,433,891 (10,733,536) 154,500 32,756 (327,345) (240,024) 142,969,698 263,664 190,275 (8,705) (80,195) (33,281) (135,768) 114,000 (5,414,544) (12,256,745) - (16,903,346) (5,222,964) (34,383,055) (16,606,028) 31,327,758 $ 14,721,730 (2,333,291) 231,390 - - (2,101,901) (7,516,445) 38,844,203 $ 31,327,758 $ - $ - $ - $ 3,756 $ - $ - The accompanying Notes are an integral part of these Consolidated Financial Statements 23 Notes to Consolidated Financial Statements ORGANIZATION AND BASIS OF PRESENTATION Organization Basis of Presentation Capital Southwest Corporation (―CSC‖ or the ―Company‖) was orga- nized as a Texas corporation on April 19, 1961. Until September 1969, we operated as a licensee under the Small Business Investment Act of 1958. At that time, we transferred to our wholly-owned subsid- iary, Capital Southwest Venture Corporation (―CSVC‖) certain assets and our license as a small business investment company (―SBIC‖). CSVC is a closed-end, non-diversified investment company of the management type registered under the Investment Company Act of 1940 (the ―1940 Act‖). Prior to March 30, 1988, we were registered as a closed-end, non-diversified investment company under the 1940 Act. On that date, we elected to become a business development company subject to the provisions of 1940 Act, as amended by the Small Business Incentive Act of 1980. Because we wholly own CSVC, the portfolios of both entities are referred to collectively as ―our,‖ ―we‖ and ―us.‖ Capital Southwest Management Company (―CSMC‖), a wholly-owned subsidiary of CSC, is the management company for CSC and CSVC. CSMC generally incurs all normal operating and adminis- trative costs required for its day-to-day operations. Our portfolio is a composite of companies in which we have majority interests, as well as a number of developing companies and marketa- ble securities of established publicly-owned companies. We make available significant managerial assistance to the companies in which we invest and believe that providing material assistance to such inves- tee companies is critical to their business development activities. When appropriate, CSMC receives a monthly fixed fee for their man- agement services provided by the portfolio companies. The consolidated financial statements have been prepared in accor- dance with accounting principles generally accepted in the United States of America for investment companies. Under the investment company rules and regulations pursuant to Article 6 of Regulation S-X and the Audit and Accounting Guide for Investment Companies issued by the American Institute of Certified Public Accountants (the ―AICPA Guide‖), we are precluded from consolidating any entity other than another investment company. An exception to this general principle in the AICPA Guide occurs if the investment company has an investment in an operating company that provides services to the investment company. Therefore, our consolidated financial statements include our management company, CSMC. We classify our portfolio investments in accordance with the re- quirements of the 1940 Act. Under the 1940 Act, ―Control Invest- ments‖ 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. Under the 1940 Act, ―Affiliate Investments‖ are defined as investments in which we own between 5% and 25% of the voting securities. Under the 1940 Act, ―Non-Control/Non-Affiliate Investments‖ are defined as investments that are neither Control In- vestments nor Affiliated Investments. 24 SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES 1. Significant Accounting Policies The following is a summary of significant accounting policies followed in the preparation of the consolidated financial statements of CSC, CSVC and CSMC (together, the ―Company‖). Fair Value Measurements. The Company adopted FASB ASC Topic 820 ―Fair Value Measurements” on April 1, 2008. ASC Topic 820 (1) creates a single definition of fair value, (2) establishes a framework for measuring fair value, and (3) expands disclosure requirements about items measured at fair value. The Statement applies to both items recognized and reported at fair value in the financial statements and items disclosed at fair value in the notes to the financial statements. The Statement does not change existing accounting rules governing what can or what must be recognized and reported at fair value in the Company’s financial statements, or disclosed at fair value in our notes to the financial statements. Additionally, Topic 820 does not eliminate practicability exceptions that exist in accounting pronouncements amended by this Statement when measuring fair value. Prior to ASC Topic 820, certain measurements of fair value were based on the price that would be paid to acquire an asset, or received to assume a liability (an entry price). FASB Topic 820 clarifies the defi- nition of fair value as the price that would be received from the sale of an asset, or paid to transfer a liability, in an orderly transaction be- tween market participants at the measurement date (that is, an exit price). The exit price is based on the amount that the holder of the asset or liability would receive or need to pay in an actual transaction (or in a hypothetical transaction if an actual transaction does not exist) at the measurement date. In some circumstances, the entry and exit price may be the same; however, they are conceptually different. 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, the Company uses valuation techniques that place greater reliance on observable inputs and less reliance on unob- servable inputs. Due to the inherent uncertainty in the valuation process, the Company’s 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 environ- ment, portfolio company performance and other events may occur over the lives of the investments may cause the gains or losses ulti- mately 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 invest- ments. Our Board of Directors retained Duff & Phelps to provide li- mited scope third party valuation services on eight investments com- prising 81.3% of our net asset value at March 31, 2010. Please refer to our Form 10-K for full disclosure of Duff & Phelps’ services. We believe our investments at March 31, 2010 and 2009 approx- imate fair value as of those dates based on the market in which we operate and other conditions in existence at those reporting periods. 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. Investments. Investments are stated at market or fair value deter- mined 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. Investments are recorded on a trade date basis. 25  Segment Information. The Company operates and manages its business in a singular segment. As an investment company, the Company invests in portfolio companies in various industries and geo- graphic areas as presented in the portfolio of investments. Use of Estimates. The preparation of financial statements in con- formity with accounting principles generally accepted in the United States of America requires management to make estimates and as- sumptions that affect the amounts reported in the financial statements and accompanying notes. Actual results could differ from those esti- mates. Interest and Dividend Income. Interest and dividend income is rec- orded on an accrual basis to the extent amounts are expected to be collected. Dividend income is recorded at ex-dividend date for mar- ketable 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 will generally es- tablish a reserve against the interest or dividend income, thereby plac- ing the loan or debt security’s status on non-accrual basis and cease recognizing interest income on that loan or debt security until the bor- rower has demonstrated the ability and intent to pay contractual amounts due. If a loan or debt security’s status significantly improves regarding ability to service the debt or other obligations, it will be res- tored to accrual basis. Federal Income Taxes. CSC and CSVC have elected and intend to comply with the requirements of the Internal Revenue Code (IRC) necessary to qualify as regulated investment companies (RICs). By meeting these requirements, they will not be subject to corporate fed- eral income taxes on ordinary income distributed to shareholders. In order to comply as a RIC, each company is required to timely distri- bute to its shareholders at least 90% of investment taxable income, as defined by the Code, each year. Taxable income generally differs from net income for financial reporting purposes due to temporary and 26 permanent differences in the recognition of income and expenses. Taxable income generally excludes net unrealized appreciation or de- preciation, as investment gains or losses are not included in taxable income until they are realized. The Company’s policy is to retain and pay the 35% corporate tax on realized long-term capital gains. For investment companies that qualify as RICs under the IRC, federal in- come taxes payable on security gains that the company elects to re- tain are accrued only on the last day of the tax year, December 31. Therefore, CSC and CSVC made no provision for federal income taxes on such gains and net investment income in their financial statements. CSMC, a wholly owned subsidiary of CSC, is not a RIC and is re- quired to pay taxes at the current corporate rate. The Company accounts for interest and penalties as part of operat- ing expenses. There were no interest or penalties incurred during the years ended March 31, 2010, 2009 and 2008. Deferred Taxes. The Company sponsors a qualified defined benefit pension plan which covers its employees and employees of certain of its controlled affiliates. Deferred taxes related to the qualified defined benefit pension plan are recorded as incurred. Stock-Based Compensation. At March 31, 2010, the Company has two stock-based incentive compensation plans. These plans encourage and enable the officers, employees, non-employee directors, and other key persons of the Company to acquire an interest in the Company. We account for our share-based compensation using the fair value method, as prescribed by ASC 718, Compensation – Stock Compensa- tion. Accordingly, we recognize compensation cost 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 are de- termined on the date of grant using the Black-Scholes pricing model and are expensed over the vesting period of the related stock options. See ―Note 5, Stock-Based Compensation‖ for further discussion.  Defined Pension Benefits and Other Postretirement Plans. We record annual amounts relating to defined benefit pension plans based on calculations, which include various actuarial assumptions such as discount rates and assumed rates of return depending on the pension plan. Material changes in pension costs may occur in the future due to changes in the discount rate, changes in the expected long-term rate of return, changes in levels of contributions to the plans and other fac- tors. 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 postretirement defined benefit plans in the Consolidated Statements of Assets and Liabilities in the year in which the changes occur and measure postretirement defined benefit plan assets and obligations as of the date of the employer’s fiscal year-end. The Com- pany presently uses March 31 as the measurement date for all of its postretirement defined benefit plans. Concentration of Credit Risk. The Company places its idle cash with financial institutions in various money market accounts, which routine- ly exceed the Federal Deposit Insurance Corporation insured limit. As of March 31, 2010 and March 31, 2009, the Company’s money market account balances exceeded the Federal Deposit Insurance Corpora- tion’s limits by $3.1 million and $13.8 million, respectively. Recent Accounting Pronouncements ASC No. 715-20-50-Pension Plan and Postretirement Benefit Plan Disclosure. In December 2008, the FASB issued ASC No. 715-20-50, ―Compensation –Retirement Benefits” (―ASC 715-20-50‖). ASC 715- 20-50 requires enhanced disclosures about our plan assets for the defined benefit pension and other postretirement benefit plans. The enhanced disclosures required by this ASC are intended to provide users of financial statements with a greater understanding of: (1) how investment allocation decisions are made, including the factors that are pertinent to an understanding of investment policies and strate- gies; (2) the major categories of plan assets; (3) the inputs and valua- tion techniques used to measure the fair value of plan assets; (4) the effect of fair value measurements using significant unobservable inputs (level 3) on changes in plan assets for the period; and (5) significant concentrations of risk within plan assets. This ASC became effective for us for our fiscal year ended March 31, 2010 and resulted in certain disclosures in Note 7. ASC No. 855-10-Subsequent Events. In May 2009, the FASB issued ASC No. 855-10, ―Subsequent Events” (―ASC 855-10‖), which sets forth general standards of accounting for and disclosure of events that occur after the balance sheet date but before financial statements are issued or available to be issued. ASC 855-10 became effective in the first quarter of fiscal March 31, 2010 and did not have a material im- pact on our consolidated financial statements. Additionally, in Febru- ary 2010, the FASB issued Accounting Standards Update (―ASU‖) No. 2010-09, ―Amendments to Certain Recognition and Disclosure Re- quirements” (―ASU 2010-09‖), which became effective upon issuance and amended the guidance on subsequent events to remove the re- quirement for SEC filers to disclose the date through which an entity has evaluated subsequent events. We have evaluated certain events and transactions occurring after March 31, 2010 and, as disclosed in Note 10, we had one event that met the definition of a subsequent event for the period ended March 31, 2010. Accounting Standard Codification. The Financial Accounting Stan- dards Board’s (―FASB‖) Accounting Standards Codification™ (―ASC‖) became effective on July 1, 2009. At that date, the ASC became FASB’s officially recognized source of authoritative U.S. generally ac- cepted accounting principles (―GAAP‖) applicable to all public and non- public non-governmental entities, superseding existing FASB, Ameri- can Institute of Certified Public Accountants (―AICPA‖), Emerging Is- sues Task Force (―EIFT‖) and related literature. Rules and interpretive releases of the SEC under the authority of federal securities laws are also sources of authoritative GAAP for SEC registrants. All other ac- counting literature is considered non-authoritative. The switch to ASC affects the way companies refer to U.S. GAAP in financial statements and accounting policies. Citing particular content in the ASC involves specifying the unique numeric path to the content through the Topic, Subtopic, Section and Paragraph structure. 27  ASU No. 2009-05- Fair Value Measurements and Disclosures (Topic 820): Measuring Liabilities at Fair Value. In August 2009, the FASB issued Accounting Standards Update (―ASU‖) No. 2009-05, ―Measuring Liabilities at Fair Value” (―ASU 2009-05‖), which amends ASC 820-10. ASU 2009-05 provides clarification in circumstances when a quoted price in an active market for an identical liability is not available. In such instances, a reporting entity is required to measure fair value utilizing a valuation technique that uses (1) the quoted price of the identical liability when traded as an asset; (2) quoted prices for similar liabilities when traded as assets; or (3) another valuation technique that is consistent with the existing principles of ASC Topic 820, such as an income or market approach. ASU 2009-05 also clarifies that when estimating the fair value of a liability, a reporting entity is not required to include a separate input or adjustment to other inputs relating to the existence of a restriction that prevents the transfer of the liability. Additionally, ASU 2009-5 clarifies that both a quoted price in an active market for an identical liability at the measurement date and the quoted price for an identical liability when traded as an asset in an active market when no adjustment to the quoted price of the asset are required are Level 1 fair value measurements. This ASU became ef- fective for us for our fiscal year ended March 31, 2010 and did not have a material impact on our consolidated financial statements. ASU No. 2009-12—Fair Value Measurements and Disclosures (Topic 820): Investments in Certain Entities That Calculate Net Asset per Share (or Its Equivalent). In September 2009, the FASB issued ASU No. 2009-12 ―Investments in Certain Entities That Calculate Net Asset Per Share (or Its Equivalent),‖ which provides further guidance for measuring the fair value of investments in certain entities that calcu- late net asset value per share or its equivalent; provided the invest- ment does not have a readily determined fair value and the net asset value is calculated in a manner that is consistent with ASC Topic 946- Financial Services-Investment Companies, as of the reporting entities’ measurement date, including the measurement of all or substantially all of the underlying investments of the investee in accordance with Topic 820. In such instances, a reporting entity is permitted to esti- mate the fair value of an investment using the net asset value per share. This ASU became effective for us for our fiscal year ended March 31, 2010 and did not have a material impact on our consolidat- ed financial statements. ASU No. 2010-06, Fair Value Measurements and Disclosures (Topic 820): Improving Disclosures about Fair Value Measurements. In Janu- ary 2010, the FASB issued ASU No. 2010-06 ―Improving Disclosures about Fair Value Measurements,‖ which provides more robust disclo- sures about (1) the different classes of assets and liabilities measured at fair value, (2) the valuation techniques and inputs used, (3) the activity in Level 3 fair value measurements, and (4) the transfers be- tween Levels 1, 2, and 3. ASU 2010-06 is effective for annual and in- terim periods beginning after December 15, 2009, except for the re- quirement to provide the Level 3 activity on a gross basis, which is effective for annual periods beginning after December 15, 2010 and for interim periods within those fiscal years. The Company will adopt ASU 2010-06 in the first quarter of 2010, except for the requirement to provide the Level 3 activity on a gross basis, which will be adopted after December 15, 2010. The Company does not expect the adoption of these disclosures to have a material impact on our consolidated financial position or results of operations. 2. Investments We fair value our investments in accordance with GAAP as deter- mined in good faith by our Board of Directors. 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 partici- pants 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 Topic 820 ―Fair Value Measurements and Disclosures.‖ Where inputs for an asset or liability fall in more than one level in the fair val- 28 ue hierarchy, the investment is classified in its entirety based on the lowest level input that is significant to that investment’s fair value measurement. The fair value hierarchy gives the highest priority to quoted prices in active markets for identical investments (Level 1) and lowest priority to unobservable inputs (Level 3). We use judgment and consider factors specific to the investment in determining the sig- nificance of an input to a fair value measurement. 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 that are accessible at the mea- surement date for identical, unrestricted assets or liabilities. We use Level 1 inputs for publicly traded unrestricted securities for which we do not have a controlling interest. 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 securities traded on the NASDAQ on the valuation date. Level 2: Investments whose values are based on data other than the quoted prices included within Level 1 that are observable for the asset or liability, either directly or indirectly. We did not value any of our investments using level 2 inputs as of March 31, 2010. Level 3: Investments whose values are based on prices or valua- tion techniques that require inputs that are both unobservable and significant to the overall fair value measurement. These inputs re- flect management’s own assumptions about the assumptions a market participant would use in pricing the investment. We use Level 3 inputs for measuring the fair value of substantially all of our investments. See ―Notes to Schedule of Investments‖ (c) on page 17 for the investment policy used to determine the fair value of these investments. As required by ASC 820, when the inputs used to measure a fair value fall within different levels of the hierarchy, the level within the fair value measurement is categorized is based on the lowest level input that is significant to the fair value measurement in its entirety. For example, a level 3 fair value measurement may include inputs that are observable (Levels 1 and 2) and unobservable (3). We conduct re- views of fair value hierarchy on a quarterly basis. Changes in the ob- servability of valuation inputs may result in a reclassification of certain assets. The following fair value hierarchy tables set forth our investment portfolio by level as of March 31, 2010 and 2009 (in millions): Fair Value Measurements at 3/31/2010 Using Asset Category Debt Partnership Interests Preferred Equity Common Equity Total Investments Total $ 14.6 8.6 35.3 419.4 $477.9 Asset Category Debt Partnership Interests Preferred Equity Common Equity Total Investments Total $ 8.3 6.8 16.4 365.2 $396.7 Quoted Prices in Active Markets for Identical Assets Level 1 $ - - - 21.0 $21.0 Significant Other Observable Inputs Level 2 $ - - - - $ - Significant Unobservable Inputs Level 3 $ 14.6 8.6 35.3 398.4 $456.9 Fair Value Measurements at 3/31/2009 Using Quoted Prices in Active Markets for Identical Assets Level 1 $ - - - 13.8 $13.8 Significant Other Observable Inputs Level 2 $ - - - - $ - Significant Unobservable Inputs Level 3 $ 8.3 6.8 16.4 351.4 $382.9 29  The following tables set forth a summary of changes in the fair value of investment assets and liabilities measured using Level 3 inputs dur- ing the years ended March 31, 2010 (in millions): held at reporting date was $63,933,254 and $(124,976,775), respec- tively. Net Unrealized Net New Conversion of Fair Value Appreciation Investments Security from Fair Value Asset Category 3/31/09 (Depreciation) (Divestitures) Debt to Equity 3/31/10 Debt $ 8.3 $ 4.9 2.7 $ (1.3) $ 14.6 Partnership Interests Preferred Equity Common 6.8 (0.2) 2.1 - 8.6 16.4 9.4 8.2 1.3 35.3 Equity 351.4 49.3 (2.3) - 398.4 Total Investments $382.9 $ 63.4 $10.7 - $ 456.9 Net Unrealized Net New Conversion of Fair Value Appreciation Investments Security from Fair Value Asset Category 3/31/08 (Depreciation) (Divestitures) Debt to Equity 3/31/09 Debt $ 9.0 $ (5.0) $ 4.3 $ - $ 8.3 Partnership Interests Preferred Equity Common Equity Equity 5.3 (0.9) 21.8 (11.5) 458.3 (107.2) 2.3 6.1 0.3 - - - 6.8 16.4 351.4 Warrants 0.4 (0.4) - - - Total Investments $ 494.8 $ (124.9) $13.0 $- $ 382.9 The amount of total gains for the years ended March 31, 2010 and 2009 included in change in net assets attributable to the change in net unrealized appreciation (depreciation) relating to assets (level 3) still 30 3. Income Taxes We operate to qualify as a RIC under Subchapter M of the IRC. In order to qualify as a RIC, we must annually distribute at least 90% of our taxable ordinary income, based on our tax year, to our sharehold- ers in a timely manner. Ordinary income includes net short-term capi- tal gains but excludes net long-term capital gains. A RIC is not subject to federal income tax on the portion of its ordinary income and long- term capital gains that are distributed to its shareholders, including ―deemed distributions‖ discussed below. As permitted by the IRC, a RIC can designate dividends paid in the subsequent tax year as divi- dends of current year ordinary income and net long-term gains if those dividends are both declared by the extended due date of the RIC’s federal income tax return and paid to shareholders by the last day of the subsequent tax year. We have a calendar tax year end of December 31. We have distributed or intend to distribute sufficient dividends to eliminate taxable income for our completed tax years. If we fail to satisfy the 90% distribution requirement or otherwise fail to qualify as a RIC in any tax year, we would be subject to tax in such year on all of our taxable income, regardless of whether we made any distributions to our shareholders. For the tax years ended December 31, 2009 and 2008, we declared and paid ordinary dividends in the amount of $2,993,310 and $12,256,745, respectively. Additionally, we are also subject to a nondeductible federal excise tax of 4% if we do not distribute at least 98% of our investment com- pany ordinary taxable income before the end of our tax year. For the tax year ended December 31, 2009 we distributed 100% of our in- vestment company ordinary taxable income. As a result we have made no provision for income taxes on ordinary taxable income for the tax year ended December 31, 2009.  A RIC may elect to retain its long-term capital gains by designating them as a ―deemed distribution‖ to its shareholders and paying a fed- eral tax of 35% on the long-term capital gains for the benefit of its shareholders. Shareholders would then report their share of the re- tained capital gains on their income tax returns as if it had been re- ceived and report a tax credit for the tax paid on their behalf by the RIC. Shareholders then add the amount of the ―deemed distribution,‖ net of such tax, to the basis of their shares. For the tax year ended December 31, 2009, we have estimated net long-term capital gains of $2,327,150 for tax purposes and $1,682,616 for book purposes, which we elected to retain and treat as deemed distributions to our shareholders. Likewise, for the tax year ended December 31, 2008, we had net long-term capital gains of $14,922,751 for tax purposes and $15,936,644 for book purposes, which we elected to retain and treat as deemed distributions to our shareholders. As a result of our election to retain long-term capital gains, we incurred federal taxes on behalf of our shareholders in the amount of $814,503 and $5,222,964 for the tax years ended December 31, 2009 and 2008, respectively. As of December 31, 2009, we did not have any undistributed long- term capital gains since they are being treated as a ―deemed distribu- tion.‖ For the tax years ended December 31, 2009 and 2008, CSC and CSVC qualified to be taxed as RICs. We intend to meet the applicable qualifications to be taxed as a RIC in future years. Management feels it is probable that we will maintain our RIC status for a period longer than one year. However, either company’s ability to meet certain port- folio diversification requirements of RICs in future years may not be controllable by such company. CSMC, a wholly owned subsidiary of CSC, is not a RIC and is re- quired to pay taxes at the current corporate rate. The Company spon- sors a qualified defined benefit pension plan which covers its em- ployees and employees of certain of its wholly owned portfolio compa- nies. Deferred taxes related to the qualified defined pension plan are recorded as incurred. 4. Undistributed 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 is that required minimum fund distributions are based on income and gain amounts determined in accordance with federal income tax regula- tions, rather than GAAP. The differences created can be temporary, meaning that they will reverse in the future, or they can be perma- nent. In subsequent periods, when all or a portion of a temporary difference becomes a permanent difference, the amount of the per- manent difference will be reclassified to ―additional capital.‖ The following table sets forth a summary of our net realized gains on transactions by category: Net Realized Gains On Transaction In For the Tax Year Ended December 31, Investment Securities of Unaffiliated issuers Affiliated issuers Investments other than securities 2009 $206,5212 1,433,472 - 2008 $15,936,644 - - Net realized gain on investments before taxes $1,639,994 $15,936,644 Income tax expense Net realized gain on investments 814,503 $ 825,491 5,222,964 $10,713,680 Net realized gains (for tax purposes) $2,327,150 $14,922,751 As a result of our election to retain long-term capital gains, we in- curred federal taxes on behalf of our shareholders in the amounts listed in the table above. As of March 31, 2010, we did not have undi- stributed long-term capital gains (losses) since they are being treated as a ―deemed distribution,‖ while we reported undistributed long-term capital gains of $42,622 as of March 31, 2009. 5. Employee Stock Option Plan On July 20, 2009, shareholders approved our 2009 Stock Incentive Plan (the ―2009 Plan‖), which provides for the granting of stock op- tions to employees and officers of the Company and authorizes the 31 issuance of common stock upon exercise of such options for up to 140,000 shares. All options are granted at or above market price, generally expire up to ten years from the date of grant, and are gen- erally exercisable on or after the first anniversary of the date of grant in five annual installments. Options to purchase 38,750 shares at a price of $76.74 (market price at the time of the grant) were granted on October 19, 2009. Additionally, options to purchase 20,000 shares at a price of $95.79 (market price at time of the grant) were granted on March 22, 2010. All 58,750 shares remain outstanding, thus leav- ing 81,250 options available for grant under the plan. The Company 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 pre- viously granted under the 1999 Plan and outstanding on July 20, 2009 continue to be governed by the provisions of the 1999 Plan. All op- tions granted under the 1999 Plan were granted at or above market price, generally expire up to ten years from the date of grant, and are generally exercisable on or after the first anniversary of the date of grant in five to ten annual installments. We recognize compensation cost over the straight-line method for all share-based payments granted and for all awards granted to em- ployees prior to April 1, 2006 that remain unvested. The fair value of the stock options are determined on the date of grant using the ―Black-Scholes Pricing Model‖ and are expensed over the vesting pe- riod of the related stock options. Accordingly, for the years ended March 31, 2010, 2009 and 2008, we recognized compensation ex- pense of $675,210, $503,645, and $263,664 respectively. As of March 31, 2010, the total remaining unrecognized compensa- tion cost related to non-vested stock options was $3,332,391, which will be amortized over the weighted-average service period of approx- imately 4.1 years. 32 The following table summarizes the 2009 Plan and the 1999 Plan price per option at grant date using the Black-Scholes Pricing Model: Date of Issuance 2009 Plan March 22, 2010 October 19, 2009 1999 Plan July 30, 2008 July 21, 2008 July 16, 2007 July 17, 2006 May 15, 2006 Weighted Average Fair Value Black-Scholes Pricing Model Assumptions Expected Risk-Free Dividend Yield Expected Volatility Interest Rate Expected Life (in years) $32.56 $25.36 0.84% 1.04% 2.43% 2.36% 37.8% 37.6% $29.93 $27.35 $41.78 $33.05 $31.28 0.62% 0.67% 0.39% 0.61% 0.64% 3.36% 3.41% 4.95% 5.04% 5.08% 20.2% 20.2% 19.9% 21.2% 21.1% 5 5 5 5 5 7 7 The following summarizes activity in the stock option plans for the years ended March 31, 2010, 2009 and 2008: 2009 Plan Balance at March 31, 2009 Granted Exercised Canceled Balance at March 31, 2010 Number of shares Weighted Average Exercise Price - 58,750 - - 58,750 $ - 83.23 - - $83.23 1999 Plan Balance at March 31, 2008 Balance at March 31, 2009 Granted Exercised Canceled 70,400 37,500 - - 107,900 - - - 107,900 Balance at March 31, 2010 Combined Balance at March 31, 2010 166,650 Granted Exercised Canceled $110.00 123.72 - - $114.78 - - - $114.78 $103.65 March 31, 2010 Outstanding Exercisable Weighted Average Aggregate Intrinsic Remaining Contractual Term Value 4.1 years 3.4 years $4,889,443 $1,158,499 At March 31, 2010, the range of exercise prices and weighted- average remaining contractual life of outstanding options was $65.00 to $152.98 and 4.1 years, respectively. There were no options exer- cised during the years ended March 31, 2010 and March 31, 2009. The total intrinsic value of options exercised during the years ended March 31, 2008 was $75,129. The exercise prices ranged from $65.00 to $93.49 per share for the each of the years ended March 31, 2008. New shares were issued for $231,390 cash received from op- tion exercises for the years ended March 31, 2008. At March 31, 2010, 2009 and 2008, the number of options exercis- able was 38,960, 21,445 and 9,930, respectively and the weighted- average exercise price of those options was $107.94, $97.00 and $79.01, respectively. 6. Employee Stock Ownership Plan CSC and one of its controlled affiliates sponsor a qualified employee stock ownership plan (―ESOP‖) in which certain employees participate. Contributions to the plan, which are invested in CSC stock, are made at the discretion of the Board of Directors. A participant’s interest in contributions to the ESOP fully vests after five years of active service. Effective April 1, 2007, the vesting period for the ESOP is three years. During the 3 years ended March 31, 2010, the Company made contributions to the ESOP, which were charged against net investment income, of $144,436 in 2010, $0 in 2009 and $94,210 in 2008. 7. Retirement Plans CSC sponsors a qualified defined benefit pension plan which covers its employees and employees of certain of its controlled affiliates. The following information about the plan represents amounts and informa- tion related to CSC’s participation in the plan and is presented as though CSC 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 10 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, 2010. Additionally, CSC 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 tables set forth the qualified plan’s net pension benefit, benefit obligation, fair value of plan assets, and amounts recognized in CSC’s consolidated statements of assets and liabilities at March 31, 2010, 2009 and 2008; as well as amounts recognized in CSC’s consol- idated statements of assets and liabilities at March 31, 2010 and 2009: Years Ended March 31 2010 2009 2008 Net pension benefit Service cost-benefits earned during the year ........................................... $116,746 Interest cost on projected benefit obligation 191,936 (735,366) Expected return on assets ..................... Net amortization ................................... 9,006 Net pension benefit from qualified plan ... $(417,678) $67,340 290,310 (732,837) 3,725 $(371,462) $67,514 222,895 (673,366) 3,725 $(379,232) Change in benefit obligation Benefit obligation at beginning of year ............................................ $2,914,813 116,746 Service cost ......................................... 191,936 Interest cost ......................................... Actuarial gain (loss) .............................. 295,379 Benefits paid ........................................ (68,131) Plan change ......................................... - Benefit obligation at end of year ............. $3,450,443 $3,699,285 67,340 290,310 (916,874) $3,965,100 67,514 222,895 (160,840) (259,810) (395,384) - $3,699,285 33 34,262 $2,914,513 Years Ended March 31 2010 2009 2008 Years Ended March 31 2010 2009 2008 Change in plan assets Fair value of plan assets at beginning of year ........................................... $8,383,373 $11,120,337 $12,973,292 (1,457,571) Actual return on plan assets .................. 2,204,158 (395,384) Benefits paid ....................................... (68,131) Fair value of plan assets at end of year ................................................ $10,519,400 (2,477,154) (259,810) $ 8,383,373 $11,120,337 March 31 2010 2009 Change in benefit obligation Benefit obligation at beginning $934,427 of year ............................................ 26,847 Service cost ......................................... 60,334 Interest cost ......................................... 61,332 Actuarial gain (loss) .............................. - Benefits paid ........................................ Plan change ......................................... - Benefit obligation at end of year ............. $1,082,941 $942,122 10,986 104,777 (74,613) $1,178,891 10,483 57,588 (169,072) (68,934) (135,768) - $942,122 20,089 $934,427 Funded status and amounts recognized in our consolidated statements of assets and liabilities Actuarial present value of benefit obligations: Accumulated benefit obligation.......................... $(3,076,629) $(2,630,743) Projected benefit obligation for service rendered to date ................................................................ $(3,450,443) $(2,914,513) Amounts recognized in our consolidated statements of assets and liabilities Projected benefit obligation....................................... $(1,082,941) $(934,427) Unrecognized net (gain) loss from past experience March 31 2010 2009 8,383,373 5,468,860 different from that assumed and effects of changes in assumptions ................................... Unrecognized prior service costs ............................... Additional asset, FAS 158 ......................................... 518,775 Prepaid pension cost included in pension liabilities ...... $(1,082,941) 618,712 $(934,427) (347,741) $(431,432) (171,034) (187,280) Plan assets at fair value* .......................................... 10,519,400 Funded status ......................................................... 7,068,957 Unrecognized net (gain) loss from past experience different from that assumed and effects of changes in assumptions ................................... 1,328,748 150,710 Unrecognized prior service costs ............................... Additional asset, FAS 158 ......................................... (1,479,458) Prepaid pension cost included in pension assets .......... $ 7,068,957 2,502,161 159,716 (2,661,877) $ 5,468,860 _____________ *Primarily equities and bonds including approximately 25,000 shares of CSC Common Stock. The following tables set forth the retirement restoration plan’s net pension benefit and benefit obligation amounts at March 31, 2010, 2009 and 2008; as well as amounts recognized in CSC’s consolidated statements of assets and liabilities at March 31, 2010, 2009: Years Ended March 31 2010 2009 2008 Net pension benefit Service cost-benefits earned during the year ......................................... Interest cost on projected benefit obligation Net amortization .................................. Net pension benefit from qualified plan .. $26,847 60,334 (38,605) $48,576 $10,986 104,777 2,470 $118,233 $10,483 57,588 (16,186) $51,885 34 The following assumptions were used in estimating the actuarial present value of the projected benefit obligations: Years Ended March 31 2009 2010 2008 Discount rate ......................................... Rate of compensation increases ............... 6.00% 5.0% 6.5% 5.0% 6.25% 5.0% The following assumptions were used in estimating the net periodic (income)/expense: Years Ended March 31 2009 2010 2008 Discount rate ......................................... Expected return on plan assets ................ Rate of compensation increases ............... 6.5% 6.5% 5.0% 6.25% 6.5% 5.0% 6.0% 6.5% 5.0%  Following are the expected benefit payments for the next five years and in the aggregate for the years 2016-2020: Years Ended March 31 (In Thousands) 2011 2012 Qualified Plan $60 $207 $199 $191 $184 Restoration Plan $18 2013 2014 2015 $82 $93 $89 $85 2016- 2020 $1,034 $367 We use the ―Citigroup Pension Liability Index‖ to determine the discount rate. The expected rate of return on assets assumption was determined based on the anticipated performance of the various asset classes in the plan’s portfolio and the allocation of assets to each class. The anticipated asset class return is developed using historical and predicted asset return performance, considering the investments underlying each asset class and expected investment performance based on forecasts of inflation, interest rates and market indices for fixed income and equity securities. Plan Assets CSC’s pension plan is administered by a board-appointed committee that has fiduciary responsibility for the plan’s management. The trus- tee of the plan is JPMorgan Asset Management. Currently, approx- imately 18% of the assets are selected and managed by the trustee and the remainder of the assets is managed by the committee, in- vested mostly in equity securities, including CSC stock. The plan as- sets are invested using a total return approach whereby a mix of equi- ty securities, debt securities and other investments are used to pre- serve asset values, diversify risk and achieve our targeted investment return benchmark. Investment performance and asset allocation are measured and monitored on an ongoing basis. Plan assets are managed in a balanced portfolio comprised of two major components: an equity portion and a fixed income portion. The expected role of Plan equity investments is to maximize the long-term real growth of Fund assets, while the role of fixed income investments is to generate current income, provide for more stable periodic returns and provide some protection against prolonged decline in the market value of Fund equity investments. The current target allocations for plan assets are 60-80% equity, 15- 40% for fixed income, and 0-15% for cash and cash equivalents. Eq- uity investments include U.S. and foreign equities, as well as publicly traded and non-publicly traded mutual funds. Fixed income securities include long-duration government obligations, government agency obligations and corporate obligations. CSC’s pension plan asset allocations are as follows: Percentage of plan assets at March 31 2010 Asset Category Equity securities ...................................................... 74.2% Fixed income securities ............................................ 16.5% 9.3% Cash and cash equivalents ....................................... 100.0% 2009 67.7% 19.2% 13.1% 100.0% The following fair value hierarchy table sets forth our pension plan investment portfolio by level as of March 31, 2010 (in millions): Fair Value Measurements at Reporting Date Using Quoted Prices in Active Markets for Identical Assets Total Level 1 $ 7.8 $ 6.4 1.7 - 1.0 1.0 $10.5 $7.4 Significant Other Observable Inputs Level 2 $ 1.4 1.7 - $ 3.1 Significant Unobservable Inputs Level 3 $ - - - $ - Asset Category Equity securities (a) Fixed income securities (b) Cash and cash equivalents Total There were no plan assets valued using significant unobservable inputs (level 3) as of March 31, 2010. (a) This category includes investment in equity securities of large, medium and small companies and equity investments in foreign companies. Mutual funds in- cluded in this category are valued using the net asset value per unit as of the valua- tion date. These investments include shares of our common stock. At March 31, 2010 and 2009, Capital Southwest Corporation common stock represented 21.9% and 22.7%, respectively, of the plan assets. b) This category includes investments in investment grade fixed income instru- ments, primarily U.S. government obligations. 35 8. Commitments CSC has agreed, subject to certain conditions, to invest up to $5,518,463 in seven portfolio companies. The Company leases office space under an operating lease which requires base annual rentals of approximately $101,000 through April, 2013. For the three years ended March 31, total rental expense charged to investment income was $92,075 in 2010, $84,117 in 2009 and $80,569 in 2008. 9. Sources of Income Income was derived from the following sources: Years Ended March 31 2010 Companies more than 25% owned ............. Companies 5% to 25% owned .................... Companies less than 5% owned .............. Other sources, including temporary investments Investment Income Realized Gain Interest Dividends Income Other (Loss) on Investments Before Income Taxes $14,473 $3,359,942 $1,055,900 $1,433,472 1,500 326,940 13,000 – 1,009,276 101,798 206,522 206,522 19,618 $1,044,867 337 $3,788,680 $1,275,759 – - $1,639,994 Investment Income Years Ended March 31 2009 Companies more than Interest Dividends Realized Gain (Loss) on Investments Before Income Taxes Other Income Years Ended March 31 2008 Companies more than Investment Income Realized Gain Interest Dividends (Loss) Investments Before Income Taxes Other Income 25% owned ............. $ – $2,979,631 $839,800 $ – Companies 5% to 25 owned ..................... Companies less than 5% owned ............... Other sources, including temporary investments ............. 364 ,762 326 940 42,500 – 469,066 350,262 – 240,024 1,421,722 $2,255,550 – $3,656,833 – $882,300 – $240,024 10. Subsequent Events On April 29, 2010 Capital Southwest Corporation, Lifemark Group, a wholly owned investment of the Company, NorthStar Memorial Group, LLC and NorthStar Cemetery Services of California, LLC, a wholly owned subsidiary of NorthStar (―Purchaser‖), entered into a Stock Purchase Agreement, providing for the sale of all issued and outstand- ing shares of capital stock of Lifemark Group to Purchaser. Consideration for the sale will be cash in the aggregate of $84,750,000. Pursuant to terms of the Stock Purchase Agreement, the purchase price will be reduced by the amount of the Lifemark’s outstanding indebtedness. The purchase price will also be subject to an adjustment based on certain estimated costs or expenses that have been or will be incurred by the Company or its subsidiary asso- ciated with, arising out of or relating to the distribution of certain as- sets. In addition, the purchase is subject to customary adjustments based on the amount of Seller’s net assets at the time the sale is com- pleted. 25% owned ............. $ – $10,946,581 $1,055,000 $ – Companies 5% to 25% owned .................... Companies less than 5% owned .............. Other sources, including temporary investments ............ 36 249,417 326,940 20,750 – 743,937 260,357 9 15,979,266 381,861 – $1,375,215 $11,533,878 $1,076,039 $15,979,266 280 – The Stock Purchase Agreement contains representations and war- ranties, covenants, indemnification provisions and closing conditions that are customary for transactions of this type, including covenants by the Seller related to the conduct of business between the signing of the Stock Purchase Agreement and completion of the sale. Comple- tion of the transaction is subject to customary closing conditions for transactions of this type, including approval from the State of Califor- nia. Schedule of Investments in and Advances to Affiliates SCHEDULE 12-14 Portfolio Company/Type of Investment (1) Control Investments THE RECTORSEAL CORPORATION 27,907 shares of common stock............. LIFEMARK GROUP 1,449,026 shares of common stock ........ THE WHITMORE MANUFACTURING COMPANY 80 shares of common stock ................... ALAMO GROUP INC. 2,830,300 shares of common stock ........ HEELYS, INC. 9,317,310 shares of common stock ... MEDIA RECOVERY, INC 800,000 shares Series A Convertible Preferred Stock, convertible into 800,000 shares of common stock at $1.00 ............. 4,000,002 shares common stock ........... PALM HARBOR HOMES, INC. 7,855,121 shares common stock ........... BALCO, INC. 445,000 shares common stock and 60,920 shares Class B non-voting common stock DENNIS TOOL COMPANY 20,725 shares 5% Convertible Preferred Stock, convertible into 20,725 shares of common stock at $48.25 per share ......... 140,137 shares common stock .............. DISCOVERY ALLIANCE, LLC 90.0% limited liability company ............. HUMAC COMPANY 1,041,000 shares of common stock ........ Total Control Investments Affiliated Investments ENCORE WIRE CORPORATION 4,086,750 shares of common stock ........ Amount of Interest, Fees or Dividends Credited in Income (2) Fair Value at March 31, 2009 Gross Additions (3) Gross Reductions (4) Fair Value at March 31, 2010 $ 2,477,870 $ 107,200,000 $ 13,000,000 $ - $ 120,200,000 500,000 71,000,000 - 649,467 36,000,000 11,500,000 - - 71,000,000 47,500,000 717,872 22,642,400 19,812,100 - 42,454,500 - - - 13,975,965 5,869,905 - 19,845,870 2,500,000 12,300,000 - - (300,000) (1,100,000) 2,200,000 11,200,000 46,972 9,818,902 3,000,000 (5,984,947) 6,833,955 - 6,600,000 1,400,000 - 8,000,000 - 33,333 999,981 2,868,000 - - (999,981) (2,868,000) - - - 450,000 300,000 - 750,000 4,800 $ 4,430,314 133,000 $ 286,488,248 30,000 $ 54,912,005 - $ (11,252,928) 163,000 $ 330,147,325 $339,940 $65,388,000 $2,043,375 $ - $67,431,375 37 Schedule of Investments in and Advances to Affiliates SCHEDULE 12-14 Amount of Interest, Fees or Dividends Credited in Income (2) Fair Value at March 31, 2009 Gross Additions (3) Gross Reductions (4) Fair Value at March 31, 2010 - - 2 2,857,759 $(1,000,000) $1,500 - $1,000,000 - $ - 1,300,000 $ - 1,300,000 Portfolio Company/Type of Investment (1) Affiliated Investments (continued) CMI HOLDING COMPANY, INC. 10% Convertible Promissory Note, due 2009 ......... 10% Convertible Promissory Note, due 2013 ......... 1,631,516 shares Series C-1 Convertible Preferred Stock, convertible into 1,631,516 shares of common stock at $2.15 per share .. 2,327,658 shares Series C-1 Convertible Preferred Stock, convertible into 2,327,658 shares of common stock at $1.72 per share .. Warrants to purchase 109,012 shares of common stock at $1.72 per share, expiring 2012 Warrants to purchase 636,151 shares of Series A-1 Convertible Preferred Stock at $1.72 per share expiring 2017 and 2019 Warrants to purchase 90,698 shares of Series D or D-1 Convertible Pre- ferred Stock at $1.72 per share expiring 2017 PALLETONE, INC. 12.3% Senior Subordinated Notes, $2,000,000 due 2012 150,000 shares of common stock Warrant to purchase 15,294 shares of common stock at $1.00 per share, expiring 2011 BOXX TECHNOLOGIES, INC. 3,125,354 shares Series B Convertible Preferred Stock, convertible into 3,125,354 shares of common stock at $0.50 per share WELLOGIX, INC. 4,788,371 shares Series A-1 Convertible Preferred Stock, convertible into 4,788,371 shares of common stock at $1.0441 per share Total Affiliated Investments Total Control & Affiliated Investments This schedule should be read in conjunction with the Company’s Consolidated Financial Statements, including the Consolidated Schedules of Investments and Notes to Consolidated Financial Statements. - $(1,000,000) $(12,252,928) 2 $73,589,142 $403,736,467 2 $66,388,010 $352,876,258 - $ 8,201,132 $63,113,137 - $ 341,440 $4,771,754 1,999,998 - 2,000,000 2 2,857,761 2 2 - - - - 2 2 - - - - - - - - - - - - - - - - - - - - - - - - - - - (1) The principal amount and ownership detail as shown in the Consolidated Schedules of Investments. (2) Represents the total amount of interest, fees and dividends, credited to income for the portion of the year an investment was included in the Control or Non- Control/Non-Affiliate categories, respectively. (3) Gross additions include increases in the cost basis of investments resulting from new portfolio investments, follow-on investments and accrued PIK interest, and the exchange of one or more existing securities for one or more new securities. Gross additions also include net increases in unrealized appreciation or net decreases in unrealized depreciation as well as movement of an existing portfolio company into this category and out of a different category. (4) Gross reductions included in decreases in the cost basis of investment resulting from principal payments or sales and exchanges of one or more existing securities for one or more new securities. Gross reductions also include net increases in unrealized depreciation or net decreases in unrealized appreciation as well as the movement of an existing portfolio company out of this category and into a different category. 38 Selected Per Share Data and Ratios 2010 Years Ended March 2008 2007 2009 2006 Per Share Data Investment income .................................................................................................................................. Operating expenses ................................................................................................................................ Interest expense ...................................................................................................................................... Income taxes ........................................................................................................................................... $ 1.63 $ 3.74 $ 1.75 (.76) - (.03) (.98) - (.03) (.04) (1.04) - $ 1.79 $ 1.25 (.51) (.11) (.01) (.57) (.12) (.01) Net investment income ............................................................................................................................ Distributions from undistributed net investment income ........................................................................... .56 (.80) 2.72 (3.28) .96 (.60) 1.09 (.60) .62 (.60) Net realized gain (loss) net of tax ............................................................................................................ Net increase (decrease) in unrealized appreciation of investments ......................................................... Treasury stock repurchase * Exercise of employee stock options ** ..................................................................................................... - Stock option expense .............................................................................................................................. Net change in pension plan funded status ............................................................................................... Treasury Stock ........................................................................................................................................ Adjustment to initially apply FASB No. 158, net of tax ............................................................................. .18 .12 - - .22 18.88 2.87 (42.56) .06 (36.76) 3.85 38.00 4.00 32.22 - .13 (.39) 1.40 - (.09) .07 (.30) - - (.49) .04 - - .30 (.04) - - - - Increase (decrease) in net asset value .................................................................................................... 19.16 (39.11) (36.66) 42.19 36.20 Net asset value Beginning of year ................................................................................................................................. 110.98 150.09 186.75 144.56 108.36 End of year .......................................................................................................................................... $130.14 $110.98 $150.09 $186.75 $144.56 Ratios and Supplemental Data Ratio of operating expenses to average net assets ................................................................................. .71% 1.96% Ratio of net investment income to average net assets ............................................................................. Portfolio turnover rate .............................................................................................................................. 1.16% 2.51% .87% .47% .46% .58% .22% .36% .68% .13% .42% .51% 2.36% Net asset value total return ...................................................................................................................... 18.50% (22.56)% (19.27)% 29.85% 34.31% Shares outstanding at end of period (000s omitted) ................................................................................ 3,741 3,741 3,889 3,886 3,860 ____________ * Net increase is due to purchases of common stock at prices less than beginning period net asset value. **Net decrease is due to the exercise of employee stock options at prices less than beginning of period net asset value. 39 Management’s Report on Internal Control Over Financial Reporting Management is responsible for establishing and maintaining adequate internal control over financial reporting. Internal control over financial reporting is defined in Rules 13a-15(f) and 15d-15(f) under the Se- curities Exchange Act of 1934 as a process designed by, or under the supervision of the Company’s principal executive and principal financial officers and effected by the Company’s Board of Directors, manage- ment and other personnel to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally ac- cepted accounting principles and include those policies and procedures that: pertain to the maintenance of records that in reasonable detail accu- rately and fairly reflect the transactions and dispositions of the as- sets of the Company; provide reasonable assurance that transactions are recorded as ne- cessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the Company are being made only in accordance with authorizations of management and directors of the Company; and provide reasonable assurance regarding prevention or timely detec- tion of unauthorized acquisition, use or disposition of the Company’s assets that could have a material effect on the financial statements. Because of its inherent limitations, internal controls over financial re- porting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to risk that controls may become inadequate because of changes in condi- 40 tions, or that the degree of compliance with the policies or procedures may deteriorate. Management has assessed the effectiveness of our internal control over financial reporting as of March 31, 2010. In making this assess- ment, management used the criteria described in ―Internal Control- Integrated Framework‖ issued by the Committee of Sponsoring Or- ganizations of the Treadway Commission (COSO). Based on the re- sults of this assessment, management (including our Chief Executive Officer and our Chief Financial Officer) has concluded that, as of March 31, 2010, the Company’s internal control over financial reporting was effective. The effectiveness of the Company’s internal control over financial re- porting has been audited by Grant Thornton LLP, the independent registered public accounting firm, as stated in their report which ap- pears on the next page of this Annual Report on Form 10-K. Date: May 28, 2010 /s/ Gary L. Martin Gary L. Martin Chairman of the Board and President /s/ Tracy L. Morris Tracy L. Morris Chief Financial Officer (chief financial/accounting officer) Report of Independent Registered Public Accounting Firm Board of Directors and Shareholders Capital Southwest Corporation We have audited Capital Southwest Corporation (a Texas Corpo- ration) and subsidiaries’, (the ―Company‖) internal control over financial reporting as of March 31, 2010, based on criteria estab- lished in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commis- sion (COSO). The Company’s management is responsible for main- taining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Management’s Report on Internal Control Over Financial Reporting. Our responsibility is to express an opinion on the Company’s internal control over finan- cial reporting based on our audit. We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal con- trol over financial reporting was maintained in all material re- spects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, testing and evaluating the design and operating effectiveness of internal control based on the assessed risk, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasona- ble basis for our opinion. A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted ac- counting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reason- able assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with gen- erally accepted accounting principles, and that receipts and ex- penditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the fi- nancial statements. Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projec- tions of any evaluation of effectiveness to future periods are sub- ject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. In our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of March 31, 2010, based on criteria established in Internal Control—Integrated Framework issued by COSO. We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated statements of assets and liabilities of the Company as of March 31, 2010 and 2009, including the schedule of invest- ments as of March 31, 2010 and 2009, and the related consolidat- ed statements of operations, changes in net assets and cash flows for each of the three years in the period ended March 31, 2010, and the selected per share data and ratios for each of the five years in the period ended March 31, 2010, and our report dated May 28, 2010 expressed an unqualified opinion and included ex- planatory paragraphs regarding the Company’s adoption of ASC 820, ―Fair Value Measurements and Disclosures.‖ /s/Grant Thornton, LLP Dallas, Texas May 28, 2010 41 Report of Independent Registered Public Accounting Firm Board of Directors and Shareholders Capital Southwest Corporation We have audited the accompanying consolidated statements of assets and liabilities of Capital Southwest Corporation (a Texas Corporation) and subsidiaries (the ―Company‖) as of March 31, 2010 and 2009, including the schedule of investments as of March 31, 2010 and 2009, and the related consolidated state- ments of operations, changes in net assets, and cash flows for each of the three years in the period ended March 31, 2010, and the selected per share data and ratios for each of the five years in the period ended March 31, 2010. Our audits of the basic financial statements included the Schedule of Invest- ments In and Advances to Affiliates. These financial state- ments, per share data and ratios and financial statement sche- dule are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial state- ments, per share data and ratios and financial statement sche- dule based on our audits. We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the finan- cial statements and selected 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 by examination of securities held by the custodian as of March 31, 2010 and 2009, and confirmation of securities not held by the custodian. An audit also includes assessing the accounting principles used and significant estimates made by manage- ment, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. 42 In our opinion, the consolidated financial statements and the selected per share data and ratios referred to above present fairly, in all material respects, the financial position of Capital Southwest Corporation and subsidiaries as of March 31, 2010 and 2009, and the results of their operations, changes in their net assets, and their cash flows for each of the three years in the period ended March 31, 2010, and the selected per share data and ratios for each of the five years in the period ended March 31, 2010, in conformity with accounting principles gen- erally accepted in the United States of America. Also, in our opinion, the related financial statement schedule, when consi- dered in relation to the basic financial statements taken as a whole, presents fairly, in all material respects, the information set forth therein. As discussed in Note 2 to the accompanying consolidated fi- nancial statements, effective April 1, 2008, the Company adopted Accounting Standard Codification (ASC) 820, ―Fair Value Measurements and Disclosures.‖ We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), Capital Southwest Corporation and subsidiaries’ internal con- trol over financial reporting as of March 31, 2010, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) and our report dated May 28, 2010, expressed an unqualified opinion thereon. /s/ Grant Thornton LLP Dallas, Texas May 28, 2010 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‖ and consists of three elements. The first is ―Net investment income,‖ which is the difference between the Com- pany’s income from interest, dividends and fees and its combined op- erating and interest expenses, net of applicable income taxes. The second element is ―Net realized gain (loss) on investments,‖ which is the difference between the proceeds received from disposition of port- folio securities and their stated cost, net of applicable income tax ex- pense based on the Company’s tax year. The third element is the ―Net increase in unrealized appreciation of investments,‖ which is the net change in the market or fair value of the Company’s investment port- folio, compared with stated cost. It should be noted that the ―Net rea- lized gain (loss) on investments‖ and ―Net increase in unrealized ap- preciation of investments‖ are directly related in that when an appre- ciated portfolio security is sold to realize a gain, a corresponding de- crease in net unrealized appreciation occurs by transferring the gain associated with the transaction from being ―unrealized‖ to being ―rea- lized.‖ 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 Com- pany 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 $19,618 in 2010, $381,498 in 2009 and $1,421,048 in 2008. The Company also receives management fees primarily from its controlled affiliates which aggregated $984,800 in 2010, $984,800 in 2009 and $784,800 in 2008. During the three years ended March 31, 2010, the Company recorded dividend income from the following sources: Years Ended March 31 2010 2009 2008 Alamo Group Inc. ................................... $ 679,272 $ 679,272 $ 678,732 Balco, Inc. ............................................... - - 224,400 Dennis Tool Company .............................. 33,333 49,499 62,499 Encore Wire Corporation .......................... 326,940 326,940 326,940 Heelys, Inc. ............................................. Kimberly–Clark Corporation ...................... Lifemark Group ....................................... PalletOne, Inc. ......................................... - - - - 9,317,310 89,529 - - - 167,481 571,333 - The RectorSeal Corporation ...................... 2,117,870 720,000 1,154,133 Sprint Nextel Corporation ......................... - - TCI Holdings, Inc. .................................... 81,270 81,270 6,750 81,270 The Whitmore Manufacturing Company .... 529,467 180,000 288,533 Other...................................................... 20,528 89,558 94,762 $3,788,680 $11,533,878 $3,656,833 Total operating expenses, increased by $238,007 or 6.5% during the year ended March 31, 2010. While, total operating expenses, in- creased by $697,177 or 23.5% during the year ended March 31, 2009. Due to the nature of its business, the majority of the Compa- ny’s operating expenses are related to employee and director compen- sation, office expenses, legal, professional and accounting fees and the net pension benefit. 43 Net Realized Gain (Loss) on Investments Net realized gain on investments was $1,639,994 (after income tax expense of $814,503) during the year ended March 31, 2010, com- pared with a gain of $10,756,302 (after income tax expense of $5,222,964) during 2009 and a gain of $240,024 during 2008. Man- agement does not attempt to maintain a comparable level of realized gains from year to year, but instead attempts to maximize total in- vestment portfolio appreciation. This strategy often dictates the long- term holding of portfolio securities in pursuit of increased values and increased unrealized appreciation, but may at opportune times dictate realizing gains or losses through the disposition of certain portfolio investments. Net Increase/(Decrease) in Unrealized Appreciation of Investments For the three years ended March 31, the Company recorded an in- crease in unrealized appreciation of investments of $70,624,231, in 2010 and a decrease of $159,247,203, in 2009 and a decrease of $142,969,698 in 2008. As explained in the first paragraph of this dis- cussion and analysis, the realization of gains or losses results in a cor- responding decrease or increase in unrealized appreciation of invest- ments. Set forth in the following table are the significant increases and decreases in unrealized appreciation 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 2010 2009 2008 Alamo Group Inc. ........................ $19,812,100 $(22,642,400) $(2,803,090) 5,600,000 All Components, Inc. .................... 9,276,649 (9,600,000) 14,303,625 (18,390,625) Encore Wire Corporation ............... 2,043,375 Heelys, Inc. .................................. 5,869,905 (20,963,948) (160,724,088) The Whitmore Manufacturing Company ................................... 11,500,000 - Lifemark Group ............................ Media Recovery, Inc. .................... (1,400,000) Palm Harbor Homes, Inc. .............. (2,984,947) The RectorSeal Corporation ........... 13,000,000 44 (2,000,000) 12,000,000 - 31,000,000 (22,700,000) (7,500,000) (21,601,583) (39,275,516) (37,000,000) 46,200,000 As shown in the table for the year ended March 31, 2010, we sus- tained significant increases in several of our largest investments. The largest increases in unrealized appreciation are attributable to Alamo Group, Inc., which increased $19,812,100; Heelys, Inc., which in- creased $5,869,905; Encore Wire Corporation, which increased $2,043,375, all due to an increase in their respective stock prices; as well as All Components, Inc., which increased $9,726,649 as a result of debt reduction on its senior credit facility. The $13,000,000 increase in The RectorSeal Corporation was primarily attributable to the impact of increased valuations of companies operating within their respective sector. The $11,500,000 increase in The Whitmore Manufacturing Company was attributable to improved earnings. Offsetting these increases were Media Recovery, Inc., which decreased $1,400,000 due to slowdowns in certain segments of their business; and Palm Harbor Homes, Inc., which decreased $2,984,947, due to a reduction in their stock price. A description of the investments listed above and other material components of the investment portfolio are included elsewhere in this report under the caption ―Consolidated Schedule of Investments – March 31, 2010 and 2009.‖ Portfolio Investments During the year ended March 31, 2010, the Company invested $17,234,456 in various portfolio securities listed elsewhere in this re- port under the caption ―Portfolio Changes During the Year,‖ which also lists dispositions of portfolio securities. During the 2009 and 2008 fiscal years, the Company invested a total of $13,030,107 and $10,733,536, respectively. Financial Liquidity and Capital Resources At March 31, 2010, the Company had cash and cash equivalents of approximately $4.1 million. Pursuant to the Small Business Adminis- tration (―SBA‖) regulations, cash and cash equivalents of $2.7 million held by CSVC may not be transferred or advanced to CSC without the consent of the SBA. With the exception of a capital gain distribution made in the form of a distribution of the stock of a portfolio company in the fiscal year ended March 31, 1996, the Company has elected to retain all gains realized during the past 41 years. Retention of future gains is viewed as an important source of funds to sustain the Company’s investment activity. Approximately $21.0 million of the Company’s investment portfolio is represented by unrestricted publicly traded securities and represent a source of liquidity. Funds to be used by the Company for operating or investment pur- poses may be transferred in the form of dividends, management fees or loans from Lifemark Group, The RectorSeal Corporation and The Whitmore Manufacturing Company, controlled affiliates of the Compa- ny, to the extent of their available cash reserves and borrowing capaci- ties. Management believes that the Company’s cash and cash equiva- lents and cash available from other sources described above are ade- quate to meet its expected requirements. Consistent with the long- term strategy of the Company, the disposition of investments from time to time may also be an important source of funds for future in- vestment activities. Contractual Obligations As shown below, the Company had the following contractual obliga- tions as of March 31, 2010. For information on our capital commit- ments see Note 8 of the Consolidated Financial Statements. Payments Due By Period ($ in Thousands) 1 Year Contractual Obligations Total Operating lease obligations $312 $101 Total $312 $101 2-3 Years $202 $202 More Than 3 Years $9 $9 Critical Accounting Policies Valuation of Investments In accordance with the Investment Company Act of 1940, invest- ments in unrestricted securities (freely marketable securities having readily available market quotations) are valued at market and invest- ments in restricted securities (securities subject to one or more resale restrictions) are valued at fair value determined in good faith by the Company’s Board of Directors. Under the valuation policy of the Com- pany, unrestricted securities are valued at the closing sale price for NYSE listed securities and at the lower of the closing bid price or the last sale price for Nasdaq 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, which is con- sidered to be the amount the Company may reasonably expect to receive 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 determin- ing 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 se- curities, the 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. Impact of Inflation The Company does not believe that its business is materially af- fected by inflation, other than the impact which inflation may have on the securities markets, the valuations of business enterprises and the 45 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 compa- ny due to the nature of the company’s investment portfolio. Accor- dingly 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 re- strictions 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 share- holders of the Company from achieving price appreciation and divi- dend distributions. 46 Selected Consolidated Financial Data (all figures in thousands except per share data) 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 Financial Position (as of March 31) Investments at cost..................................... $ 87,602 Unrealized appreciation .............................. 228,316 Investments at market or fair value ................................................. 315,918 Total assets ................................................ 322,668 Notes payable * .......................................... 16,000 Net assets .................................................. 303,436 3,815 Shares outstanding..................................... $ 82,194 $ 91,462 $ 97,283 $ 84,546 $ 88,597 $ 71,642 $ 81,027 $ 89,339 $ 100,023 377,920 461,831 265,287 195,598 309,666 337,476 609,513 466,544 307,296 347,481 287,060 406,949 422,022 357,183 298,490 423,979 434,384 13,000 339,891 272,211 400,157 417,947 3,857 23,000 20,500 14,000 3,857 3,829 3,829 550,428 569,368 8,000 558,036 3,860 681,155 547,571 729,507 586,685 - 725,732 583,700 3,889 3,886 - 396,635 417,543 - 415,263 3,741 477,943 491,175 - 486,926 3,741 Changes in Net Assets (years ended March 31) Net investment income ............................... $ 1,723 $ 2,042 $ 2,299 $ 2,587 $ 2,406 $ 2,389 $ 4,233 $ 3,715 $ 10,183 2,091 Net realized gain (loss) on investments ............................................ (5,126) (762) 2,007 12,603 (10,112) 15,451 14,966 240 10,756 826 Net increase (decrease) in unrealized appreciation before distributions ................................. (10,311) 36,971 (69,689) 114,068 27,810 Increase (decrease) in net assets from operations before distributions ................................. Cash dividends paid ................................... Employee stock options exercised ................................................ - Stock option expense ................................. - Change in pension plan 499 - 997 - - - - - (65,383) 129,258 (2,309) (13,714) (2,289) 38,251 (2,295) 20,104 (2,314) (2,297) 124,355 147,682 (142,969) (159,246) 70,624 142,195 (2,314) 166,881 (139,014) (2,333) (2,323) (138,307) (12,257) 73,541 (2,993) 208 231 - 169 263 1,795 - 503 - 675 440 - funded status .......................................... Treasury stock ............................................ Adjustment to initially apply FASB Statement No. 158, net of tax .. Increase (decrease) in net assets - - - - - - - - - - - - - - (1,178) - (1,473) (16,903) - (16,003) - - (67,680) 127,946 - - 17,790 - 140,089 1,173 - - 167,695 (142,031) (168,437) - 71,663 36,455 Per Share Data (as of March 31) Net assets .................................................. $ 79.54 65.00 Closing market price ................................... $ 88.77 $ 71.09 $ 103.75 $ 108.36 $ 144.56 $ 186.75 $ 150.09 123.72 79.10 153.67 48.15 95.50 75.47 68.75 $110.98 76.39 $130.14 90.88 Cash dividends paid ................................... .60 .60 .60 .60 .60 .60 .60 .60 3.26 .80 Excludes quarter-end borrowing which is repaid on the first business day after year end. 47 Stock Transfer Agent April 1, 2008 are as follows: Shareholder Information American Stock Transfer & Trust Company, 59 Maiden Lane, New York, NY 10038 (telephone 800-937-5449) 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 700 record holders of its common stock at March 31, 2010. This total does not include an estimated 4,000 shareholders with shares held under beneficial ownership in nominee name or within clearinghouse positions of brokerage firms or banks. Market Prices The Company’s common stock trades on The Nasdaq Global Market 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 Nasdaq: Quarter Ended March 31, 2010 .......................................................... December 31, 2009 .................................................... September 30, 2009 ................................................... June 30, 2009 ............................................................ High Low $96.04 $78.51 71.72 79.95 69.60 82.90 67.60 84.21 Quarter Ended March 31, 2009 .......................................................... December 31, 2008 .................................................... September 30, 2008 ................................................... June 30, 2008 ............................................................ High Low $109.66 $53.57 141.50 60.52 146.81 102.02 128.99 103.67 Dividends The payment dates and amounts of cash dividends per share since 48 Payment Date May 30, 2008 ............................................................................ October 31, 2008 ...................................................................... November 28, 2008 ................................................................... December 26, 2008 ................................................................... May 29, 2009 ............................................................................ November 30, 2009 ................................................................... Cash Dividend $0.40 0.30 0.40 2.16 0.40 0.40 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 (ordinary income) of regulated investment companies. Instead of distributing realized long- term capital gains to shareholders, the Company has ordinarily elected to retain such gains to fund future investments. 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 share- holders of record who own a minimum of 25 shares. The Company pays all costs of administration of the Plan except brokerage transac- tion fees. Upon request, shareholders may obtain information on the Plan from the Company, 12900 Preston Road, Suite 700, Dallas, Texas 75230. Telephone (972) 233-8242. Questions and answers about the Plan are on the next page. Annual Meeting The Annual Meeting of Shareholders of Capital Southwest Corpora- tion will be held on Monday, July 19, 2010, at 10:00 a.m. in the North Dallas Bank Tower Meeting Room (second floor), 12900 Preston Road, Dallas, Texas 75230. Dividend Reinvestment Plan – Questions and Answers What are the benefits of joining the Plan? • As a participant in the Automatic Dividend Reinvestment and Op- tional Cash Contribution Plan, your dividends are reinvested and you may make cash contributions of $100 to $10,000 in any month to purchase additional shares of Capital Southwest Corporation stock for your plan account. • Because purchases are made on a pooled basis, transaction costs should be less than those associated with individual purchases of small numbers of shares. Who is eligible to join? Only holders of record of 25 or more shares are eligible. If your shares are held in the name of a broker or other nominee, you must instruct your broker or nominee to register the shares directly in your name. Is there any cost to participate in the Plan? You pay only your share of transaction costs, which are included in the price of purchased shares. Capital Southwest pays all costs of admin- istration. How does the automatic dividend reinvestment feature work? The Plan, available to all shareholders of record of 25 or more shares, provides a convenient way to acquire additional shares. After you join, cash dividends on your shares (including shares you hold and shares in your plan account), or on a lesser number of shares you may speci- fy, will automatically be reinvested by American Stock Transfer & Trust Company as your agent. May I deposit Shares for safekeeping? Although not required, you may deposit share certificates registered in your name for addition to your plan account. The agent will automati- cally reinvest dividends on all shares in your plan account. How does the optional cash contribution feature work? To make voluntary cash purchases, you first must join the Plan and participate in the automatic dividend reinvestment feature. Contribu- tions for voluntary cash purchases of $100 to $10,000 in any month can then be made by sending a check to the agent, together with the remittance form which accompanies each plan account statement. Contributions can also be made by completing an automatic cash withdrawal authorization form, enabling you to make regular monthly purchases with funds transferred from your bank account. What statements will I receive? Each time shares are purchased, you will receive a statement showing the total shares in your plan account, the amount of the latest rein- vested dividend or optional cash contribution, the number of shares purchased and the price per share. How is information reported for income tax purposes? Reinvested dividends are subject to income tax to the same extent as if received in cash. You will receive a Form 1099 information return regarding the Federal income tax status of all dividends paid during the year. How would I terminate my participation in the Plan? You may terminate your participation at any time by giving notice to the agent. Upon termination, you will receive a certificate for the number of shares then held in your plan account, plus a check for any fractional share interest. How do I join the Plan? Call Capital Southwest at (972) 233-8242 for a plan brochure and au- thorization form. Then, sign and return the authorization form to American Stock Transfer & Trust Company, Dividend Reinvestment Dept., P.O. Box 922 Wall Street Station, New York, NY 10269-0560. Your name or names should be signed as they appear on your stock certificates. You may register all of your shares in the Plan or such lesser number of shares (a minimum of 25) as you indicate. 49 Federal Income Tax Information For Shareholders on December 31, 2009 Capital Southwest Corporation (―CSC‖) elected to retain the taxable net long-term capital gains realized during its taxable year ended De- cember 31, 2009, and pay the applicable Federal income tax, as shown below on a per share basis. Nominees who received Form 2439 were required to issue a sup- plemental Form 2439 to beneficial owners at December 31, 2008. If you owned shares of CSC which were held in the name of a broker or other nominee and have not received a supplemental Form 2439, you should request Form 2439 from the record holder to substantiate the available 2009 tax benefits. Net long-term capital gains retained Federal income tax paid $0.622 per share $0.2177 per share For Shareholders from 1968 through 2008 In accordance with the Internal Revenue Code, shareholders of record on December 31, 2009 were required to include their pro rata portion ($0.622 per share) of these gains on Schedule D of their 2009 Federal tax returns and are entitled to a credit for, or a refund of, their pro rata portion ($0.2177 per share) of the Federal income tax paid by CSC. This payment will ordinarily exceed the corresponding tax liabili- ty and result in a net credit or refund. Each shareholder is deemed to have reinvested the amount con- structively distributed (less the tax), and accordingly is entitled to in- crease the cost basis of his shares by $0.4043 per share. This will reduce the future tax liability when those shares of CSC are sold. Internal Revenue Service Form 2439 was mailed to all shareholders of record on December 31, 2009 setting forth the specific amounts to be included in each shareholder’s 2009 tax return. This form was ac- companied by a detailed instruction letter entitled ―Important Tax In- formation‖ dated January 29, 2010, which contained tax information applicable to all shareholders. This instruction letter also described the procedure to be used by tax-exempt shareholders such as pension trusts and individual retirement accounts to obtain a cash refund of $0.2177 per share by filing IRS Form 990-T. 50 In certain years from 1968 through 2009, CSC made elections to retain taxable net long-term capital gains. The table below shows the record dates for all years for which CSC made such elections and the per share amounts of the retained long-term capital gains, the Federal income taxes paid and the amounts by which shareholders on each record date are entitled to increase the tax basis of each share (ad- justed for stock splits in 1976, 1981 and 1987): Record date March 31, 1968 March 31, 1969 March 31, 1970 March 31, 1983 March 31, 1984 March 31, 1985 December 31, 1986 December 31, 1989 December 31, 1991 December 31, 1992 December 31, 1996 December 31, 1997 December 31, 1998 December 31, 1999 December 31, 2005 December 31, 2006 December 31, 2008 December 31, 2009 Retained capital gains per share $0.5041 0.3102 0.2366 1.2106 0.1797 0.3469 3.2523 3.2378 5.9375 2.0823 4.7546 4.9821 0.2001 3.0474 3.5761 8.1469 3.9883 0.6220 Federal income taxes paid per share $0.1292 0.0852 0.0662 0.3390 0.0503 0.0971 0.9106 1.1008 2.0187 0.7080 1.6641 1.7437 0.0700 1.0666 1.2516 2.8514 1.3959 0.2177 Increase in tax basis per share $0.3749 0.2250 0.1704 0.8716 0.1294 0.2498 2.3417 2.1370 3.9188 1.3743 3.0905 3.2384 0.1301 1.9808 2.3245 5.2955 2.5924 0.4043 Professionals Gary L. Martin, Chairman of the Board and President, joined Capital Southwest in 1972 and served as Chief Financial Officer, subsequently serving as Vice President and Secretary-Treasurer. From 1979 to 2007, he served as President and Chief Executive Officer of The Whit- more Manufacturing Company, a portfolio company of Capital South- west. His previous experience included a financial management posi- tion within the commercial development industry. He earned a BBA degree from the University of Oklahoma. William M. Ashbaugh, Senior Vice President, joined Capital South- west in 2001. Previously, he served as Managing Director in the cor- porate finance departments of Hoak Breedlove Wesneski & Co., Prin- cipal Financial Securities, Inc. and Southwest Securities and as First Vice President, Corporate Finance, with Rauscher Pierce Refsnes (now RBC Dain Rauscher). His experience includes direction of public offer- ings, private placements and merger and acquisition transactions. He holds an MBA summa cum laude from The University of Texas at Aus- tin and a BS summa cum laude from Texas A&M University. Marquez D. Bela, Vice President, joined Capital Southwest in 2010. Previously, he served as Managing Member of Covalent Capital, a pri- vate equity firm focused on early stage to mid-size companies. Prior to Covalent Capital, he was with SKM Growth Investors, an affiliate of Saunders Karp and Megrue, a $1.5 billion equity fund. His previous experience includes operational consulting and investment banking with Goldman Sach’s high technology practice. He graduated from the University of Texas at Austin, where he received a B.A. from the Plan II Honors Program and a B.B.A in finance from the Business Honors Program. Glenn M. Neblett, Vice President, joined Capital Southwest in 2010. Previously, he served as Director in the corporate finance and financial sponsors groups at Houlihan Lokey, where he advised clients in mer- gers and acquisitions, private placements and restructurings. He holds undergraduate and graduate degrees from Baylor University, and is a Chartered Financial Analyst and Certified Public Accountant. Ray D. Schwertner, Vice President, joined Capital Southwest in 2009. Previously, he served as President and Chief Executive Officer of The Whitmore Manufacturing Company, a portfolio company of Capital Southwest, from 2007 to 2009 and as Secretary-Treasurer from 1990 to 2007. His previous experience included a financial management position in the manufacturing industry and in public accounting. He earned a BBA degree from Angelo State University and is a Certified Public Accountant. Tracy L. Morris, Chief Financial Officer, Chief Compliance Officer and Corporate Secretary, joined Capital Southwest in 2007. Previously, she served as Controller of Best Merchant Partners, LP and Silverleaf Resorts, Inc. She received a BS degree from Millersville University of Pennsylvania and is a Certified Public Accountant. William R. Thomas III, Assistant Vice President, joined Capital Southwest in 2006. Previously, Will served as a U.S. Air Force officer in varied positions including chief pilot of an airlift group, director of logistics operations and chief of aircraft development contracts. He has also served as a consultant for Investor Group Services, where he analyzed potential investments in mid-market companies. He has an MBA from Harvard Business School and a BS in engineering sciences from the U.S. Air Force Academy. 51 

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