EX-13 2 capital10kex13mar3101.txt ANNUAL REPORT TO SHAREHOLDERS Twelve Largest Investments - March 31, 2001 ================================================================================ Palm Harbor Homes, Inc. $78,551,000 -------------------------------------------------------------------------------- Palm Harbor Homes, Dallas, Texas, is an integrated manufactured housing company, building, retailing, financing and insuring homes produced in 15 plants in Alabama, Arizona, Florida, Georgia, North Carolina, Ohio, Oregon and Texas and sold in 28 states by over 150 independent dealers and 145 company-owned retail superstores. Palm Harbor manufactures high-quality, energy-efficient homes designed to meet the need for affordable housing, particularly among retirees and newly-formed families. During the year ended March 30, 2001, Palm Harbor earned $19,829,000 ($0.87 per share) on net sales of $650,451,000, compared with earnings of $38,596,000 ($1.66 per share) on net sales of $777,471,000 in the previous year. The March 30, 2001 closing Nasdaq bid price of Palm Harbor's common stock was $15.188 per share. At March 31, 2001, the $10,931,955 investment in Palm Harbor by Capital Southwest and its subsidiary was valued at $78,551,000 ($10.00 per share), consisting of 7,855,121 restricted shares of common stock, representing a fully-diluted equity interest of 34.5%. ================================================================================ The RectorSeal Corporation $47,500,000 -------------------------------------------------------------------------------- The RectorSeal Corporation, Houston, Texas, with two plants in Texas and a plant in New York, manufactures chemical specialty products including pipe thread sealants, firestop sealants, plastic solvent cements and other formulations for plumbing and industrial applications. RectorSeal's major subsidiary, Jet-Lube, Inc., with plants in Texas, England and Canada, produces anti-seize compounds, specialty lubricants and other products used in industrial and oil field applications. Another subsidiary, Cargo Chemical, produces a limited line of automotive chemical products. RectorSeal also owns a 20% equity interest in The Whitmore Manufacturing Company (described subsequently). During the year ended March 31, 2001, RectorSeal earned $5,669,000 on revenues of $56,240,000, compared with earnings of $4,988,000 on revenues of $53,858,000 in the previous year. RectorSeal's earnings do not reflect its 20% equity in The Whitmore Manufacturing Company. At March 31, 2001, Capital Southwest owned 100% of RectorSeal's common stock having a cost of $52,600 and a value of $47,500,000. ================================================================================ Skylawn Corporation $38,000,000 -------------------------------------------------------------------------------- Skylawn Corporation, Hayward, California owns and operates cemeteries, mausoleums and mortuaries. Skylawn's operations, all of which are in California, include a mausoleum and an adjacent mortuary in Oakland and cemeteries and mausoleums in San Mateo, Hayward, Sacramento and Napa, the latter three of which also have mortuaries at the cemetery sites. These entities have provided cemetery and funeral services to their respective communities for many years. A captive insurance company and funeral and cemetery trusts enable Skylawn's clients to make pre-need arrangements. For the fiscal year ended March 31, 2001, Skylawn, earned $4,120,000 on revenues of $25,799,000. In the previous year, Skylawn, after adopting a change in accounting principle, earned $2,940,000 on revenues of $24,574,000. Before this change, fiscal 2000 earnings were $4,163,000. At March 31, 2001, Capital Southwest owned 100% of Skylawn Corporation's common stock, which had a cost of $4,510,400 and was valued at $38,000,000. ================================================================================ Alamo Group Inc. $28,213,000 -------------------------------------------------------------------------------- Alamo Group Inc., Seguin, Texas, is a leading designer, manufacturer and distributor of heavy-duty, tractor-mounted mowing and other vegetation maintenance equipment, power-sweeping equipment and replacement parts. Founded in 1969, Alamo Group operates 11 manufacturing facilities and serves governmental, industrial and agricultural markets in the U.S. and Europe. For the year ended December 31, 2000, Alamo reported consolidated earnings of $10,770,000 ($1.11 per share) on net sales of $215,874,000, compared with earnings of $6,102,000 ($0.63 per share) on net sales of $176,608,000 in the previous year. The March 30, 2001 closing NYSE market price of Alamo's common stock was $14.30 per share. At March 31, 2001, the $2,065,047 investment in Alamo by Capital Southwest and its subsidiary was valued at $28,213,000 ($10.00 per share), consisting of 2,821,300 restricted shares of common stock, representing a fully-diluted equity interest of 27.2%. ================================================================================ Media Recovery, Inc. $18,000,000 -------------------------------------------------------------------------------- Media Recovery, Inc., Graham, Texas, distributes computer and office automation supplies and accessories to corporate customers through its direct sales force with 25 offices in 18 states. Its Shockwatch division manufactures impact and tilt monitoring devices used to detect mishandled shipments. Media Recovery's subsidiary, The Damage Prevention Company, Denver, Colorado, manufactures dunnage products used to prevent damage in trucking, rail and export container shipments. During the year ended September 30, 2000, Media Recovery reported net income of $3,139,000 on net sales of $92,705,000, compared with net income of $2,418,000 on net sales of $88,707,000 in the previous year. At March 31, 2001, the $5,415,000 investment in Media Recovery by Capital Southwest and its subsidiary was valued at $18,000,000, consisting of 4,800,000 shares of Series A convertible preferred stock, representing a fully-diluted equity interest of 68.2%. ================================================================================ Encore Wire Corporation $13,623,000 -------------------------------------------------------------------------------- Encore Wire Corporation, McKinney, Texas, manufactures a broad line of copper electrical wire and cable including non-metallic sheathed cable, underground feeder cable and THHN cable for residential, commercial and industrial construction. Encore's products are sold through large-volume distributors and building materials retailers. For the year ended December 31, 2000, Encore reported net income of $8,050,000 ($0.52 per share) on net sales of $283,689,000, compared with net income of $6,594,000 ($0.42 per share) on net sales of $229,670,000 in the previous year. The March 30, 2001 closing Nasdaq bid price of Encore's common stock was $7.813 per share. At March 31, 2001, the $5,800,000 investment in 2,724,500 shares of Encore's restricted common stock by Capital Southwest and its subsidiary was valued at $13,623,000 ($5.00 per share), representing a fully-diluted equity interest of 17.1%. ================================================================================ Concert Industries Ltd. $11,162,000 -------------------------------------------------------------------------------- Concert Industries Ltd., Vancouver, British Columbia, manufactures latex, thermal and multi-bonded air-laid materials produced in state-of-the-art facilities in Thurso, Quebec; Falkenhagen, Germany; Charleston, South Carolina; and Gatineau, Quebec (to be launched in 2001). Its air-laid materials are used as absorbent cores in feminine hygiene, specialty diapers and adult incontinence products. Other applications are wet wipes, industrial wipes, food packaging pads and disposable medical products. During the year ended December 31, 2000, Concert reported net income of C$7,375,000 (C$0.31 per share) on net sales of C$86,606,000, compared with net income of C$5,388,000 (C$0.30 per share) on net sales of C$47,658,000 in the previous year. The March 30, 2001 closing Toronto Stock Exchange market price of Concert's common stock was C$6.30 (US$4.00) per share. At March 31, 2001, the US$10,867,649 investment by Capital Southwest and its subsidiary in a junior secured note, exchangeable subordinated debentures, 787,286 shares of common stock and a warrant to acquire 83,643 shares of common stock was valued at US$11,162,000, representing a fully-diluted equity interest of 9.8%. ================================================================================ AT&T Corp. - Liberty Media Group $9,483,768 -------------------------------------------------------------------------------- AT&T Corp. - Liberty Media Group, New York, New York, acquired by AT&T as part of Tele-Communications, Inc. in March 1999, produces, acquires and distributes entertainment, sports and informational programming services and electronic retailing services, which are delivered via cable television and other technologies to viewers in the United States and overseas. For the year ended December 31, 2000, Liberty Media Group reported net income of $1.488 billion ($0.58 per share) on net sales of $1.526 billion compared with a net loss of $2.081 billion ($0.80 per share) on net sales of $1.011 billion in the previous year. The March 30, 2001 closing NYSE market price of Series A Liberty Media Group common (tracking) stock was $14.00 per share. At March 31, 2001, Capital Southwest owned 677,412 unrestricted shares of Series A Liberty Media Group tracking stock, having a total cost of $25 and a market value of $9,483,768 ($14.00 per share). ================================================================================ All Components, Inc. $8,750,000 -------------------------------------------------------------------------------- All Components, Inc., Farmers Branch, Texas, distributes and produces memory and other components for personal computer manufacturers, retailers and value-added resellers. Through its Dallas-based sales and distribution center and its contract manufacturing plants in Austin, Texas and Boise, Idaho, the company serves over 2,000 customers throughout the United States. During the year ended August 31, 2000, All Components reported net income of $4,025,000 on net sales of $220,835,000, compared with net income of $2,542,000 on net sales of $157,932,000 in the previous year. At March 31, 2001, the $150,000 investment in All Components by Capital Southwest's subsidiary was valued at $8,750,000 consisting of 150,000 shares of Series A convertible preferred stock, representing a 29.0% fully-diluted equity interest. ================================================================================ The Whitmore Manufacturing Company $8,000,000 -------------------------------------------------------------------------------- The Whitmore Manufacturing Company, with plants in Rockwall, Texas and Cleveland, Ohio, 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 subsidiary, Fluid Protection Corporation, manufactures fluid contamination control devices. During the year ended March 31, 2001, Whitmore reported net income of $41,000 on net sales of $11,536,000, compared with a net loss of $10,600 on net sales of $13,176,000 in the previous year. The company is owned 80% by Capital Southwest and 20% by Capital Southwest's subsidiary, The RectorSeal Corporation (described on page 7). At March 31, 2001, the direct investment in Whitmore by Capital Southwest was valued at $8,000,000 and had a cost of $1,600,000. ================================================================================ Mail-Well, Inc. $7,338,000 -------------------------------------------------------------------------------- Mail-Well, Inc., Englewood, Colorado, is a consolidator of companies engaged in producing envelopes and labels and in printing for commercial applications and for distributors. Mail-Well has approximately 15,000 employees and operates more than 140 plants and numerous sales offices throughout North America and the United Kingdom. For the year ended December 31, 2000, Mail-Well reported earnings of $27,618,000 ($0.56 per share) on net sales of $2,425,215,000, compared with earnings of $64,482,000 ($1.20 per share) on net sales of $1,887,230,000 in the previous year. The March 30, 2001 closing NYSE market price of Mail-Well's common stock was $4.87 per share. At March 31, 2001, the $2,986,870 investment in Mail-Well by Capital Southwest was valued at $7,338,000 ($3.50 per share), consisting of 2,096,588 restricted shares of common stock, representing a fully-diluted equity interest of 3.5%. ================================================================================ Organized Living, Inc. $6,000,000 -------------------------------------------------------------------------------- Organized Living, Inc., Lenexa, Kansas, is a leading specialty retailer of high quality products designed to provide storage and organization solutions for customers' home and office needs. The company's superstores provide a one-stop shopping destination for storage and organization products for every area of the home including closets, kitchens, laundry rooms, pantries, bathrooms, bedrooms, playrooms, garages and offices. Organized Living currently operates 14 superstores in retail areas in 12 states. During the year ended March 31, 2001, Organized Living reported a net loss of $3,483,000 on net sales of $49,408,000, compared with a net loss of $4,141,000 on net sales of $31,261,000 in the previous year. At March 31, 2001, the investment by Capital Southwest in 2,500,001 shares of Series D convertible preferred stock, was valued at its cost of $6,000,000 and represented a fully-diluted equity interest of 10.0% to 12.7%.

Notes to Portfolio of Investments (a) The percentages in the "Equity" column express the potential equity interests held by Capital Southwest Corporation and Capital Southwest Venture Corporation (together, the "Company") in each issuer. Each percentage represents the amount of the issuer's common stock the Company owns or can acquire as a percentage of the issuer's total outstanding common shares, plus shares reserved for all outstanding warrants, convertible securities and employee stock options. The symbol "<1%" indicates that the Company holds a potential equity interest of less than one percent. (b) Unrestricted securities (indicated by ++) are freely marketable securities having readily available market quotations. All other securities are restricted securities which are subject to one or more restrictions on resale and are not freely marketable. At March 31, 2001, restricted securities represented approximately 90% of the value of the consolidated investment portfolio. (c) Under the valuation policy of the Company, unrestricted securities are valued at the closing sale price for listed securities and at the closing bid price for 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 as determined by the Board of Directors. Fair value is considered to be the amount which the Company may reasonably expect to receive for portfolio securities if such securities were sold on the valuation date. Valuations as of any particular date, however, are not necessarily indicative of amounts which may ultimately be realized as a result of future sales or other dispositions of securities. Among the factors considered by the Board of Directors in determining the fair value of restricted securities are the financial condition and operating results of the issuer, the long-term potential of the business of the issuer, the market for and recent sales prices of the issuer's securities, the values of similar securities issued by companies in similar businesses, the proportion of the issuer's securities owned by the Company, the nature and duration of resale restrictions and the nature of any rights enabling the Company to require the issuer to register restricted securities under applicable securities laws. In determining the fair value of restricted securities, the Board of Directors considers the inherent value of such securities without regard to the restrictive feature and adjusts for any diminution in value resulting from restrictions on resale. (d) Agreements between certain issuers and the Company provide that the issuers will bear substantially all costs in connection with the disposition of common stocks, including those costs involved in registration under the Securities Act of 1933 but excluding underwriting discounts and commissions. These agreements, which cover common stocks owned at March 31, 2001 and common stocks which may be acquired thereafter through exercise of warrants and conversion of debentures and preferred stocks, apply to restricted securities of all issuers in the investment portfolio of the Company except securities of the following issuers, which are not obligated to bear registration costs: Humac Company, Skylawn Corporation and The Whitmore Manufacturing Company. (e) The descriptions of the companies and ownership percentages shown in the portfolio of investments were obtained from published reports and other sources believed to be reliable, are supplemental and are not covered by the report of independent auditors. Acquisition dates indicated are the dates specific securities were acquired. Certain securities were received in exchange for or upon conversion or exercise of other securities previously acquired. Portfolio Changes During the Year New Investments and Additions to Previous Investments Amount ------------ Airformed Composites, Inc. ............................ $ 500,000 Amfibe, Inc............................................ 5,210 BOXX Technologies, Inc. ............................... 500,000 CDC Technologies, Inc. ................................ 40,003 Concert Industries Ltd. ............................... 3,799,649 Diamond State Ventures, L.P. .......................... 47,321 Dyntec, Inc. .......................................... 3,835 First Capital Group of Texas III, L.P. ................ 100,000 Heeling, Inc. ......................................... 2,700,000 Organized Living, Inc. ................................ 1,000,000 Rewind Holdings, Inc. ................................. 123,750 Sprockets.com, Inc. ................................... 1,300,000 STARTech Seed Fund II ................................. 450,000 Texas Capital Bancshares, Inc. ....................... 5,000,006 VocalData, Inc. ....................................... 352,305 ------------ $ 15,922,079 ============ Dispositions and Write-offs Amount Cost Received ------------- ------------- All Components, Inc. ................... $ 450,000 $ 450,000 American Homestar Corporation .......... 3,405,824 12,922 Amfibe, Inc. .......................... 205,210 6,179,200 Dyntec, Inc. ........................... 4,503,835 174,000 iChoose, Inc. .......................... 1,100,001 - SDI Investments Liquidating Trust ...... 118,000 841,255 Vonova Corporation (formerly International Talk.com, Inc.)....................... 3,000,000 - ------------- ------------- $ 12,782,870 $ 7,657,377 ============= ============= Repayments Received..................... $ 540,000 ============= Capital Southwest Corporation and Subsidiary Consolidated Statements of Financial Condition March 31 --------------------------- Assets 2001 2000 ------------ ------------ Investments at market or fair value (Notes 1, 2 and 10) Companies more than 25% owned (Cost: 2001 - $23,140,865, 2000 - $23,380,865)................... $205,273,759 $200,608,759 Companies 5% to 25% owned (Cost: 2001 - $17,642,756, 2000 - $22,579,414)................... 19,623,004 22,760,506 Companies less than 5% owned (Cost: 2001 - $46,818,025, 2000 - $39,042,158)................... 91,020,746 100,259,870 ------------ ------------ Total investments (Cost: 2001 - $87,601,646, 2000 - $85,002,437)................... 315,917,509 323,629,135 Cash and cash equivalents.................. 1,137,767 63,986,715 Receivables................................ 264,377 238,594 Other assets (Note 8)...................... 5,348,315 4,731,360 ------------ ------------ Totals.................................. $322,667,968 $392,585,804 ============ ============ March 31 --------------------------- Liabilities and Shareholders' Equity 2001 2000 ------------ ------------ Note payable to bank (Note 4) ............. $ 5,000,000 $ 60,000,000 Notes payable to portfolio companies (Note 4) 6,000,000 5,000,000 Accrued interest and other liabilities (Note 8) 2,135,052 2,220,753 Deferred income taxes (Note 3)............. 77,924,303 83,489,085 Subordinated debenture (Note 5)............ 5,000,000 5,000,000 ------------ ------------ Total liabilities ..... 96,059,355 155,709,838 ------------ ------------ Shareholders' equity (Notes 3 and 6) Common stock, $1 par value: authorized, 5,000,000 shares; issued, 4,252,416 shares at March 31, 2001 and March 31, 2000........................ 4,252,416 4,252,416 Additional capital...................... 6,450,747 6,450,747 Undistributed net investment income................................ 3,550,573 4,117,104 Undistributed net realized gain on investments........................... 70,382,314 73,613,301 Unrealized appreciation of investments - net of deferred income taxes.......... 149,005,865 155,475,700 Treasury stock - at cost (437,365 shares)...................... (7,033,302) (7,033,302) ------------ ------------ Net assets at market or fair value, equivalent to $59.40 per share at March 31, 2001, and $62.09 per share at March 31, 2000 on the 3,815,051 shares outstanding... 226,608,613 236,875,966 ------------ ------------ Totals.................................. $322,667,968 $392,585,804 ============ ============ See Notes to Consolidated Financial Statements

See Notes to Consolidated Financial Statements

See Notes to Consolidated Financial Statements

See Notes to Consolidated Financial Statements Notes to Consolidated Financial Statements 1. Summary of Significant Accounting Policies Capital Southwest Corporation ("CSC") is a business development company subject to regulation under the Investment Company Act of 1940. Capital Southwest Venture Corporation ("CSVC"), a wholly-owned subsidiary of CSC, is a Federal licensee under the Small Business Investment Act of 1958. The following is a summary of significant accounting policies followed in the preparation of the consolidated financial statements of CSC and CSVC (together, the "Company"): Principles of Consolidation. The consolidated financial statements have been prepared on the value method of accounting in accordance with accounting principles generally accepted in the United States of America for investment companies. All significant intercompany accounts and transactions have been eliminated in consolidation. Cash and Cash Equivalents. All temporary cash investments having a maturity of three months or less when purchased are considered to be cash equivalents. Investments. Investments are stated at market or fair value determined by the Board of Directors as described in the Notes to Portfolio of Investments and Note 2 below. The average cost method is used in determining cost of investments sold. Investments are recorded on a trade date basis. Dividends are recognized on the ex-dividend date and interest income is accrued daily. 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 geographic areas as presented in the portfolio of investments. 2. Valuation of Investments The consolidated financial statements as of March 31, 2001 and 2000 include securities valued at $285,059,091 (90% of the value of the consolidated investment portfolio) and $272,736,962 (84% of the value of the consolidated investment portfolio), respectively, whose values have been determined by the Board of Directors in the absence of readily ascertainable market values. Because of the inherent uncertainty of valuation, these values may differ significantly from the values that would have been used had a ready market for the securities existed, and the differences could be material. 3. Income taxes For the tax years ended December 31, 2000, 1999 and 1998, CSC and CSVC qualified to be taxed as regulated investment companies ("RICs") under applicable provisions of the Internal Revenue Code. As RICs, CSC and CSVC must distribute at least 90% of their taxable net investment income (investment company taxable income) and may either distribute or retain their taxable net realized gain on investments (capital gains). Both CSC and CSVC intend to meet the applicable qualifications to be taxed as RICs in future years; however, either company's ability to meet certain portfolio diversification requirements of RICs in future years may not be controllable by such company. No material provision was made for Federal income taxes on the investment company taxable income of CSC and CSVC for the 2001, 2000 and 1999 fiscal years. Such income was distributed to shareholders in the form of cash dividends for which CSC and CSVC receive a tax deduction. With respect to net investment income, the income tax expense for each of the three years ended March 31, 2001 includes a deferred tax provision related to the net pension benefit. CSC and CSVC may not qualify or elect to be taxed as RICs in future years. Therefore, consolidated deferred Federal income taxes of $79,310,000 and $83,151,000 have been provided on net unrealized appreciation of investments of $228,315,863 and $238,626,698 at March 31, 2001 and 2000, respectively. Such appreciation is not included in taxable income until realized. Deferred income taxes on net unrealized appreciation of investments have been provided at the then currently effective maximum Federal corporate tax rate on capital gains of 35% at March 31, 2001 and 2000.

The following table sets forth the qualified plan's funded status and amounts recognized in the Company's consolidated statements of financial condition: March 31 -------------------------- 2001 2000 ----------- ----------- Actuarial present value of benefit obligations: Accumulated benefit obligation ................ $(2,938,747) $(2,965,576) =========== =========== Projected benefit obligation for service rendered to date .......................................... $(3,255,669) $(3,260,366) Plan assets at fair value* ......................... 8,758,035 9,837,547 ----------- ----------- Excess of plan assets over the projected benefit obligation .................................... 5,502,366 6,577,181 Unrecognized net (gain) loss from past experience different from that assumed and effects of changes in assumptions ........................ 109,379 (1,518,207) Prior service costs not yet recognized ............. (151,642) (162,965) Unrecognized net assets being amortized over 19 years ...................................... (295,308) (369,139) ----------- ----------- Prepaid pension cost included in other assets ...... $ 5,164,795 $ 4,526,870 =========== =========== ------------- *Primarily equities and bonds including approximately 30,000 shares of common stock of the Company. Components of net pension benefit related to the qualified plan include the following: Years Ended March 31 ----------------------------------------- 2001 2000 1999 ----------- ----------- ----------- Service cost - benefits earned during the year ....................... $ 50,961 $ 43,818 $ 68,710 Interest cost on projected benefit obligation ..................... 205,976 193,397 199,301 Actual return on assets ............. 758,307 146,241 1,171,030 Net amortization and deferral ....... (1,653,169) (960,903) (1,901,221) ----------- ----------- ----------- Net pension expense (benefit) from qualified plan ................. $ (637,925) $ (577,447) $ (462,180) =========== =========== =========== The Company also sponsors an unfunded Retirement Restoration Plan, which is a nonqualified plan that provides for the payment, upon retirement, of the difference between the maximum annual payment permissible under the qualified retirement plan pursuant to Federal limitations and the amount which would otherwise have been payable under the qualified plan. The following table sets forth the Retirement Restoration Plan's benefit obligation at March 31, 2001, 2000 and 1999: Years Ended March 31 ----------------------------------------- 2001 2000 1999 ----------- ----------- ----------- Change in benefit obligation Benefit obligation at beginning of year ....................... $ 2,026,495 $ 2,166,180 $ 2,051,899 Service cost ........................ 4,945 4,089 13,087 Interest cost ....................... 113,497 117,541 117,635 Amendments .......................... -- -- 83,360 Actuarial gain (loss) ............... (176,776) (261,315) (99,801) Benefits paid ....................... (209,947) -- -- ----------- ----------- ----------- Benefit obligation at end of year.... $ 1,758,214 $ 2,026,495 $ 2,166,180 =========== =========== =========== The following table sets forth the status of the Retirement Restoration Plan and the amounts recognized in the consolidated statements of financial condition: March 31 -------------------------- 2001 2000 ----------- ----------- Projected benefit obligation ....................... $(1,758,214) $(2,026,495) Unrecognized net (gain) loss from past ex- perience different from that assumed and effects of changes in assumptions ......... (131,675) 45,101 Unrecognized prior service costs ................... 69,875 83,360 Unrecognized net obligation ........................ -- 19,823 ----------- ----------- Accrued pension cost included in other liabilities.. $(1,820,014) $(1,878,211) =========== =========== The Retirement Restoration Plan expenses recognized during the years ended March 31, 2001, 2000 and 1999 of $151,751, $141,463 and $150,555, respectively, are offset against the net pension benefit from the qualified plan. The weighted-average discount rate and rate of increase in future compensation levels used in determining the actuarial present value of the projected benefit obligation were 6.5% and 5.0%, respectively, at March 31, 2001, March 31, 2000 and March 31, 1999. The expected long-term rate of return used to project estimated earnings on plan assets for the qualified plan was 7.5% for the years ended March 31, 2001 and March 31, 2000 and 8.5% for the year ended March 31, 1999. The calculations also assume retirement at age 65, the normal retirement age. 9. Sources of Income Income was derived from the following sources: Investment Income Realized Gain Years Ended --------------------------------------- (Loss) on March 31 Investments -------- Other Before Income 2001 Interest Dividends Income Taxes ---- ----------- ----------- ----------- ------------- Companies more than 25% owned ......... $ 72,800 $ 2,585,386 $ 494,900 $ -- Companies 5% to 25% owned ............. -- -- -- (3,000,000) Companies less than 5% owned .......... 217,080 370,447 35,500 (2,125,493) Other sources, including temporary investments ....... 252,361 -- -- -- ----------- ----------- ----------- ----------- $ 542,241 $ 2,955,833 $ 530,400 $(5,125,493) =========== =========== =========== =========== 2000 ---- Companies more than 25% owned ......... $ 106,400 $ 1,440,755 $ 487,400 $ -- Companies 5% to 25% owned ............. -- -- (1,500) 8,133,870 Companies less than 5% owned .......... 173,105 438,098 39,500 1,097,572 Other sources, including temporary investments ....... 604,647 -- -- -- ----------- ----------- ----------- ----------- $ 884,152 $ 1,878,853 $ 525,400 $ 9,231,442 =========== =========== =========== =========== 1999 ---- Companies more than 25% owned ......... $ 140,000 $ 1,644,270 $ 490,900 $ -- Companies 5% to 25% owned ............. 3,495 -- 34,750 -- Companies less than 5% owned .......... 688,210 322,090 13,000 1,530,691 Other sources, including temporary investments ....... 475,963 -- -- -- ----------- ----------- ----------- ----------- $ 1,307,668 $ 1,966,360 $ 538,650 $ 1,530,691 =========== =========== =========== =========== 10. Summarized Financial Information of Wholly-Owned Portfolio Companies The Company has three significant wholly-owned portfolio companies - The RectorSeal Corporation, The Whitmore Manufacturing Company and Skylawn Corporation - which are neither investment companies nor business development companies. Accordingly, the accounts of such portfolio companies are not included with those of the Company. Summarized combined financial information of the three portfolio companies is as follows: (all figures in thousands) March 31 ------------------------------ 2001 2000 -------- -------- Condensed Balance Sheet Data Assets Cash and temporary investments ...................... $ 14,815 $ 12,547 Receivables ........................ 30,504 30,022 Inventories ........................ 37,536 36,523 Property, plant and equipment ...... 38,609 34,604 Other assets ....................... 19,781 19,671 -------- -------- Totals ........................... $141,245 $133,367 ======== ======== Liabilities and Shareholder's Equity Long-term debt ..................... $ 8,334 $ 9,669 Other liabilities .................. 19,412 17,205 Shareholder's equity ............... 113,499 106,493 -------- -------- Totals ........................... $141,245 $133,367 ======== ======== Condensed Statements of Income 2001 2000 1999 -------- -------- -------- Revenues............................ $ 93,575 $ 91,608 $ 83,426 Costs and operating expenses........ $ 81,087 $ 79,237 $ 72,566 Net income.......................... $ 9,830 $ 7,917 $ 7,021 11. Commitments The Company has agreed, subject to certain conditions, to invest up to $3,881,154 in six portfolio companies. The Company leases office space under an operating lease which requires base annual rentals of approximately $58,000 through February, 2003. For the three years ended March 31, total rental expense charged to investment income was $58,145 in 2001, $57,479 in 2000 and $58,798 in 1999.

--------------- *Net decrease is due to exercise of employee stock options at less than beginning of period net asset value. Independent Auditors' Report The Board of Directors and Shareholders Capital Southwest Corporation: We have audited the accompanying consolidated statements of financial condition of Capital Southwest Corporation and subsidiary as of March 31, 2001 and 2000, including the portfolio of investments as of March 31, 2001, and the related consolidated statements of operations, changes in net assets, and cash flows for each of the years in the three-year period ended March 31, 2001 and the selected per share data and ratios for each of the years in the five-year period ended March 31, 2001. These financial statements and per share data and ratios are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements and per share data and ratios based on our audits. We conducted our audits in accordance with auditing standards generally accepted in the United States of America. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements and per share data and ratios are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. Our procedures included verification of securities owned as of March 31, 2001 and 2000, by examination of such securities held by the custodian. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion the consolidated financial statements and selected per share data and ratios referred to above present fairly, in all material respects, the financial position of Capital Southwest Corporation and subsidiary as of March 31, 2001 and 2000, the results of their operations, the changes in their net assets and their cash flows for each of the years in the three-year period ended March 31, 2001, and the selected per share data and ratios for each of the years in the five-year period ended March 31, 2001, in conformity with accounting principles generally accepted in the United States of America. KPMG LLP Dallas, Texas April 20, 2001 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 "Decrease in net assets from operations" and consists of three elements. The first is "Net investment income", which is the difference between the Company's income from interest, dividends and fees and its combined operating and interest expenses, net of applicable income taxes. The second element is "Net realized gain (loss) on investments", which is the difference between the proceeds received from disposition of portfolio securities and their stated cost, net of applicable income tax expense. The third element is the "Net decrease in unrealized appreciation of investments", which is the net change in the market or fair value of the Company's investment portfolio, compared with stated cost, net of a decrease in deferred income taxes which would become payable if the unrealized appreciation were realized through the sale or other disposition of the investment portfolio. It should be noted that the "Net realized gain (loss) on investments" and "Net decrease in unrealized appreciation of investments" are directly related in that when an appreciated portfolio security is sold to realize a gain, a corresponding decrease in net unrealized appreciation occurs by transferring the gain associated with the transaction from being "unrealized" to being "realized." Conversely, when a loss is realized on a depreciated portfolio security, an increase in net unrealized appreciation occurs. Net Investment Income The Company's principal objective is to achieve capital appreciation. Therefore, a significant portion of the investment portfolio is structured to maximize the potential return from equity participation and provides minimal current yield in the form of interest or dividends. The Company also earns interest income from the short-term investment of cash funds, and the annual amount of such income varies based upon the average level of funds invested during the year and fluctuations in short-term interest rates. During the three years ended March 31, the Company had interest income from temporary cash investments of $249,000 in 2001, $599,000 in 2000 and $476,000 in 1999. The Company also receives management fees from its wholly-owned portfolio companies which aggregated $458,400 in each of the years ended March 31, 2001, March 31, 2000 and March 31, 1999. During the three years ended March 31, 2001, the Company recorded dividend income from the following sources: Years Ended March 31 ------------------------------------ 2001 2000 1999 ---------- ---------- ---------- AT&T Corp. ......................... $ 68,621 $ 146,570 $ -- Alamo Group Inc. ................... 677,112 790,756 1,170,400 Dennis Tool Company ................ 49,999 49,999 -- Kimberly-Clark Corporation ......... 84,126 81,039 77,952 The RectorSeal Corporation ......... 960,000 240,000 240,000 Skylawn Corporation ................ 658,275 300,000 150,000 TCI Holdings, Inc./Westmarc Communications .................. 81,270 81,270 81,270 Texas Shredder, Inc. ............... 40,460 40,460 40,460 The Whitmore Manufacturing Company . 240,000 60,000 60,000 Other .............................. 95,970 88,759 146,278 ---------- ---------- ---------- $2,955,833 $1,878,853 $1,966,360 ========== ========== ========== Total operating expenses, excluding interest expense, decreased by $47,073 or 4.6% and by $498,967 or 32.7% during the years ended March 31, 2001 and 2000, respectively. Due to the nature of its business, the majority of the Company's operating expenses are related to employee and director compensation, office expenses, legal and accounting fees and the net pension benefit. Interest expense increased by $688,075 and by $40,088 during the years ended March 31, 2001 and 2000, respectively, due to increased borrowings. Net Realized Gain (Loss) on Investments Net realized loss on investments was $3,230,987 (after income tax benefit of $1,894,506) during the year ended March 31, 2001, compared with a gain of $6,019,892 (after income tax expense of $3,211,550) during 2000 and a gain of $994,949 (after income tax expense of $535,742) during 1999. Management does not attempt to maintain a comparable level of realized gains from year to year, but instead attempts to maximize total investment portfolio appreciation. This strategy often dictates the long-term holding of portfolio securities in pursuit of increased values and increased unrealized appreciation, but may at opportune times dictate realizing gains through the disposition of certain portfolio investments. Net Decrease in Unrealized Appreciation of Investments For the three years ended March 31, the Company recorded a decrease in unrealized appreciation of investments before income taxes of $10,310,835, $38,071,790 and $63,433,545 in 2001, 2000 and 1999, respectively. As explained in the first paragraph of this discussion and analysis, the realization of gains or losses results in a corresponding decrease or increase in unrealized appreciation of investments. Set forth in the following table are the significant increases and decreases in unrealized appreciation (before the related change in deferred income taxes and 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 -------------------------------------------- 2001 2000 1999 ------------ ------------ ------------ AT&T Corp. .................... $ (4,681,896) $ 430,271 $ 3,532,591 AT&T Corp.-Liberty Media Group (10,605,732) 11,183,260 3,131,973 Alamo Group Inc. .............. 2,821,000 7,276,953 (20,615,000) All Components, Inc. .......... 3,450,000 1,975,000 1,225,000 American Homestar Corporation . -- (4,224,707) (11,547,532) Amfibe, Inc. .................. -- 3,900,000 (2,400,000) Balco, Inc. ................... -- (2,529,600) 3,422,440 CDC Technologies, Inc/Drew Scientific Group PLC ... (2,592,541) (3,099,156) -- Dennis Tool Company ........... 1,430,000 (600,000) (3,299,944) Dyntec, Inc. .................. -- (4,499,998) -- Encore Wire Corporation ....... -- (2,724,000) (19,013,000) Global Crossing Ltd./Frontier Corporation ............ (1,763,282) 1,004,248 605,215 Mail-Well, Inc. ............... (6,290,000) (5,241,000) (6,214,860) Media Recovery, Inc. .......... 10,000,000 2,585,000 615,000 Palm Harbor Homes, Inc. ....... (7,855,000) (39,276,000) (12,568,000) PETsMART, Inc. ................ 654,220 (3,271,100) (1,758,216) The RectorSeal Corporation .... 5,500,000 3,500,000 -- Rewind Holdings, Inc. ......... (1,123,750) (2,200,000) -- SDI Holding Corp. ............. -- -- 6,000,000 Skylawn Corporation ........... 3,000,000 -- (7,000,000) Sprint Corporation-FON Group .. (2,952,720) 1,003,500 1,149,741 Sprint Corporation-PCS Group .. (1,674,000) 1,560,375 743,634 Sprockets.com, Inc. ........... (1,299,999) -- -- The Whitmore Manufacturing Company ................ -- (800,000) 2,800,000 A description of the investments listed above and other material components of the investment portfolio is included elsewhere in this report under the caption "Portfolio of Investments - March 31, 2001." Deferred Taxes on Unrealized Appreciation of Investments The Company provides for deferred Federal income taxes on net unrealized appreciation of investments. Such taxes would become payable at such time as unrealized appreciation is realized through the sale or other disposition of those components of the investment portfolio which would result in taxable transactions. At March 31, 2001 consolidated deferred Federal income taxes of $79,310,000 were provided on net unrealized appreciation of investments of $228,315,863 compared with deferred taxes of $83,151,000 on net unrealized appreciation of $238,626,698 at March 31, 2000. Deferred income taxes at March 31, 2001 and 2000 were provided at the then currently effective maximum Federal corporate tax rate on capital gains of 35%. Portfolio Investments During the year ended March 31, 2001, the Company invested $15,922,079 in various portfolio securities listed elsewhere in this report under the caption "Portfolio Changes During the Year," which also lists dispositions and write-offs of portfolio securities. During the 2000 and 1999 fiscal years, the Company invested a total of $21,924,423 and $13,170,132, respectively. Financial Liquidity and Capital Resources At March 31, 2001, the Company had cash and cash equivalents of $1.1 million. Pursuant to Small Business Administration ("SBA") regulations, cash and cash equivalents of $0.1 million held by CSVC may not be transferred or advanced to CSC without the consent of the SBA. Under current SBA regulations and subject to SBA's approval of its credit application, CSVC would be entitled to borrow up to $58.3 million in addition to the $5 million presently outstanding. The Company also has an unsecured $15,000,000 revolving line of credit from a commercial bank, of which $10,000,000 was available at March 31, 2001. 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 33 years. Retention of future gains is viewed as an important source of funds to sustain the Company's investment activity. Approximately $30.9 million of the Company's investment portfolio is represented by unrestricted publicly-traded securities, which have an ascertainable market value and represent a primary source of liquidity. Funds to be used by the Company for operating or investment purposes may be transferred in the form of dividends, management fees or loans from Skylawn Corporation, The RectorSeal Corporation and The Whitmore Manufacturing Company, wholly-owned portfolio companies of the Company, to the extent of their available cash reserves and borrowing capacities. Management believes that the Company's cash and cash equivalents and cash available from other sources described above are adequate to meet its expected requirements. Consistent with the long-term strategy of the Company, the disposition of investments from time to time may also be an important source of funds for future investment activities. Impact of Inflation The Company does not believe that its business is materially affected by inflation, other than the impact which inflation may have on the securities markets, the valuations of business enterprises and the relationship of such valuations to underlying earnings, all of which will influence the value of the Company's investments. Risks Pursuant to Section 64(b)(1) of the Investment Company Act of 1940, a business development company is required to describe the risk factors involved in an investment in the securities of such company due to the nature of the company's investment portfolio. Accordingly the Company states that: The Company's objective is to achieve capital appreciation through investments in businesses believed to have favorable growth potential. Such businesses are often undercapitalized small companies which lack management depth and have not yet attained profitability. The Company's venture investments often include securities which do not yield interest or dividends and are subject to legal or contractual restrictions on resale, which restrictions adversely affect the liquidity and marketability of such securities. Because of the speculative nature of the Company's investments and the lack of any market for the securities initially purchased by the Company, there is a significantly greater risk of loss than is the case with traditional investment securities. The high-risk, long-term nature of the Company's venture investment activities may prevent shareholders of the Company from achieving price appreciation and dividend distributions.

Shareholder Information Stock Transfer Agent 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 900 record holders of its common stock at March 31, 2001. This total does not include an estimated 1,800 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 Stock 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 High Low ------------------------------------------------------------------------ June 30, 1999.................................... $82 $71 1/8 September 30, 1999............................... 81 71 December 31, 1999................................ 70 7/8 56 March 31, 2000................................... 60 44 Quarter Ended High Low ------------------------------------------------------------------------ June 30, 2000.................................... $61 1/4 $53 September 30, 2000............................... 62 1/2 57 December 31, 2000............................... 59 3/4 50 5/8 March 31, 2001................................... 68 1/8 52 Dividends The payment dates and amounts of cash dividends per share since April 1, 1999 are as follows: Payment Date Cash Dividend ----------------------------------------------------------------------- May 28, 1999.............................................. $0.20 November 30, 1999......................................... 0.40 May 31, 2000.............................................. 0.20 November 30, 2000......................................... 0.40 May 31, 2001.............................................. 0.20 The amounts and timing of cash dividend payments have generally been dictated by requirements of the Internal Revenue Code regarding the distribution of taxable net investment income (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 shareholders of record who own a minimum of 25 shares. The Company pays all costs of administration of the Plan except brokerage transaction fees. Upon request, shareholders may obtain information on the Plan from the Company, 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 Corporation will be held on Monday, July 16, 2001, at 10:00 a.m. in the North Dallas Bank Tower Meeting Room (first floor), 12900 Preston Road, Dallas, Texas.