SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-Q (x) Quarterly report pursuant to section 13 or 15(d) of the Securities Exchange Act of 1934 FOR THE QUARTERLY PERIOD ENDED NOVEMBER 30, 1994 ( ) Transition report pursuant to section 13 or 15(d) of the Securities Exchange Act of 1934. Commission file number 0-15525 CAPITAL ASSOCIATES, INC. (Exact name of registrant as specified in its charter) DELAWARE 84-1055327 (State or other jurisdiction of (IRS Employer Identification No.) incorporation or organization) 7175 WEST JEFFERSON AVENUE, LAKEWOOD, COLORADO 80235 (Address of principal executive offices) (Zip Code) Registrant's telephone number, including area code: (303) 980-1000 Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes X No The number of shares outstanding of the Registrant's $.008 par value common stock at January 11, 1995, was 10,179,747. CAPITAL ASSOCIATES, INC. AND SUBSIDIARIES INDEX PAGE PART I. FINANCIAL INFORMATION NUMBER ------ Item 1. Financial Statements (Unaudited) Consolidated Balance Sheets - November 30, 1994 and May 31, 1994 3 Consolidated Statements of Operations - Three and Six Months Ended November 30, 1994 and 1993 4 Consolidated Statements of Cash Flows - Six Months Ended November 30, 1994 and 1993 5 Notes to Consolidated Financial Statements 6-10 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations 11-19 PART II. OTHER INFORMATION Item 1. Legal Proceedings 20 Exhibit Index 21 Signature 23 CAPITAL ASSOCIATES, INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS (UNAUDITED) (DOLLARS IN THOUSANDS) ASSETS NOVEMBER 30, MAY 31, 1994 1994 ------------ ------- Cash, including restricted funds of $1,682 and $1,567, respectively $ 2,490 $ 2,072 Accounts receivable, net of allowance for doubtful accounts of $204 and $343, respectively 777 1,375 Income tax refunds receivable - 250 Equipment held for sale or re-lease 5,095 5,242 Residual values and other receivables arising from equipment under lease sold to private investors 4,260 5,098 Net investment in direct finance leases 17,091 18,106 Leased equipment, net 13,313 15,615 Investments in affiliated limited partnerships 10,981 12,178 Other 4,765 5,779 Notes receivable arising from sale-leaseback transactions 26,850 32,417 Discounted lease rentals assigned to lenders arising from equipment sale transactions 84,799 111,593 --------- --------- $ 170,421 $ 209,725 ========= ========= LIABILITIES AND STOCKHOLDERS' EQUITY Revolving Credit Facility $ 4,108 $ 49 Accounts payable and other liabilities 6,752 8,187 Term Loan 11,500 18,718 Deferred income taxes 800 830 Obligations under capital leases arising from sale-leaseback transactions 26,807 32,337 Discounted lease rentals 98,909 128,505 --------- --------- 148,876 188,626 --------- --------- Stockholders' equity: Common stock 62 60 Additional paid-in capital 16,899 16,689 Retained earnings 4,635 4,401 Treasury stock (51) (51) --------- --------- Total stockholders' equity 21,545 21,099 --------- --------- $ 170,421 $ 209,725 ========= ========= The accompanying notes are an integral part of these consolidated financial statements. CAPITAL ASSOCIATES, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED) (DOLLARS IN THOUSANDS, EXCEPT EARNINGS PER SHARE) THREE MONTHS ENDED SIX MONTHS ENDED -------------------------- ------------------------- NOVEMBER 30, NOVEMBER 30, NOVEMBER 30, NOVEMBER 30, 1994 1993 1994 1993 ------------ ------------ ------------ ------------ Revenue: Equipment sales to affiliated limited partnerships $ 7,531 $ 21,882 $ 16,238 $ 49,525 Other equipment sales 10,895 9,616 14,112 25,259 Leasing 1,625 3,609 3,723 7,838 Interest 2,961 4,008 6,325 7,520 Other 1,384 785 2,767 2,101 ---------- ---------- ---------- ---------- Total revenue 24,396 39,900 43,165 92,243 ---------- ---------- ---------- ---------- Costs and expenses: Equipment sales 17,532 29,661 28,035 70,508 Leasing 821 1,288 1,748 2,996 Operating and other expenses 2,379 3,167 5,243 6,273 Provision for losses 25 145 225 1,060 Interest Non-recourse debt 3,260 4,887 6,976 9,630 Recourse debt 261 464 549 1,018 ---------- ---------- ---------- ---------- Total costs and expenses 24,278 39,612 42,776 91,485 ---------- ---------- ---------- ---------- Net income before income taxes 118 288 389 758 Income tax expense 47 115 155 303 ---------- ---------- ---------- ---------- Net income $ 71 $ 173 $ 234 $ 455 ========== ========== ========== ========== Earnings per common and common equivalent share $ 0.01 $ 0.02 $ 0.02 $ 0.04 ========== ========== ========== ========== Weighted average number of common and dilutive common equivalent shares outstanding used in computing earnings per share 10,744,000 11,029,000 10,782,000 11,043,000 ========== ========== ========== ========== The accompanying notes are an integral part of these consolidated financial statements. CAPITAL ASSOCIATES, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED) (DOLLARS IN THOUSANDS) SIX MONTHS ENDED -------------------------- NOVEMBER 30, NOVEMBER 30, 1994 1993 ------------ ------------ (Note 3) Net cash provided by operating activities $ 9,672 $ 20,332 -------- --------- Cash flows from investing activities: Equipment purchased for leasing (5,536) (1,847) Net receipts from affiliated public income funds ("PIFs") 1,059 1,030 Sale of the investment in Corporate Express, Inc. 677 - -------- --------- Net cash used for investing activities (3,800) (817) -------- --------- Cash flows from financing activities: Proceeds from discounting of lease rentals 1,215 2,479 Principal payments on discounted lease rentals (3,722) (12,794) Proceeds from sales of common stock 212 - Net payments on recourse debt (3,159) (9,752) -------- --------- Net cash used for financing activities (5,454) (20,067) -------- --------- Net increase (decrease) in cash 418 (552) Cash at beginning of period 2,072 3,210 -------- --------- Cash at end of period $ 2,490 $ 2,658 ======== ========= Supplemental schedule of cash flow information: Recourse interest paid $ 38 $ 1,003 Non-recourse interest paid 640 1,878 Income taxes paid 319 181 Income tax refunds received 898 1,614 Supplemental schedule of non-cash investing and financing activities: Discounted lease rentals assigned to lenders arising from equipment sales transactions 3,123 28,050 Assumption of discounted lease rentals in lease acquisitions 3,347 15,675 Increase in other receivables relating to equipment sale transactions 558 1,658 Defeasance of discounted lease rentals related to bankrupt lessee 518 - The accompanying notes are an integral part of these consolidated financial statements. CAPITAL ASSOCIATES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) 1. Basis of Presentation The accompanying unaudited consolidated financial statements have been prepared in accordance with generally accepted accounting principles for interim financial information and the instructions to Form 10-Q and Rule 10-01 of Regulation S-X. Accordingly, they do not include all of the information and disclosures required by generally accepted accounting principles for annual financial statements. In the opinion of management, all adjustments (consisting of normal recurring adjustments) considered necessary for a fair presentation have been included. For further information, please refer to the financial statements of Capital Associates, Inc. (the "Company"), and the related notes, included within the Company's Annual Report on Form 10-K for the fiscal year ended May 31, 1994 (the "1994 Form 10-K"), previously filed with the Securities and Exchange Commission. The balance sheet at May 31, 1994 has been derived from the audited financial statements included in the Company's 1994 Form 10-K. Certain reclassifications have been made in the 1994 financial statements to conform to the 1995 presentation. 2. Debt Facilities On December 2, 1994, the Company refinanced its existing recourse operating debt facility (the "Old Debt Facility") with a new recourse operating debt facility (the "New Debt Facility"). The Old Debt Facility consisted of two facilities, a term loan facility (the "Old Term Loan") and a revolving credit facility (the "Old Revolving Credit Facility"). On December 2, 1994, the outstanding principal balance of the Old Term Loan (plus accrued and unpaid interest) was $11.5 million, and the outstanding principal balance of the Revolving Credit Facility (plus accrued and unpaid interest and fees) was $3.5 million. The Company repaid the outstanding principal balances of both facilities, accrued and unpaid interest on both facilities and fees and other costs owing under the Old Debt Facility to the lenders thereunder (the "Old Lenders") with proceeds from the New Debt Facility, and the Old Lenders, the Company, Capital Associates International, Inc. ("CAII"), and certain of the Company's other subsidiaries executed a joint Settlement Agreement and Release of Liens and Claims. The lenders under the New Debt Facility are Norwest Bank Colorado, National Association (the "Agent"), Norwest Equipment Finance, Inc. (the "Collateral Agent") and First Interstate Bank of Denver, N.A. (collectively referred to herein as the "New Lenders"). The Borrower under the New Debt Facility is CAII. The New Debt Facility consists of three facilities, a term loan facility (the "New Term Loan"), a working capital facility (the "Working Capital Facility") and a warehouse facility (the "Warehouse Facility"). The principal amount of the New Term Loan is $13 million. CAII is entitled to use the proceeds of the New Term Loan solely to retire the outstanding balance of the Old Debt Facility and to pay all costs and expenses of closing the New Debt Facility. The Company drew the entire principal amount of the New Term Loan on December 2, 1994 together with a drawdown of $2.5 million on the Warehouse Facility, and used the proceeds as follows: (1) $11.5 million to repay the entire outstanding principal balance of, plus accrued and unpaid interest on, the Old Term Loan, (2) $3.6 million to repay the entire outstanding principal balance of, plus accrued and unpaid interest and fees on, the Old Revolving Credit Facility and (3) $.4 million to pay fees and costs of closing the New Debt Facility. The New Term Loan is a 36-month facility. The principal amount of the New Term Loan is payable in 36 substantially equal monthly installments. Principal reductions under the New Term Loan are scheduled to occur as follows (in thousands): Six Months ending May 31, 1995 $ 2,167 Fiscal Year ending May 31, 1996 4,333 Fiscal Year ending May 31, 1997 4,333 Fiscal Year 1998 through November 30, 1997 (the scheduled termination date of the New Term Loan) 2,167 -------- $ 13,000 ======== CAII is obligated, under certain circumstances, to make Mandatory Principal Payments (as defined below) under the New Debt Facility. A portion of such Mandatory Principal Payments may be applied to the outstanding principal balance of the New Term Loan. See the discussion of Mandatory Principal Payments below. The New Term Loan bears interest at the Agent's Prime Rate plus .75%, payable monthly, in arrears. On December 2, 1994, the Agent's Prime Rate was 8.5%. The principal amount of the Working Capital Facility is $5 million. The Working Capital Facility is a revolving facility. CAII has the right to borrow, repay and reborrow under the Working Capital Facility up to the principal amount thereof. CAII is entitled to use the proceeds of the Working Capital Facility for its short-term working capital purposes and for the warehousing of leases pending the funding of such leases under the Warehousing Facility or the obtaining of permanent financing with respect thereto. On December 2, 1994, the Working Capital Facility had no balance outstanding and the availability under the Working Capital Facility was $5 million. The Working Capital Facility is a 12-month facility. The outstanding principal balance of the Working Capital Facility, along with all accrued and unpaid interest thereon, is payable in full on November 30, 1995. As discussed above, CAII is obligated, under certain circumstances, to make mandatory principal payments under the New Debt Facility ("Mandatory Principal Payments"). A Mandatory Principal Payment will be required if, and to the extent that, the outstanding principal balances of the New Term Loan and the Working Capital Facility advances, in the aggregate, at any time result in a Collateral Coverage Ratio (as discussed below) of less than 1.25 to 1.00. Mandatory Principal Payments will be applied first to the outstanding principal balance of the Working Capital Facility and next to the outstanding principal balance of the New Term Loan. The Working Capital Facility bears interest at the Agent's Prime Rate plus .75%, payable monthly, in arrears. As discussed above, on December 2, 1994, the Agent's Prime Rate was 8.5%. The principal amount of the Warehouse Facility is currently $12 million (subject to increase to up to $32 million as described below). The Warehouse Facility is a revolving facility. CAII has the right to borrow, repay and reborrow under the Warehouse Facility up to the principal amount thereof. CAII is entitled to use the proceeds of the Warehouse Facility for acquiring or funding leases for resale or as temporary financing pending the securing of permanent financing for any such leases. On December 2, 1994, the outstanding principal balance under the Warehouse Facility was $2.5 million. The availability under the Warehouse Facility is equal to the lesser of (1) $12 million (subject to increase to up to $32 million as described below) and (2) the Warehouse Borrowing Base (i.e., the lesser of $12 million (subject to increase to up to $32 million as described below) or 97.5% of the sum of the present value of eligible warehouse lease rentals and 50% of eligible warehouse lease residual values), reduced by the outstanding indebtedness under the Warehouse Facility. As of December 2, 1994, (a) the Warehouse Borrowing Base amount was approximately $3.1 million, (b) the outstanding principal balance under the Warehouse Facility was approximately $2.5 million and (c) the remaining availability under the Warehouse Facility was approximately $9.5 million. The loan agreement evidencing the New Debt Facility (the "New Loan Agreement") contemplates that additional lenders ("Additional Lenders") may be added to the New Loan Agreement until the principal amount of the Warehouse Facility is increased to $32 million. The Lenders have the right to approve or disapprove the addition of any Additional Lender(s) to the New Loan Agreement. The Warehouse Facility bears interest at the Agent's Prime Rate plus .50%, payable monthly, in arrears. As discussed above, on December 2, 1994, the Agent's Prime Rate was 8.5%. The New Debt Facility (1) is collateralized by all of CAII's assets and (2) is senior, in order of priority, to all of CAII's indebtedness, other than liens which are senior by operation of law, other liens to which the Lenders have subordinated their position and non-recourse financing liens on specific equipment and leases. The Company and certain of the Company's and CAII's subsidiaries have guaranteed CAII's obligations under the New Loan Agreement and have pledged all of their assets, with limited exceptions, to collateralize their guaranties. The New Loan Agreement requires CAII to (1) ensure that the Company maintains, on a consolidated basis, an Interest Coverage Ratio (i.e., the ratio of pre-tax earnings, as defined, plus interest expense to interest expense) of not less than 1.20 to 1.00, (2) maintain a Collateral Coverage Ratio (i.e., the ratio of Working Capital leases and other eligible investment assets to the outstanding principal balances of the Term Loan and Working Capital Facility) of not less than 1.25 to 1.00, (3) ensure that the Company maintains, on a consolidated basis, a Leverage Ratio (i.e., the ratio of all recourse debt of the Company to shareholders' equity) of not greater than 2.50 to 1.00, (4) ensure that the Company maintains, on a consolidated basis a Tangible Net Worth of not less than $20 million (increased by 75% of annual net income, with no reduction for losses), (5) maintain a Cash Flow Coverage Ratio (i.e., the ratio of the Company's cash flow (as defined) to its debt service requirements) of not less than 1.40 to 1.00, (6) maintain, from and after February 28, 1996, a Non-Residual Collateral Coverage Ratio (i.e., the Collateral Coverage Ratio calculated without taking into account residual values) of not less than 1.15 to 1.00 and (7) maintain an Equipment Classification Concentration Limit (i.e., equipment type, excluding inventory aircraft) of no greater than 15% of the net book value of all of CAII's equipment. CAII is obligated to pay the following on-going fees under the New Debt Facility: (1) a Working Capital Commitment Fee equal to .50% per annum on the daily average unused Working Capital commitment, payable quarterly in arrears, and (2) a Warehousing Commitment Fee equal to .375% per annum on the daily average unused Warehouse Facility commitment, payable quarterly in arrears, and (3) reasonable fees and out-of-pocket costs associated with each of the Agents audits or inspections of CAII's collateral or business, not to exceed four audits in any calendar year. In addition, CAII has agreed to acquire, at its own cost, an interest rate protection contract with respect to not less than 50% of the principal amount of the New Term Loan. As of the time these financial statements were prepared, CAI was in the process of obtaining quotes for an interest rate contract. As of the time these financial statements were prepared, there were no defaults existing under the New Debt Facility. The New Debt Facility significantly restricts CAII's ability to pay dividends, or loan or advance funds to the Company. 3. Consolidated Statements of Cash Flow Consistent with the reclassification described in the Company's first quarter fiscal 1995 report on Form 10-Q, the principal portion of receipts of direct financing leases and proceeds from sales of equipment have been classified as "Cash flows from operating activities". Previously, such amounts were reported as "Cash flows from investing activities". The effect of the reclassifications on previously issued financial statements is as follows: Six months ended November 30, 1993 ---------------------- Previously Restated Reported Amounts ---------- -------- Net cash provided by operating activities $ 4,710 $ 20,332 Net cash provided by (used for) investing activities 14,805 (817) Net cash used for financing activities (20,067) (20,067) -------- -------- Net decrease in cash and cash equivalents $ (552) $ (552) ========= ======== 4. Bankrupt Lessee During the second quarter fiscal 1994, a lessee filed for bankruptcy protection under Chapter 11 of the Bankruptcy code. The aggregate net book value of equipment under four leases with this lessee is $486,000 at November 30, 1994. The lessee has not remitted its quarterly lease payments due January 1, 1995. Potential outcomes are (i) the lessee affirms its leases and the Company collects all rents due under the leases or (ii) the lessee rejects one or more of the leases and returns the underlying equipment to the Company. If the leases are rejected and the equipment is returned to the Company, it is possible that remarketing proceeds will be less than the net book value of the equipment. However, if the lessee affirms the leases, the Company would not be subject to a loss. The lessee has not made its intentions known at this time and, accordingly, a loss is not probable at this time. Regardless of the lessee's decision to accept or reject the leases, management believes that the ultimate outcome will not have a material adverse impact on the Company's financial position. Item 2. Management's Discussion and Analysis of Financial Conditiona and Results of Operations I. Results of Operations Presented below are schedules (prepared solely to facilitate the discussion of results of operations that follows) showing condensed income statement categories and analyses of changes in those condensed categories derived from the Consolidated Statements of Operations. Condensed Consolidated Condensed Consolidated Statements of Operations Statements of Operations for the Three Months for the Six Months Ended November 30, ended November 30, ------------------------ Effect on ------------------------ Effect on 1994 1993 net income 1994 1993 net income --------- ---------- ---------- --------- -------- ---------- (in thousands) Equipment sales margin $ 894 $ 1,837 $ (943) $ 2,315 $ 4,275 $ (1,960) Leasing margin (net of interest expense on discounted lease rentals) 505 1,442 (937) 1,324 2,732 (1,408) Other income 1,384 785 599 2,767 2,101 666 Operating and other expenses (2,379) (3,167) 788 (5,243) (6,272) 1,029 Provision for losses (25) (145) 120 (225) (1,060) 835 Interest expense on recourse debt (261) (464) 203 (549) (1,018) 469 Income taxes (47) (115) 68 (155) (303) 148 -------- -------- ------ -------- -------- -------- Net income $ 71 $ 173 $ (102) $ 234 $ 455 $ (221) ======== ======== ====== ======== ======== ======== Equipment Sales Equipment sales revenue (and related equipment sales margin) consists of the following (in thousands): THREE MONTHS ENDED NOVEMBER 30, -------------------------------------------- Increase 1994 1993 (Decrease) -------------------- -------------------- ----------------- Revenue Margin Revenue Margin Revenue Margin ------- ------ ------- ------ ------- ------ Transactions during initial lease term: Equipment under lease sold to PIFs $ 7,531 $ 206 $ 21,882 $ 538 Equipment under lease sold to private investors 9,924 70 7,872 319 -------- ------- -------- ------- --------- --------- 17,455 276 29,754 857 $ (12,299) $ (581) -------- ------- -------- ------- --------- --------- Transactions subsequent to initial lease termination ("Remarketing Sales"): Sales of off-lease equipment 673 327 1,127 441 Sales-type leases 124 117 232 154 Excess collections (cash collections in excess of the associated residual value from equipment under lease sold to private investors) 174 174 385 385 -------- ------- -------- ------- --------- --------- 971 618 1,744 980 (773) (362) Provision for losses (25) (145) 120 -------- ------- -------- ------- --------- --------- Remarketing sales results in excess of provision for losses 971 593 1,744 835 (773) (242) -------- ------- -------- ------- --------- --------- Total equipment sales $ 18,426 $ 869 $ 31,498 $ 1,692 $ (13,072) $ (823) ======== ======= ======== ======= ========= ========= SIX MONTHS ENDED NOVEMBER 30, -------------------------------------------- Increase 1994 1993 (Decrease) -------------------- -------------------- ----------------- Revenue Margin Revenue Margin Revenue Margin ------- ------ ------- ------ ------- ------ Transactions during initial lease term: Equipment under lease sold to PIFs $ 16,238 $ 427 $ 49,525 $ 1,270 Equipment under lease sold to private investors 11,722 256 20,951 738 -------- ------- -------- ------- --------- -------- 27,960 683 70,476 2,008 $ (42,516) $ (1,325) -------- ------- -------- ------- --------- -------- Transactions subsequent to initial lease termination ("Remarketing Sales"): Sales of off-lease equipment 1,078 585 2,540 942 Sales-type leases 602 337 976 533 Excess collections (cash collections in excess of the associated residual value from equipment under lease sold to private investors) 710 710 792 792 -------- ------- -------- ------- --------- -------- 2,390 1,632 4,308 2,267 (1,918) (635) Provision for losses (225) (1,060) 835 -------- ------- -------- ------- --------- -------- Remarketing sales results in excess of provision for losses 2,390 1,407 4,308 1,207 (1,918) 200 -------- ------- -------- ------- --------- -------- Total equipment sales $ 30,350 $ 2,090 $ 74,784 $ 3,215 $ (44,434) $ 1,125 ======== ======= ======== ======= ========= ======== Equipment Sales to PIFs and to Private Investors Equipment sales to PIFs significantly decreased during the six months ended November 30, 1994, as compared to the similar period in fiscal 1994, principally because fewer leases were identified and closed that satisfied the PIF's underwriting standards. The first two quarters of fiscal 1994 were the largest quarters with respect to equipment sales to the PIFs during that fiscal year, and were substantially greater than the historical average for quarterly sales to PIFs. Equipment sales to private investors for the first fiscal six months 1994 included sales of approximately $13.2 million of "seasoned" leases (i.e., previously originated leases held in the Company's portfolio). As the Company's lease portfolio has declined in size (sometimes referred to herein as "portfolio run-off"), fewer seasoned leases have been available for sale (as the Company sold approximately $5 million of seasoned leases to private investors during 1995). During the first fiscal six months 1995, equipment sales to private investors consisted primarily of new leases originated for sale to private investors, however, not enough leases were originated to offset the decline in the sale of seasoned leases. Remarketing Sales and Provision for Losses The remarketing of equipment for an amount greater than its book value is reported as equipment sales margin or as leasing margin. The realization of less than the carrying value of equipment (which is typically not known until remarketing subsequent to the initial lease termination has occurred) is recorded as provision for loss. As shown in the table above, the realizations from sales exceeded the provision for losses for the first fiscal six months 1995, even without considering realizations from remarketing activities recorded as leasing margin, as discussed below. Margins from remarketing sales (i.e., sales occurring after the initial lease term) are affected by the amount of equipment leases that matures in a particular quarter. In general, as the size of the Company's lease portfolio has declined in size, fewer leases have matured and less equipment has been available for remarketing each quarter. As a result, remarketing revenue declined during the first fiscal six months 1995 compared to the comparable period in fiscal 1994. However, as shown above, the margin from remarketing sales increased during first fiscal six months 1995, although no assurances can be given that this trend will continue. In the absence of significant additions to the lease portfolio, management believes that remarketing revenue and margin will decline in future quarters. Residual values are established equal to the estimated value to be received from the equipment following termination of the lease. In estimating such values, the Company considers all relevant facts regarding the equipment and the lessee, including, for example, the likelihood that the lessee will re-lease the equipment. The Company performs ongoing quarterly assessments of its assets to identify other than temporary losses in value. The Company has not identified material probable new losses during the six months ended November 30, 1994; however, see Note 4 to Notes to Consolidated Financial Statement for discussion regarding an identified loss contingency. During the first fiscal six months 1994, a greater than expected amount of equipment under lease that the Company expected to be released was, instead, terminated and returned to the Company. The amounts recovered (and expected to be recovered) from the sale of such equipment were less than the previously estimated residual value, and accordingly, an appropriate provision for loss was recorded during first fiscal six months 1994. The Company also recorded a provision for loss of $180,000 for the possible sale of one of its aircraft during the first fiscal six months 1994. LEASING MARGIN Leasing margin consists of the following (in thousands): Three Months Ended Six Months Ended November 30, November 30, ------------------- ---------------- 1994 1993 1994 1993 ------ ------ ------ ------ Leasing revenue $ 1,625 $ 3,609 $ 3,723 $ 7,838 Leasing costs and expenses (821) (1,288) (1,748) (2,996) Net interest expense on related discounted lease rentals (299) (879) (651) (2,110) ------- -------- -------- -------- Leasing margin $ 505 $ 1,442 $ 1,324 $ 2,732 ======= ======== ======== ======== Leasing margin ratio 31% 40% 36% 35% == == == == Leasing margin has declined and is expected to decline further as a result of portfolio run-off. See the discussion under "Business Plan" below. As the portfolio runs off, the declining basis for calculating quarterly leasing margin will result in ratios that vary from quarter to quarter. OTHER INCOME Other Income consists of the following (in thousands): Three Months Ended Six Months Ended November 30, November 30, ------------------ ------------------ 1994 1993 1994 1993 -------- -------- -------- -------- Fees and distributions from the Company-sponsored PIFs $ 784 $ 804 $ 1,562 $ 1,594 Sale of the investment in Corporate Express, Inc. stock 411 - 671 - Interest on income tax refunds - - 178 431 Other, principally recovery of sales and property tax amounts previously expensed 189 (19) 356 76 ------- ------- ------- -------- $ 1,384 $ 785 $ 2,767 $ 2,101 ======= ======= ======= ======== Other than fees and distributions from the company-sponsored PIFs, the Company does not expect to realize material amounts in the future with respect to the other items listed above. OPERATING AND OTHER EXPENSES Operating and other expenses decreased $1.0 million (16%) for the first fiscal six months 1995 as compared to the comparable period in fiscal year 1994. The decrease principally reflects a reduction in salaries and wages, accomplished, in part, through a reduction-in-force of 29 full-time employees during June 1994. As of November 30, 1994, the Company had 91 full-time employees compared to 119 full-time employees at November 30, 1993. INTEREST INCOME AND EXPENSE Interest revenue arises when equipment financed with non-recourse debt is sold to investors. The Consolidated Statements of Operations reflect an equal amount of interest expense. The decline in interest expense on non-recourse debt (net of the associated interest revenue) is due to portfolio run-off. The decrease in interest expense on recourse debt reflects the decline in the outstanding balance of the Old Debt Facility. The changes in the Company's lease portfolio during the six months ended November 30, 1994 consisted of the following: Discounted lease Direct finance rentals, net of leases, operating discounted lease leases, net and rentals assigned Net investment equipment held to lenders arising in lease for sale or re-lease from equipment sales portfolio -------------------- -------------------- -------------- As of May 31, 1994 $ 38,963 $ (16,912) $ 22,051 Leases added to the Company's lease portfolio 5,468 (3,347) 2,121 Leases added to the Company's lease portfolio (and sold in December 1994) 2,751 - 2,751 Leases sold to private investors (4,946) 2,266 (2,680) Provision for losses (225) - (225) Change as a result of portfolio run-off (6,512) 3,883 (2,629) --------- --------- --------- As of November 30, 1994 $ 35,499 $ (14,110) $ 21,389 ========= ========= ========= A jet aircraft having a net book value of $5 million is included in Equipment Held for Sale or Re-Lease. The Company is attempting to remarket the aircraft through re-lease or sale. Borrowings under the Old Revolving Credit Facility increased from $49,000 at May 31, 1994 to $4,108,000 at August 31, 1994. As shown in the table above, the increase results from the utilization of such borrowings to add leases to the Company's lease portfolio. MATERIAL NON-EARNING ASSETS A significant portion of the Company's stockholders' equity of approximately $22 million is represented by these material non-earning assets: (i) a jet aircraft with a carrying value of approximately $5 million as discussed above, and (ii) maximum possible amounts receivable under the MBank contracts of approximately $11 million (with a carrying value of approximately $3 million) as discussed in the Company's annual report on Form 10-K for the year ended May 31, 1994. The Company's results of operations would be improved if funds from conversion of the above assets were invested in a lease portfolio. Management believes that these conversions can occur without loss to the Company. However, the timing of such conversion is not predictable. II. Liquidity and Capital Resources The Company's activities are principally funded by its Working Capital and Warehouse Credit Facilities, rents, proceeds from sales of on-lease equipment (to its PIFs and third party investors), non-recourse debt, fees and distributions from its PIFs and sales of on lease equipment to its PIFs or third-party investors and/or re-leases of equipment during and after the expiration of the initial lease terms and other cash receipts. Currently, only one PIF, Capital Preferred Yield Fund-III, ("CPYF-III") is selling units to the public. Through November 30, 1994 CPYF III sold $11.3 million of units. In recent months, there has been a decline in units sales which the Company believes can be attributed to the rise in rates of fixed income securities. Four of the Company's PIFs including CPYF-III are in the reinvestment stage and are using a portion of their available cash to purchase additional equipment from the Company. Two of the Company's PIFs are in the liquidation stage and are no longer purchasing equipment. Management believes the Company's ability to generate cash from operations is sufficient to fund operations, particularly when operations are viewed as including investing and financing activities. In this context, it should be noted that through November 30, 1994, the Company reduced its aggregate outstanding indebtedness under its Debt Facility by $3.2 million since May 31, 1994 and has improved its recourse debt-to-equity ratio as follows: November 30, 1994 May 31, 1994 ----------------- ------------ Recourse debt outstanding under the Debt Facility $ 15,608 $ 18,767 Stockholders' equity $ 21,545 $ 21,099 Recourse debt/stockholders' equity .72 to 1 .89 to 1 However, as the recourse debt outstanding has declined, the Company's lease portfolio has also declined. As discussed in Note 2 to Notes to Consolidated Financial Statements, on December 2, 1994, the Company replaced its Old Debt Facility with a New Debt Facility. Under the New Debt Facility a greater amount of financing is available to the Company to originate new leases. As the Company utilizes the New Debt Facility to originate leases, the recourse debt/stockholders equity ratio is expected to increase. III. Revised Business Plan As discussed in the 1994 Form 10-K, beginning in fiscal year 1991, the Company agreed with its Old Lenders to begin repaying its Old Debt Facility. As discussed herein, on December 2, 1994, the Company refinanced its Old Debt Facility with proceeds drawn on its New Debt Facility. Beginning in fiscal 1991 and continuing through December 1, 1994, the Company used substantially all of its available cash flow (after payment of operating expenses) to repay its Old Debt Facility. As a result of making these repayments, the Company did not have funds to significantly add to its own leasing portfolio, and, accordingly, the portfolio shrank, leasing revenue declined and the ultimate profitability of the Company's core leasing business declined. On December 2, 1994, the Company closed its New Debt Facility. See Note 2 to Notes to Consolidated Financial Statements for a detailed discussion of the New Debt Facility. The Working Capital Facility and the Warehouse Facility provide the Company with $17 million (which, under certain circumstances, may increase to up to $37 million) to fund new lease originations and purchases. The Company believes that the level of funding available under the New Debt Facility should enable the Company to (1) increase the size of its own lease portfolio, (2) originate/acquire additional leases for sales to its PIFs and private equity investors, (3) ultimately increasing leasing revenue and related profits and (4) reduce overall borrowing costs since the Company was subject to significant legal and restructuring costs under the Old Debt Facility which it no longer incurs under the New Debt Facility. In its fiscal 1995 Business Plan, the Company identified the following primary goals for fiscal year 1995: (1) maintain profitability, (2) continue to build the Company's lease marketing and private equity syndication capabilities, (3) replace its Old Debt Facility, (4) further reduce G&A and (5) take appropriate steps to position the Company to access new capital in future years. In October 1994, the Company evaluated its performance for the first quarter fiscal year 1995 against its 1995 Business Plan goals and concluded the following: * although the Company had reported a profit of $.02 per share for the first quarter, its ninth consecutive profitable quarter, the profit resulted largely from "other income" items (e.g., the sale of a portion of the Company's Corporate Express stock and interest on income tax refunds) and not from the Company's core leasing business; * although the Company had been continually enhancing its lease origination capabilities by adding lease originators, the level of lease originations were substantially below their 1995 Business Plan targets - hence the sales of PIF units, leases sold to the PIFs, lease revenues and lease profits were all below their projected first fiscal quarter 1995 Business Plan targets; * the Company had entered into negotiations with its New Lenders to replace the Old Debt Facility; and * G&A costs were substantially on target. In November 1994, senior management determined that lease originations, sales of PIF units, equipment sold to the PIFs, lease revenues, and private equity sales for the second quarter fiscal 1995 were below their 1995 Business Plan targets. Senior management, in the face of these results, revised its 1995 Business Plan (the "Revised 1995 Business Plan"), taking the following steps: * the Company re-assigned the responsibility for lease originations from its Senior Vice President-Marketing to its President and Chief Executive Officer; * the Company appointed a National Sales Manager; * the Company retained a recruiting firm to assist in hiring additional field lease origination personnel; * the Company decided to terminate its non-productive non-core business activities and focus its attention solely on its core business activities; and * the Company focused on purchasing wholesale lease transactions as an interim measure until it could complete the rebuilding of its field sales force and bring new lease originations in line with its Revised 1995 Business Plan targets. The Company also identified several other factors which could adversely impact profitability in the future: * because of the flattening of the yield curve for debt securities during calendar year 1994, lease rates are not rising in line with the Company's cost of funds; * even if lease originations increase significantly, growth in the Company's profits will be slow because as a portfolio grows, under generally accepted accounting principles, operating leases tend to have a negative leasing margin after interest expense during the early term of such leases; * the cost of funds for many of the Company's competitors is lower than the Company's cost of funds; and * certain of the Company's competitors also price transactions with tax benefits not available to the Company. A significant portion of the Company's stockholders' equity of approximately $22 million is represented by two material non-earning assets: (1) a jet aircraft with a carrying value of approximately $5 million as discussed on page 15 of 23, and (2) maximum possible amounts receivable under the MBank contracts of approximately $11 million (with a carrying value of approximately $3 million) as discussed in the Company's annual report on Form 10-K for the year ended May 31, 1994. The Company's results of operations would be improved if funds from conversion of the above assets were invested in a lease portfolio. Management believes that these conversions can occur without loss to the Company. However, the timing of such conversion is not predictable. For the prior three years, the Company could not originate a significant amount of leases for its own account because it did not have the financing to fund and hold those incremental originations. Now, as discussed above, the Company believes that it has the necessary funds under its New Debt Facility to (1) increase the size of its own lease portfolio, (2) originate/acquire additional leases for sales to PIFs and private equity investors and (3) ultimately increase revenue and related profits. The Company is aggressively seeking to hire qualified, experienced field lease originators to originate new leases for the Company's own portfolio and for sale to third parties. However, assuming that the Company is successful in hiring such persons, (a) it will take a period of time before new lease transactions can be closed, (b) new operating lease transactions "throw off" losses (for financial reporting purpose) during their early years and (c) the Company will incur substantial hiring and deal costs in increasing the size of its field originations force and adding new leases to its portfolio. During this period, the Company may realize small operating losses or reduced operating profits as a result of these costs. The amount of longer-term, future profits from these efforts will depend, at least in part, on the amount of capital available to the Company and the cost of that capital relative to the cost of capital of the Company's competitors. The Company will continue to seek out new sources of lower cost capital, including, among other things, (1) expanding the availability under its Warehouse Facility, (2) obtaining additional nonrecourse debt, (3) attracting new equity capital (which could include a sale of all or a part the Company, possibly coupled with an infusion of new funds into the Company from the purchaser), (4) structuring securitized financing vehicles, (5) obtaining equity from private purchases of equipment leases originated or purchased by the Company and/or (6) entering into strategic alliances/combinations with other leasing/financial services companies. No assurances can be given, however, that (A) the steps being taken by the Company will improve the Company's profitability or even maintain profitability, (B) will provide the Company with, or access to, additional sources of capital. CAPITAL ASSOCIATES, INC. AND SUBSIDIARIES PART II OTHER INFORMATION Item 1. Legal Proceedings a. There have been no material developments in the MBank Litigation (see the discussion of the MBank Litigation in the 1994 Form 10-K) since the date of the 1994 Form 10-K, except for the following: (1) discovery is completed and the parties have filed all of their pre-trial briefs, (2) the court held oral argument on several of the pending summary judgment motions and (3) the parties are awaiting the court's decision on those summary judgment motions. b. The Company is involved in various legal proceedings ordinary, routine and incidental to its business. In the opinion of senior management, none of these proceedings, individually or in the aggregate, should, if determined adversely to the Company, have an adverse effect on the Company or its operations. Item 4. Submission of Matters to a Vote of Security Holders The 1994 Annual Meeting of Stockholders of the Company (the "Annual Meeting") was held on October 13, 1994. At the Annual Meeting, James D. Edwards, Gary M. Jacobs, Dennis J. Lacey, William B. Patton, Jr., Peter F. Schabarum, and James D. Walker were re-elected as directors of the Company. Item 6. Exhibits and Reports on Form 8-K a. Included as exhibits are the items listed in the Exhibit Index. The Company will furnish to its shareholders a copy of any of the exhibits listed therein upon payment of $.25 per page to cover the costs to the Company of furnishing the exhibits. b. There were no reports on Form 8-K filed during the three months ended November 30, 1994. Item No. Exhibit Index 11A Computation of Primary Earnings Per Share. A computation of fully diluted earnings per share is not presented as it is the same as the computation of primary earnings per share. EX-27 Financial Data Schedule Exhibit 11A CAPITAL ASSOCIATES, INC. AND SUBSIDIARIES COMPUTATION OF PRIMARY EARNINGS PER SHARE THREE MONTHS ENDED SIX MONTHS ENDED ------------------------- ------------------------- November 30, November 30, November 30, November 30, 1994 1993 1994 1993 ------------ ------------ ------------ ------------ Shares outstanding at beginning of period 10,062,000 9,654,000 9,759,000 9,654,000 Shares issued during the period (weighted average) 3,000 - 302,000 - Shares earned but not issued under the CEO Bonus Plan - 50,000 - 50,000 Dilutive shares contingently issuable upon exercise of options (weighted average) 1,887,000 2,286,000 1,966,000 2,286,000 Less shares assumed to have been purchased for treasury with assumed proceeds from exercise of stock options (weighted average) (1,208,000) (961,000) (1,245,000) (947,000) ----------- ----------- ----------- ---------- Total shares, primary 10,744,000 11,029,000 10,782,000 11,043,000 =========== =========== =========== ========== Net income $ 71,000 $ 173,000 $ 234,000 $ 455,000 =========== =========== =========== ========== Income per common and common equivalent share, primary $ 0.01 $ 0.02 $ 0.02 $ 0.04 =========== =========== =========== ========== CAPITAL ASSOCIATES INC. AND SUBSIDIARIES SIGNATURE Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. CAPITAL ASSOCIATES, INC. ------------------------------------ Registrant Date: January 17, 1995 By: /s/Anthony M. Dipaolo -------------------------------- Anthony M. DiPaolo, Senior Vice-President and Controller (Principal Accounting Officer)