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, 1998
[ ] 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 12, 1999, was 5,211,757.
Exhibit Index - Page 18
1 of 19
CAPITAL ASSOCIATES, INC. AND SUBSIDIARIES
INDEX
-----
PAGE
PART I. FINANCIAL INFORMATION NUMBER
Item 1. Financial Statements
Consolidated Balance Sheets - November 30, 1998 (Unaudited)
and May 31, 1998 3
Consolidated Statements of Income - Three and Six Months
Ended November 30, 1998 and 1997 (Unaudited) 4
Consolidated Statements of Cash Flows - Six Months Ended
November 30, 1998 and 1997 (Unaudited) 5
Notes to Consolidated Financial Statements 6 - 7
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations 8 - 16
PART II. OTHER INFORMATION
Item 1. Legal Proceedings 17
Item 6. Exhibits and Reports on Form 8-K 17
Exhibit Index 18
Signature 19
2 of 19
CAPITAL ASSOCIATES, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(Dollars in thousands)
ASSETS
(Unaudited)
November 30, May 31,
1998 1998
------------ ---------
Cash and cash equivalents $ 3,955 $ 17,684
Receivables from affiliated limited partnerships 308 352
Accounts receivable, net 5,898 5,835
Inventory 1,997 1,141
Residual values and other receivables arising from
equipment under lease sold to private investors, net 7,507 4,277
Net investment in direct finance leases 28,329 31,181
Leased equipment, net 129,896 104,825
Investments in affiliated limited partnerships 2,582 3,589
Deferred income taxes 3,699 3,600
Other assets 4,477 4,883
Discounted lease rentals assigned to lenders
arising from equipment sale transactions 23,825 37,626
--------- ---------
$ 212,473 $ 214,993
========= =========
LIABILITIES AND STOCKHOLDERS' EQUITY
Recourse debt $ 53,029 $ 49,088
Accounts payable - equipment purchases 34,050 25,029
Accounts payable and other liabilities 14,607 11,379
Discounted lease rentals 85,309 104,311
--------- ---------
186,995 189,807
--------- ---------
Stockholders' equity:
Common stock 32 32
Additional paid-in capital 16,866 16,863
Retained earnings 8,663 8,374
Treasury stock (83) (83)
--------- ---------
Total stockholders' equity 25,478 25,186
--------- ---------
$ 212,473 $ 214,993
========= =========
The accompanying notes are an integral part
of these consolidated financial statements.
3 of 19
CAPITAL ASSOCIATES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
(Unaudited)
(Dollars in thousands, except earnings per share)
Three Months Ended Six Months Ended
November 30, November 30,
--------------------- ---------------------
1998 1997 1998 1997
--------- --------- --------- ---------
Revenue:
Equipment sales to PIFs $ 3,316 $ 12,321 $ 11,344 $ 23,703
Other equipment sales 38,897 54,458 87,512 78,933
Leasing 8,534 4,132 17,649 8,549
Interest 746 937 1,624 1,892
Other 1,065 1,391 2,388 2,200
--------- --------- --------- ---------
Total revenue 52,558 73,239 120,517 115,277
--------- --------- --------- ---------
Costs and expenses:
Equipment sales to PIFs 3,230 12,057 11,095 23,173
Other equipment sales 37,183 52,747 84,347 76,168
Leasing 5,679 2,849 11,584 5,653
Operating and other expenses 3,404 2,603 7,072 5,093
Provision for losses 25 230 50 400
Interest:
Non-recourse debt 2,053 1,318 4,200 2,667
Recourse debt 823 455 1,851 955
--------- --------- --------- ---------
Total costs and expenses 52,397 72,259 120,199 114,109
--------- --------- --------- ---------
Net income before income taxes 161 980 318 1,168
Income tax expense 15 245 29 292
--------- --------- --------- ---------
Net income $ 146 $ 735 $ 289 $ 876
========= ========= ========= =========
Earnings per common share:
Basic $ 0.03 $ 0.15 $ 0.06 $ 0.17
========= ========= ========= =========
Diluted $ 0.03 $ 0.14 $ 0.05 $ 0.16
========= ========= ========= =========
Weighted average number of
common shares outstanding:
Basic 5,149,000 5,036,000 5,129,000 5,031,000
========= ========= ========= =========
Diluted 5,419,000 5,383,000 5,398,000 5,374,000
========= ========= ========= =========
The accompanying notes are an integral part
of these consolidated financial statements.
4 of 19
CAPITAL ASSOCIATES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
(Dollars in thousands)
Six Months Ended
---------------------
November 30,
1998 1997
--------- ---------
Net cash provided by operating activities $ 42,442 $ 27,007
--------- ---------
Cash flows from investing activities:
Equipment purchased for leasing, net (41,740) (23,084)
Investment in leased office facility and
capital expenditures (377) (371)
Net receipts from affiliated public income funds 1,007 544
--------- ---------
Net cash used for investing activities (41,110) (22,911)
--------- ---------
Cash flows from financing activities:
Proceeds from securitization 10,527 -
Principal payments on securitization (735) -
Proceeds from discounting of lease rentals - 5,334
Principal payments on discounted lease rentals (27,133) (5,456)
Proceeds from sales of common stock 3 25
Net borrowings (payments) on revolving credit
facilities 1,609 (965)
Net borrowings on Term Loan 668 633
--------- ---------
Net cash used for financing activities (15,061) (429)
--------- ---------
Net increase (decrease) in cash and cash equivalents (13,729) 3,667
Cash and cash equivalents at beginning of period 17,684 6,194
--------- ---------
Cash and cash equivalents at end of period $ 3,955 $ 9,861
========= =========
Supplemental schedule of cash flow information:
Recourse interest paid $ 1,851 $ 955
Non-recourse interest paid 2,375 776
Income taxes paid 57 225
Income tax refunds received 260 70
Supplemental schedule of non-cash investing and
financing activities:
Discounted lease rentals assigned to lenders
arising from equipment sale transactions 6,973 942
The accompanying notes are an integral part
of these consolidated financial statements.
5 of 19
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 only 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,
1998 (the "1998 Form 10-K"), previously filed with the Securities and
Exchange Commission.
The balance sheet at May 31, 1998 was derived from the audited financial
statements included in the Company's 1998 Form 10-K.
2. Securitization Facility
-----------------------
The Company established a securitization facility (the "Securitization
Facility") in August 1998 through a wholly-owned special purpose subsidiary
("SPS") which purchased from the Company equipment leases and related lease
rental payments. The SPS in turn borrowed from Concord Minuteman Capital
Company, LLC, a commercial paper conduit entity, as Senior Lender, and Key
Corporate Capital, Inc., as Junior Lender based on the present value of the
lease rental payments, after being discounted by various factors. The
Securitization Facility includes a firm commitment allowing the Company to
add leases during its initial term of 364 days. The Securitization Facility
is comprised of a senior loan with a maximum principal amount of
$50,000,000 ("Senior Loan") a junior loan with a maximum principal amount
of $5,000,000 ("Junior Loan") and a residual loan with a maximum principal
amount of $10,000,000 ("Residual Loan").
The Senior Loan and the Junior Loan are each a revolving securitization
supported by a security interest in the SPS's ownership of leases and the
related lease rental payments. The SPS is required to enter into interest
rate hedges to provide protection against increasing interest rates
attributable to the outstanding Senior and Junior Loans. The Senior Loan
and the Junior Loan are each repaid out of the collections from the rental
payments attributable to the leases and are recourse only to the extent of
the underlying leases. The Senior and Junior Loans are included with
"Discounted lease rentals" in the accompanying Consolidated Balance Sheets.
The Residual Loan by Key Corporate Capital, Inc. is secured by the residual
value of the equipment acquired by the SPS and is expected to be repaid
from the proceeds related to any remarketing of the equipment. As the SPS
borrows money under the Residual Loan, the SPS lends those funds to the
Company. The loan to the Company is evidenced by a demand promissory note
which can be called only in the event of certain bankruptcy or insolvency
events relating to the Company, or if the remarketing proceeds from the
equipment, together with any other funds that the SPS has available to it
after payment of amounts owed to the Senior and Junior Lenders are
inadequate to pay the amounts then due on the Residual Loan. The Residual
Loan is included with "Recourse debt" in the accompanying Consolidated
Balance Sheets.
6 of 19
CAPITAL ASSOCIATES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
2. Securitization Facility, continued
-----------------------
The Company will service the leases subject to the Securitization Facility
and has been appointed the remarketer of the equipment that secures the
Residual Loan. The Securitization Facility terminates and the right of the
Company to continue as servicer and remarketer terminates, upon the
occurrence of various events, including the Company's failure to maintain
certain financial ratios and defaults under other indebtedness of the
Company.
The Company had approximately $7.9 million outstanding under the Senior and
Junior Loans and approximately $1.7 million under the Residual Loan on
November 30, 1998. Interest on the Senior Loan is equal to the LIBO rate
(5.55% at November 30, 1998) per annum. Interest on the Junior Loan is
equal to the LIBO rate plus 2.8% per annum. Interest on the Residual Loan
is equal to the LIBO rate plus 3.25% per annum.
On December 14, 1998, the Company increased the amounts outstanding under
the Senior and Junior Loans by approximately $5.7 million and by
approximately $.9 million under the Residual Loan.
3. Senior Facility
---------------
The Senior Facility, as amended, was amended December 23, 1998. Under the
terms of the amendment, the term of the Senior Facility was extended from
December 24, 1998 to November 26, 2000 and the maximum amount allowable
under the Warehouse Credit Facility and the Working Capital Facility was
increased to $61,250,000 and $6,900,000, respectively.
4. Stock Options
-------------
In November 1998, a director of the Company exercised stock options for
86,250 shares of common stock with an average exercise price of $1.53 by
paying the par value in cash of $690.00 and issuing a note payable to the
Company equal to approximately $131,000, the remainder of the exercise
price. The outstanding balance at November 30, 1998 was approximately
$131,000 and was included in the equity section of the balance sheet. The
note bears interest at the rate of 4.5% compounded semi-annually and is due
November 3, 2002.
7 of 19
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations
I. Results of Operations
---------------------
GENERAL COMMENTS
Several factors cause operating results to fluctuate, including (i) the
seasonality of lease originations, (ii) variations in the relative
percentages of the Company's leases originated and held which are
classified as DFLs or OLs, and (iii) the level of fee income obtained from
the sale of leases in excess of lease equipment cost. The Company varies
the volume of originated leases held relative to leases sold to private
investors when and as the Company determines that it would be in its best
interests, taking into account profit opportunities, portfolio
concentration, residual risk and its fiduciary duty to originate leases for
its PIFs.
Because the Company finances certain of its lease transactions with
recourse and non-recourse debt, the ultimate profitability of its leasing
transactions is dependent, in part, on the difference between the interest
rate inherent in the lease and the underlying debt rate. The ultimate
profitability of the Company's leasing transactions is dependent, in part,
on the general level of interest rates. Lease rates tend to rise and fall
with interest rates, although lease rate movements generally lag interest
rate movements.
Certain of the Company's competitors have access to lower cost funds.
However, the Company has developed relationships with various private
investors and formed various strategic alliances with investors that have a
lower cost of capital enabling the Company to originate and sell leases at
competitive prices. As a result of the low interest rate environment and
resulting low lease rates, the Company sells the majority of leases it
originates to private investors having a lower cost of capital than the
Company.
The Company believes that in the present market there are significant
opportunities to originate leases having competitive market rates and good
credit quality. However, the Company's present capital structure (i.e.,
both cost of capital and amount available) precludes taking full advantage
of market opportunities for such leases.
The Company continues to evaluate additional sources of capital (including
sources such as a private debt placement or a public debt offering) which
would provide the liquidity necessary to significantly add leases to its
own portfolio. The goal of adding leases to its own portfolio would be to
increase leasing margin. Should the Company be successful in identifying
and closing on new sources of capital (for which no assurance can be
given), it intends to grow its own lease portfolio.
In fiscal year 1998, the Company made significant investments in its sales
force through an extensive training program and personnel expansion. In
addition, the Company invested significant amounts to enhance its expertise
in regards to computer marketing and wholesale forklift marketing. The
Company believes that its return on these investments will be realized in
the future through greater lease originations and increased residual
realizations from computers and forklifts. However, costs associated with
these activities are reflected as "Operating and Other Expenses".
During the six months ended November 30, 1998, the Company has continued to
invest in these areas and has incurred additional costs to enhance its
expertise in the area of semi-conductor test
8 of 19
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations, continued
I. Results of Operations, continued
---------------------
GENERAL COMMENTS, continued
equipment and to expand its used personal computer retail capabilities. The
Company believes that lease originations and residual realizations will, in
the future, benefit from the significant costs being incurred in these
areas. Should the Company be successful in achieving the expected benefits
(for which no assurance can be given), it is anticipated that leasing
margin and/or remarketing profits would be positively impacted in the
future. However, realization of the benefits is dependent, in part, upon
adding leases to its own portfolio, and the benefits of a lease portfolio
are realized over the lease term as leasing margin, or upon lease maturity
as remarketing income. Therefore, because the costs associated with these
investments must be expensed in the period incurred in accordance with
Generally Accepted Accounting Principals, such costs are expected to
continue to exceed the revenue generated from these initiatives for at
least the next few quarters.
INTERIM FINANCIAL RESULTS
Presented below are schedules showing condensed income statement categories
and analyses of changes in those condensed categories for the Company and
its CATG division derived from the Consolidated Statements of Income
prepared solely to facilitate the discussion of results of operations that
follows (in thousands):
Three Months Ended Six Months Ended
November 30, November 30,
------------------- --------------------
CAI Consolidated 1998 1997 Change 1998 1997 Change
---------------- ------- ------- ------- ------- ------- -------
Equipment sales margin $ 1,800 $ 1,975 $ (175) $ 3,414 $ 3,295 $ 119
Leasing margin 2,855 1,283 1,572 6,065 2,896 3,169
Other income 1,065 1,391 (326) 2,388 2,200 188
Operating and other expenses (3,404) (2,603) (801) (7,072) (5,093) (1,979)
Provision for losses (25) (230) 205 (50) (400) 350
Interest expense, net (2,130) (836) (1,294) (4,427) (1,730) (2,697)
Income taxes (15) (245) 230 (29) (292) 263
------- ------- ------- ------- ------- -------
Net income $ 146 $ 735 $ (589) $ 289 $ 876 $ (587)
======= ======= ======= ======= ======= =======
Three Months Ended Six Months Ended
November 30, November 30,
------------------- --------------------
CAI without CATG 1998 1997 Change 1998 1997 Change
---------------- ------- ------- ------- ------- ------- -------
Equipment sales margin $ 1,089 $ 1,800 $ (711) $ 1,928 $ 3,120 $(1,192)
Leasing margin 2,855 1,283 1,572 6,065 2,896 3,169
Other income 1,065 1,391 (326) 2,388 2,200 188
Operating and other expenses (2,726) (2,440) (286) (5,827) (4,930) (897)
Provision for losses (25) (230) (205) (50) (400) 350
Interest expense, net (2,109) (836) (1,273) (4,381) (1,730) (2,651)
Income taxes (15) (245) 230 (29) (292) 263
------- ------- ------- ------- ------- -------
Net income $ 134 $ 723 $ (589) $ 94 $ 864 $ (770)
======= ======= ======= ======= ======= =======
Three Months Ended Six Months Ended
November 30, November 30,
------------------- --------------------
CATG 1998 1997 Change 1998 1997 Change
---- ------- ------- ------- ------- ------- -------
Equipment sales margin $ 711 $ 175 $ 536 $ 1,486 $ 175 $ 1,311
Operating and other expenses (678) (163) (515) (1,245) (163) (1,082)
Interest expense, net (21) - (21) (46) - (46)
------- ------- ------- ------- ------- -------
Net income $ 12 $ 12 $ - $ 195 $ 12 $ 183
======= ======= ======= ======= ======= =======
9 of 19
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations, continued
I. Results of Operations, continued
---------------------
LEASE ORIGINATIONS
For the three and six months ended November 30, 1998 and 1997, the Company
originated leases having an aggregate equipment acquisition cost of $85
million and $137 million and $87 million and $120 million, respectively.
Lease originations for the three months ended November 30, 1997 include a
one time acquisition from a PIF of a portfolio of $15.3 million, which was
sold to a private investor immediately after acquisition. Lease
originations increased to $85 million from $72 million for the three months
ended November 30, 1998 compared to the three months ended November 30,
1997 without the one-time acquisition.
Generally, originated leases are initially financed utilizing the Company's
Warehouse Credit Facility and then sold to private investors or to PIF's.
Income from the sale of leases is reported in the table above as "equipment
sales margin". In addition, the Company realizes rental or finance income
from leases held prior to sale (reported as "leasing margin" in the table
above) and incurs interest expense on the Warehouse Credit Facility during
the period the leases are held.
As a result of increased lease originations, and because the Company is
holding more leases for sale to private investors, the equipment sales
margin arising from equipment under lease sold to private investors,
leasing margin, and interest expense, net have each increased for the three
and six months ended November 30, 1998 compared to the three and six months
ended November 30, 1997.
EQUIPMENT SALES (for CAI without CATG)
Equipment sales revenue and the related equipment sales margin consists of
the following (in thousands):
Three Months Ended
------------------------------------------ Increase
November 30, 1998 November 30, 1997 (Decrease)
------------------- -------------------- -----------------
Revenue Margin Revenue Margin Revenue Margin
-------- ------ -------- -------- ------- ------
Transactions during initial lease term:
Equipment under lease sold to PIFs $ 3,316 $ 86 $ 12,321 $ 264 $ (9,005) $ (178)
Equipment under lease sold to private
investors 32,430 713 51,215 471 (18,785) 242
-------- ------- -------- -------- -------- ------
35,746 799 63,536 735 (27,790) 64
-------- ------- -------- -------- -------- ------
Transactions subsequent to initial
lease term (remarketing revenue):
Sales of off-lease equipment 260 152 1,254 415 (994) (263)
Sales-type leases - - 56 56 (56) (56)
Excess collections (cash collections in
excess of the associated residual value
from equipment under lease sold to
private investors) 138 138 594 594 (456) (456)
-------- ------- -------- -------- -------- ------
398 290 1,904 1,065 (1,506) (775)
Deduct related provision for losses - (25) - (230) - 205
-------- ------- -------- -------- -------- ------
Realization of value in excess of
provision for losses 398 265 1,904 835 (1,506) (570)
Add back related provision for losses - 25 - 230 - (205)
-------- ------- -------- -------- -------- ------
398 290 1,904 1,065 (1,506) (775)
-------- ------- -------- -------- -------- ------
Total equipment sales $ 36,144 $ 1,089 $ 65,440 $ 1,800 $(29,296) $ (711)
======== ======= ======== ======== ======== ======
10 of 19
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations, continued
I. Results of Operations, continued
---------------------
EQUIPMENT SALES (for CAI without CATG), continued
Six Months Ended
------------------------------------------ Increase
November 30, 1998 November 30, 1997 (Decrease)
------------------- -------------------- -----------------
Revenue Margin Revenue Margin Revenue Margin
-------- ------ -------- -------- ------- ------
Transactions during initial lease term:
Equipment under lease sold to PIFs $ 11,344 $ 250 $ 23,703 $ 530 $(12,359) $ (280)
Equipment under lease sold to private
investors 72,178 ,181 74,983 903 (2,805) 278
-------- ------- -------- -------- -------- -------
83,522 1,431 98,686 1,433 (15,164) (2)
-------- ------- -------- -------- -------- -------
Transactions subsequent to initial
lease term (remarketing revenue):
Sales of off-lease equipment 2,148 262 1,382 458 766 (196)
Sales-type leases - - 56 56 (56) (56)
Excess collections (cash collections in
excess of the associated residual value
from equipment under lease sold to
private investors) 235 235 1,173 1,173 (938) (938)
-------- ------- -------- -------- -------- -------
2,383 497 2,611 1,687 (228) (1,190)
Deduct related provision for losses - (50) - (400) - 350
-------- ------- -------- -------- -------- -------
Realization of value in excess of
provision for losses 2,383 447 2,611 1,287 (228) (840)
Add back related provision for losses - 50 - 400 - (350)
-------- ------- -------- -------- -------- -------
2,383 497 2,611 1,687 (228) (1,190)
-------- ------- -------- -------- -------- -------
Total equipment sales $ 85,905 $ 1,928 $101,297 $ 3,120 $(15,392) $(1,192)
======== ======= ======== ======== ======== =======
Equipment Sales to PIF's
------------------------
In February 1998, the Company sold the remaining publicly offered units in
Capital Preferred Yield Fund-IV, L.P. The Company has elected not to
organize additional PIFs. As such, equipment sales to the PIFs have
declined and will continue to decline. Currently, only two PIFs are in
their reinvestment stage and are actively acquiring leases. Consequently,
equipment sales margin arising from equipment under lease sold to PIF's has
declined. In addition, fees and distributions from the PIF's (reported as
"Other Income") has also declined.
Equipment Sales to Private Investors
------------------------------------
Equipment sales to private investors decreased for the three months ended
November 30, 1998 compared to the three months ended November 30, 1997 by
$18.8 million. The decline reflects the sale in the three months ended
November 30, 1998 of a portfolio totaling $15.3 million which was acquired
from a PIF. No similar acquisition and sale occurred during the three
months ended November 30, 1998. Residual values and other receivables
arising from equipment under lease sold to private investors, net increased
primarily due to approximately $4.0 million of receivables arising from
equipment under lease sold to private investors. These amounts have been
collected.
During the three and six months ended November 30, 1998, other equipment
sales revenue related to equipment leased to two lessees accounted for 35%
and 32%, respectively, of total other equipment sales revenue. During the
six months ended November 30, 1997, other equipment sales revenue related
to one lessee accounted for 27% and 28%, respectively of total other
equipment sales revenue.
11 of 19
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations, continued
I. Results of Operations, continued
---------------------
Remarketing of the Portfolio and Related Provision for Losses
-------------------------------------------------------------
The Company has successfully realized gains on the remarketing of its
portfolio of equipment after the initial lease term for the past six years.
The remarketing of equipment for an amount greater than its book value is
reported as part of equipment sales margin (if the equipment is sold) or
leasing margin (if the equipment is re-leased). The realization of less
than the carrying value of equipment is recorded as provision for losses
(which is typically not known until remarketing after the expiration of the
initial lease term). As shown in the table above, the realizations from
sales exceeded the provision for losses during the three and six months
ended November 30, 1998 even without considering realizations from
remarketing activities recorded as leasing margin.
Remarketing revenue and the related margin sales (i.e., sales occurring
after the initial lease term) are affected by the number and dollar amount
of equipment leases that mature in a particular quarter. Because the
Company sold substantially all new lease originations to its PIFs or
private investors and retained very few lease originations for its own
account during the fiscal years preceding fiscal year 1995, and in
accordance with GAAP, the Company does not consolidate the results of its
PIFs, generally, each quarter, fewer leases mature and less equipment is
available for remarketing. In general, remarketing revenue and margin are
expected to remain at levels which are lower than fiscal 1997 and prior
years. The Company's ability to remarket additional amounts of equipment
and realize a greater amount of remarketing revenue in future periods is
dependent on adding additional leases to its portfolio. However, adding
leases to the Company's portfolio will not immediately increase the pool of
maturing leases because new leases typically are not remarketed until after
their initial term (which averages approximately four years).
Because the amount of leases added to the Company's portfolio in the past
which is now maturing has not been significant, the amount of leased
equipment available for remarketing is not consistent between quarters and
therefore the amount of remarketing revenue varies significantly between
quarters. It is expected that the quarterly variations will continue until
the Company's held portfolio is increased to a significant level.
Residual values are established equal to the estimated values to be
received from equipment following termination of the leases. In estimating
such values, the Company considers all relevant facts regarding the
equipment and the lessees, including, for example, the equipment's
remarketability, upgrade potential and the probability that the equipment
will remain in place at the end of an initial lease term. The nature of the
Company's leasing activities is that it has credit and residual value
exposure and, accordingly, in the ordinary course of business, it will
incur losses arising from these exposures. The Company performs quarterly
assessments of its assets to identify other than temporary losses in value.
The Company's policy is to record allowances for losses as soon as any
other-than-temporary declines in asset values are known. However,
chargeoffs are recorded upon the termination or remarketing of the
underlying assets. As such, chargeoffs will primarily occur subsequent to
the recording of the allowances for losses. The provision for losses
recorded during the three and six months ended November 30, 1998 reflects
the Company's best estimate of the amount necessary to maintain the
allowance for losses at a level which adequately provides for
other-than-temporary declines in the value of equipment.
12 of 19
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations, continued
I. Results of Operations, continued
---------------------
LEASING MARGIN
Leasing margin consists of the following (in thousands):
Three Months Ended Six Months Ended
November 30, November 30,
-------------------- --------------------
1998 1997 1998 1997
-------- -------- --------- ---------
Leasing revenue $ 8,534 $ 4,132 $ 17,649 $ 8,549
Leasing costs and expenses (5,679) (2,849) (11,584) (5,653)
-------- -------- -------- --------
Leasing margin $ 2,855 $ 1,283 $ 6,065 $ 2,896
======== ======== ======== ========
Leasing margin ratio 33% 31% 34% 34%
======== ======== ======== ========
The increase in leasing revenue and leasing costs during the three and six
months ended November 30, 1998 compared to the three and six months ended
November 30, 1997 is primarily due to growth in the Company's lease
portfolio, a significant portion of which will subsequently be sold. During
the three and six months ended November 30, 1998, no lessee accounted for
more than 10% of total leasing revenue. During the three and six months
ended November 30, 1997, payments from one lessee accounted for 11% and 11%
of total leasing revenue.
Leasing margin ratio may fluctuate based upon (i) the mix of direct finance
leases and operating leases, (ii) remarketing activities, (iii) the method
used to finance leases added to the Company's lease portfolio, and (iv) the
relative age and types of leases in the portfolio (operating leases have a
lower leasing margin early in the lease term, increasing as the term passes
and the majority of leases added to CAI's portfolio have been operating
leases).
OTHER INCOME
Other Income consists of the following (in thousands):
Three Months Ended Six Months Ended
November 30, November 30,
------------------ ----------------
1998 1997 1998 1997
------ ------- ------ ------
Fees and distributions from the PIFs $ 683 $ 1,298 $ 1,224 $ 1,978
Management fees from private programs 294 77 612 113
Other 88 16 552 109
------- ------- ------- -------
$ 1,065 $ 1,391 $ 2,388 $ 2,200
======= ======= ======= =======
OPERATING AND OTHER EXPENSES (for CAI without CATG)
The aggregate amount of operating and other expenses increased
approximately $286,000 and $897,000 for the three and six months ended
November 30, 1998, compared to the three and six months ended November 30,
1997, respectively. The increase is primarily due to the on-going
investment in the Company's marketing and administrative infrastructure
including costs associated with the increase in marketing personnel and
costs associated with the conversion of the Company's leasing software.
13 of 19
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations, continued
I. Results of Operations, continued
---------------------
INTEREST EXPENSE, NET (for CAI without CATG)
Interest expense, net consists of the following:
Three Months Ended Six Months Ended
November 30, November 30,
------------------ ----------------
1998 1997 1998 1997
------ -------- ------ ------
Interest income $ (746) $ (937) $ (1,624) $ (1,892)
Non-recourse interest expense 2,053 1,318 4,200 2,667
------- ------- -------- --------
Net non-recourse interest expense 1,307 381 2,576 775
Recourse interest expense 802 455 1,805 955
------- ------- -------- --------
Interest expense, net $ 2,109 $ 836 $ 4,401 $ 1,730
======= ======= ======== ========
The Company finances leases for its own portfolio primarily with
non-recourse debt. Interest income arises when equipment financed with
non-recourse debt is sold to investors. As a result, interest income
reported in the accompanying Consolidated Statements of Income reflect an
amount equal to non-recourse interest expense. Therefore, net non-recourse
interest expense on related discounted lease rentals pertains to the
Company's owned lease portfolio. Such amount increased due to an increase
in the average outstanding balance of related discounted lease rentals
related to growth in the Company's owned portfolio. It is anticipated that
net non-recourse interest expense on related discounted lease rentals will
continue to increase in the future as the Company adds additional leases
financed with non-recourse debt to its portfolio through its securitization
facility.
Recourse interest expense increased during the three months ended November
30, 1998 compared to the three months ended November 30, 1997 primarily due
to increased borrowings under the Company's Warehouse Facility used to fund
the growth in the number of leases the Company holds for sale to private
investors.
INCOME TAXES
Income tax expense is provided on income at the appropriate federal and
state statutory rates applicable to such earnings. The aggregate statutory
tax rate is 40%, adjusted for a reduction in the valuation allowance for
deferred income tax assets to reflect a reduction in uncertainty about the
utilization of the AMT credit carryforward in future years as a result of
the Company's recurring profitable results of operations (see Note 10 to
Notes to Consolidated Financial Statements in the 1998 Form 10-K). The
Company believes that it is more likely than not that the results of future
operations will generate sufficient taxable income to realize the remaining
net deferred tax assets.
CATG
The Company acquired its CATG division in November of 1997. The increase in
its equipment sales margin and operating and other expenses is due
primarily to having three and six months of activity for the three and six
months ended November 30, 1998 compared to one and four months of activity
for the three and six month periods ended November 30, 1997.
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Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations, continued
II. Liquidity and Capital Resources
-------------------------------
The Company's activities are principally funded by proceeds from sales of
on-lease equipment (to PIFs or Private Investors), non-recourse debt,
recourse bank debt rents, fees and distributions from PIFs, sales or
re-leases of equipment after the expiration of the initial lease terms and
the Securitization Facility. In addition, the Company finances receivables
of its CATG subsidiary primarily under an agreement with a specialized
finance company. Management believes the Company's ability to generate cash
from operations is sufficient to fund operations, as shown in the
accompanying Consolidated Statements of Cash Flows.
The Senior Facility, as amended, was amended December 23, 1998. Under the
terms of the amendment, the term of the Senior Facility was extended from
December 24, 1998 to November 26, 2000 and the maximum amount allowable
under the Warehouse Credit Facility and the Working Capital Facility was
increased to $61,250,000 and $6,900,000, respectively.
The Company finances leases for its own portfolio utilizing the
Securitization Facility described in Note 2 to Notes to Consolidated
Financial Statements. The Company's ability to finance leases under the
Securitization Facility will depend upon a number of factors, including
general conditions in the credit markets and the ability of the Company to
originate equipment leases which satisfy eligibility requirements set forth
in the Securitization Facility documents. There can be no assurance that
the Company will continue to originate eligible equipment leases.
On December 14, 1998, the Company increased the amounts outstanding under
the Senior and Junior Loans by approximately $5.7 million and by
approximately $.9 million under the Residual Loan.
III. Year 2000 Issue
---------------
The Company has conducted a comprehensive review of its computer systems to
identify systems that could be affected by the Year 2000 issue. The Year
2000 issue results from computer programs being written using two digits
rather than four to define the applicable year. Certain computer programs
which have time-sensitive software could recognize a date using "00" as the
year 1900 rather than the year 2000. This could result in major system
failures or miscalculations. Certain of the Company's software has already
been updated to correctly account for the Year 2000 issue. In addition, the
Company is engaged in a system conversion, whereby the Company's primary
lease tracking and accounting software is being replaced with new systems
which will account for the Year 2000 correctly. The Company expects that
the new system will be fully operational by December 31, 1999, and
therefore will be fully Year 2000 compliant. The Company does not expect
any other changes required for the Year 2000 to have a material effect on
its financial position or results of operations. As such, the Company has
not developed any specific contingency plans in the event it fails to
complete the conversion to a new system by December 31, 1999. In addition,
the Company does not expect any Year 2000 issues relating to its customers
and vendors to have a material effect on its financial position or results
of operations. The Company expensed all amounts related to its review of
the Year 2000 issue. Amounts expended to date to address the Year 2000
issue have been immaterial.
15 of 19
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations, continued
IV. New Accounting Pronouncements
-----------------------------
In June 1998, the Financial Accounting Standards Board issued SFAS No. 133,
Accounting for Derivative Instruments and Hedging Activities ("Statement
133"). Statement 133 establishes accounting and reporting standards for
derivative instruments and for hedging activities. It requires that an
entity recognize all derivatives as either assets or liabilities in the
statement of financial position and measure those instruments at fair
value. Statement 133 is effective for fiscal years beginning after June 15,
1999, with earlier application permitted. The Company plans to adopt
Statement 133 in the first fiscal quarter of fiscal year 2001 by
redesignating and documenting all hedging relationships pursuant to the
provision of Statement 133.
The Company's hedging activities are limited to the floating-to-fixed
interest rate swap acquired in connection with the Securitization Facility.
That hedge is designed to effectively hedge the exposure to interest rate
changes. As such, the impact of adoption of SFAS 133 is not expected to be
material.
V. "Safe Harbor" Statement Under the Private Securities Litigation Reform Act
---------------------------------------------------------------------------
of 1995
-------
The statements contained in this report which are not historical facts may
be deemed to contain forward-looking statements with respect to events, the
occurrence of which involve risks and uncertainties, and are subject to
factors that could cause actual future results to differ both adversely and
materially from currently anticipated results, including, without
limitation, the level of lease originations, realization of residual
values, the availability and cost of financing sources and the ultimate
outcome of any contract disputes. Certain specific risks associated with
particular aspects of the Company's business are discussed in detail
throughout Item 2 of this report and Parts I and II of the 1997 Form 10-K
when and where applicable.
16 of 19
CAPITAL ASSOCIATES, INC. AND SUBSIDIARIES
PART II
OTHER INFORMATION
Item 1. Legal Proceedings
-----------------
(a) Other. The Company is involved in other routine legal proceedings
incidental to the conduct of its business. Management believes
that none of these legal proceedings will have a material adverse
effect on the financial condition or operations of the Company.
Item 6. Exhibits and Reports on Form 8-K
--------------------------------
a. Exhibits
--------
b. Reports on Form 8-K
-------------------
None
17 of 19
Item No. Exhibit Index
- -------- -------------
10.70 Third Amendment to Loan and Security Agreement dated as of November 25,
1998 by and between Capital Associates, Inc. and Capital Associates
International, Inc. as borrowers and First Union National Bank, as Agent
and Issuing Bank and the four participating financial institutions.
10.71 Promissory Note, dated as of November 4, 1998, in the original amount of
$131,069.25 made by James D. Edwards, Director of Capital Associates,
Inc. and Capital Associates International, Inc. and payable to the order
of Capital Associates, Inc. in payment of a portion of the exercise price
for the purchase of CAI common stock, par value $.008 per share, upon the
exercise by Mr. Edwards of a portion of his stock options.
10.72 Security Agreement and Stock Pledge Agreement, dated as of November 4,
1998, pledging 86,250 shares of CAI common stock, par value $.008 per
share, executed by James D. Walker, Director of Capital Associates, Inc.
and Capital Associates International, Inc. and delivered to Capital
Associates, Inc. to secure payment and performance of Mr. Edwards
promissory note to Capital Associates International, Inc, in the original
principal amount of $131,069.25.
27 Financial Data Schedule
18 of 19
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 14, 1999 By: /s/Anthony M. DiPaolo
------------------------------------------
Anthony M. DiPaolo,
Senior Vice-President and
Chief Financial Officer
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