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 FEBRUARY 28, 1999
[_] 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 April 14, 1999, was 5,235,782.
Exhibit Index - Page 18
1 of 21
CAPITAL ASSOCIATES, INC. AND SUBSIDIARIES
INDEX
-----
PAGE
PART I. FINANCIAL INFORMATION NUMBER
Item 1. Financial Statements
Consolidated Balance Sheets - February 28, 1999 (Unaudited)
and May 31, 1998 3
Consolidated Statements of Income - Three and Nine Months
Ended February 28, 1999 and 1998 (Unaudited) 4
Consolidated Statements of Cash Flows - Nine Months Ended
February 28, 1999 and 1998 (Unaudited) 5
Notes to Consolidated Financial Statements 6 - 8
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations 9 - 18
PART II. OTHER INFORMATION
Item 1. Legal Proceedings 19
Item 6. Exhibits and Reports on Form 8-K 19
Exhibit Index 20
Signature 21
2 of 21
CAPITAL ASSOCIATES, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(Dollars in thousands)
ASSETS
(Unaudited)
February 28, May 31,
1999 1998
------------- ---------
Cash and cash equivalents $ 3,995 $ 17,684
Receivables from affiliated limited partnerships 649 352
Accounts receivable, net 4,904 5,835
Inventory 2,214 1,141
Residual values and other receivables arising from
equipment under lease sold to private investors, net 7,955 4,277
Net investment in direct finance leases 42,862 31,181
Leased equipment, net 127,133 104,825
Investments in affiliated limited partnerships 2,383 3,589
Deferred income taxes 3,778 3,600
Other assets 5,444 4,883
Discounted lease rentals assigned to lenders
arising from equipment sale transactions 21,443 37,626
--------- ---------
$ 222,760 $ 214,993
========= =========
LIABILITIES AND STOCKHOLDERS' EQUITY
Recourse debt $ 52,237 $ 49,088
Accounts payable - equipment purchases 22,416 25,029
Accounts payable and other liabilities 13,537 11,379
Discounted lease rentals 108,695 104,311
--------- ---------
196,885 189,807
--------- ---------
Stockholders' equity:
Common stock 34 32
Additional paid-in capital 16,886 16,863
Retained earnings 9,038 8,374
Treasury stock (83) (83)
--------- ---------
Total stockholders' equity 25,875 25,186
--------- ---------
$ 222,760 $ 214,993
========= =========
The accompanying notes are an integral part
of these consolidated financial statements.
3 of 21
CAPITAL ASSOCIATES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
(Unaudited)
(Dollars in thousands, except earnings per share)
Three Months Ended Nine Months Ended
February 28, February 28,
------------------------ -------------------------
1999 1998 1999 1998
---------- ---------- ---------- ----------
Revenue:
Equipment sales to PIFs $ 5,669 $ 14,857 $ 17,013 $ 38,560
Other equipment sales 40,162 59,133 127,674 138,066
Leasing 11,008 6,804 28,657 15,353
Interest 391 445 2,015 2,337
Other 1,415 1,070 3,803 3,270
---------- ---------- ---------- ----------
Total revenue 58,645 82,309 179,162 197,586
---------- ---------- ---------- ----------
Costs and expenses:
Equipment sales to PIFs 5,521 14,542 16,616 37,715
Other equipment sales 38,520 57,061 122,867 117,891
Equipment acquired from affiliated
limited partnership - - - 15,338
Leasing 7,520 4,782 19,104 10,435
Operating and other expenses 3,733 3,289 10,805 8,382
Provision for losses 85 100 135 500
Interest:
Non-recourse debt 1,814 1,148 6,014 3,815
Recourse debt 889 700 2,740 1,655
---------- ---------- ---------- ----------
Total costs and expenses 58,082 81,622 178,281 195,731
---------- ---------- ---------- ----------
Net income before income taxes 563 687 881 1,855
Income tax expense 188 172 217 464
---------- ---------- ---------- ----------
Net income $ 375 $ 515 $ 664 $ 1,391
========== ========== ========== ==========
Earnings per common share:
Basic $ 0.07 $ 0.10 $ 0.13 $ 0.27
========== ========== ========== ==========
Diluted $ 0.07 $ 0.10 $ 0.12 $ 0.26
========== ========== ========== ==========
Weighted average number of common
shares outstanding:
Basic 5,211,000 5,077,000 5,151,000 5,071,000
========== ========== ========== ==========
Diluted 5,462,000 5,371,000 5,402,000 5,398,000
========== ========== ========== ==========
The accompanying notes are an integral part
of these consolidated financial statements.
4 of 21
CAPITAL ASSOCIATES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
(Dollars in thousands)
Nine Months Ended
February 28,
-----------------------
1999 1998
-------- --------
Net cash provided by operating activities $ 59,613 $ 30,889
-------- --------
Cash flows from investing activities:
Equipment purchased for leasing, net (81,626) (61,489)
Investment in leased office facility and capital expenditures (440) (454)
Net receipts from affiliated public income funds 1,206 3,177
-------- --------
Net cash used for investing activities (80,860) (58,766)
-------- --------
Cash flows from financing activities:
Proceeds from securitization 17,068 -
Principal payments on securitization (1,815) -
Proceeds from discounting of lease rentals 25,958 13,613
Principal payments on discounted lease rentals (36,238) (9,458)
Proceeds from issuance of common stock 25 -
Net borrowings on revolving credit facilities 2,575 19,840
Net (payments) borrowings on Term Loan (15) 458
-------- --------
Net cash provided by financing activities 7,558 24,453
-------- --------
Net decrease in cash and cash equivalents (13,689) (3,424)
Cash and cash equivalents at beginning of period 17,684 6,194
-------- --------
Cash and cash equivalents at end of period $ 3,995 $ 2,770
======== ========
Supplemental schedule of cash flow information:
Recourse interest paid $ 2,740 $ 1,655
Interest cost capitalized 160 -
Non-recourse interest paid 6,014 3,815
Income taxes paid 57 859
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 7,742 942
The accompanying notes are an integral part
of these consolidated financial statements.
5 of 21
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 consolidated 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 21
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 $15 million outstanding under the Senior and
Junior Loans and approximately $3 million under the Residual Loan on
February 28, 1999. Interest on the Senior Loan is equal to the LIBO rate
(4.963% at February 28, 1999) 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 March 12, 1999, the Company increased the amounts outstanding under the
Senior and Junior Loans by approximately $6.6 million and under the
Residual Loan by approximately $1 million.
3. Non-recourse Bank Debt
----------------------
On December 20, 1998, Capital Associates International Inc. ("CAII")
obtained $15 million in committed non-recourse financing from NationsBanc
Leasing Corporation. CAII may use the committed credit at its discretion to
finance leases under a warehousing arrangement. The loan is secured by
lease transactions financed under the facility only. The loan was primarily
underwritten utilizing the underlying credit quality of the leases pledged
as collateral under the facility.
The interest rate option associated with the facility is Prime rate minus
0.25% or LIBOR plus 2.5% (7.50% & 7.46% at February 28, 1999,
respectively). The Company is required to pay a non-usage fee of 0.2% of
the unused commitment quarterly. The outstanding balance under the facility
at February 28,1999 was $2 million. The loan is included with "Discounted
lease rentals" in the accompanying consolidated Balance Sheets.
The facility contains general operating and reporting requirements,
however, no formal financial covenants are required of CAII. As of February
28, 1999, CAII was in compliance with the terms of the facility.
4. Recourse Bank Debt
------------------
On December 23, 1998 the Company renewed its senior, secured debt facility
(the "Senior Facility"). Under the terms of the renewal, the term of the
Senior Facility expires November 26, 2000 and the maximum amounts allowable
under the Warehouse Credit Facility and the Working Capital Facility were
increased to $61,250,000 and $6,900,000, respectively. The remaining terms
of the Senior Facility are substantially unchanged.
7 of 21
CAPITAL ASSOCIATES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
5. Sale of Installment Note
------------------------
In February 1999, the Company sold an installment note for $669,000 to the
parent company of the debtor. The note had a carrying value of $246,000 and
the Company recorded a gain of $423,000. The installment note was received
by the Company during the fiscal year ended May 31, 1995, in settlement of
certain litigation related to a lessee default.
6. Income Taxes
------------
Income taxes are provided on income from continuing operations at the
appropriate federal and state statutory rates applicable to such earnings.
Income tax expense differs from the amounts computed by applying the U.S.
Federal Income tax rate of 34% to pre-tax income from continuing operations
as a result of the following:
Three Months Ended Nine Months Ended
February 28, February 28,
------------------ ------------------
1999 1998 1999 1998
---- ---- ---- ----
Computed "expected" tax expense $ 191 $ 234 $ 300 $ 631
State tax provisions, net of federal benefits 75 41 95 111
Reduction in valuation allowance for
deferred income tax assets (78) (103) (178) (278)
----- ----- ----- -----
Income tax expense $ 188 $ 172 $ 217 $ 464
===== ===== ===== =====
The reduction in the valuation allowance for deferred income tax assets
reflects 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 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.
8 of 21
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
level of fee income obtained from the sale of leases in excess of lease
equipment cost, (ii) the seasonality of lease originations, (iii) the
volume of leases maturing in a particular period and the resulting gain on
remarketing, and (iv) variations in the relative percentages of the
Company's leases originated and held which are classified as DFLs or OLs.
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. The costs associated with these
activities are included in "Operating and Other Expenses".
9 of 21
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations, continued
I. Results of Operations, continued
---------------------
General Comments, continued
During the nine months ended February 28, 1999, 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 equipment and to expand its
used personal computer remarketing 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 these benefits is dependent, in part, upon adding leases to
its own portfolio. The benefits of a lease portfolio are realized over the
lease term as leasing margin, and at 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 several
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 Capital Associates Technology Group ("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 Nine Months Ended
February 28, February 28,
------------------- --------------------
CAI Consolidated 1999 1998 Change 1999 1998 Change
---------------- -------- -------- -------- -------- -------- --------
Equipment sales margin $ 1,790 $ 2,387 $ (597) $ 5,204 $ 5,682 $ (478)
Leasing margin 3,488 2,022 1,466 9,553 4,918 4,635
Other income 1,415 1,070 345 3,803 3,270 533
Operating and other expenses (3,733) (3,289) (444) (10,805) (8,382) (2,423)
Provision for losses (85) (100) 15 (135) (500) 365
Interest expense, net (2,312) (1,403) (909) (6,739) (3,133) (3,606)
Income taxes (188) (172) (16) (217) (464) 247
-------- -------- -------- -------- -------- --------
Net income $ 375 $ 515 $ (140) $ 664 $ 1,391 $ (727)
======== ======== ======== ======== ======== ========
Three Months Ended Nine Months Ended
February 28, February 28,
------------------- --------------------
CAI without CATG 1999 1998 Change 1999 1998 Change
---------------- -------- -------- -------- -------- -------- --------
Equipment sales margin $ 1,036 $ 1,774 $ (738) $ 2,964 $ 4,894 $ (1,930)
Leasing margin 3,488 2,022 1,466 9,553 4,918 4,635
Other income 1,415 1,070 345 3,803 3,270 533
Operating and other expenses (2,989) (2,701) (288) (8,816) (7,632) (1,184)
Provision for losses (83) (94) 11 (133) (493) 360
Interest expense, net (2,279) (1,396) (883) (6,660) (3,126) (3,534)
Income taxes (188) (172) (16) (217) (464) 247
------- -------- -------- -------- -------- --------
Net income $ 400 $ 503 $ (103) $ 494 $ 1,367 $ (873)
======= ======== ======== ======== ======== ========
10 of 21
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations, continued
I. Results of Operations, continued
---------------------
Interim Financial Results, continued
Three Months Ended Nine Months Ended
February 28, February 28,
------------------- --------------------
CATG 1999 1998 Change 1999 1998 Change
---- -------- -------- -------- -------- -------- --------
Equipment sales margin $ 754 $ 613 $ 141 $ 2,240 $ 788 $ 1,452
Operating and other expenses (744) (588) (156) (1,989) (750) (1,239)
Provision for losses (2) (6) 4 (2) (7) 5
Interest expense, net (33) (7) (26) (79) (7) (72)
------- ------- -------- -------- -------- --------
Net income (loss) $ (25) $ 12 $ (37) $ 170 $ 24 $ 146
======= ======= ======== ======== ======== ========
Lease Originations
For the three and nine months ended February 28, 1999 and 1998, the Company
originated leases having an aggregate equipment acquisition cost of $57
million and $194 million and $123 million and $243 million, respectively.
Lease originations for the three and nine months ended February 28, 1998
include a one time acquisition of a portfolio of $69.8 million.
Generally, originated leases are initially financed utilizing the Company's
Warehouse Credit Facility and then sold to private investors or to PIF's.
Profits from the sale of leases are reported in the table above as
"equipment sales margin". In addition, the Company realizes rental or
finance profits 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.
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
February 28, 1999 February 28, 1998 (Decrease)
----------------- ----------------- ------------------
Revenue Margin Revenue Margin Revenue Margin
------- ------ ------- ------ ------- ------
Transactions during initial lease term:
Equipment under lease sold to PIFs $ 5,669 $ 147 $ 14,857 $ 315 $ (9,188) $ (168)
Equipment under lease sold to private
investors 32,665 440 50,139 557 (17,474) (117)
-------- ------- -------- ------- --------- ------
38,334 587 64,996 872 (26,662) (285)
-------- ------- -------- ------- --------- ------
Transactions subsequent to initial lease
term (remarketing revenue):
Sales of off-lease equipment 290 60 2,442 473 (2,152) (413)
Sales-type leases 106 106 262 98 (156) 8
Excess collections (cash collections in
excess of the associated residual
value from equipment under lease
sold to private investors) 283 283 331 331 (48) (48)
-------- ------- -------- ------- --------- ------
679 449 3,035 902 (2,356) (453)
Deduct related provision for losses - (83) - (94) - 11
-------- ------- -------- ------- --------- ------
Realization of value in excess of
provision for losses 679 366 3,035 808 (2,356) (442)
Add back related provision for losses - 83 - 94 - (11)
-------- ------- -------- ------- --------- ------
679 449 3,035 902 (2,356) (453)
-------- ------- -------- ------- --------- ------
Total equipment sales $ 39,013 $ 1,036 $ 68,031 $ 1,774 $ (29,018) $ (738)
======== ======= ======== ======= ========= ======
11 of 21
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
Three Months Ended
-------------------------------------- Increase
February 28, 1999 February 28, 1998 (Decrease)
----------------- ----------------- --------------------
Revenue Margin Revenue Margin Revenue Margin
------- ------ --------- ------ ------- ------
Transactions during initial lease term:
Equipment under lease sold to PIFs $ 17,013 $ 397 $ 38,560 $ 845 $ (21,547) $ (448)
Equipment under lease sold to private
investors 104,552 1,618 125,122 1,460 (20,570) 158
--------- ------- --------- ------- --------- --------
121,565 2,015 163,682 2,305 (42,117) (290)
--------- ------- --------- ------- --------- --------
Transactions subsequent to initial lease
term (remarketing revenue):
Sales of off-lease equipment 2,440 324 3,824 931 (1,384) (607)
Sales-type leases 106 106 318 154 (212) (48)
Excess collections (cash collections in
excess of the associated residual
value from equipment under lease
sold to private investors) 519 519 1,504 1,504 (985) (985)
--------- ------- --------- ------- --------- --------
3,065 949 5,646 2,589 (2,581) (1,640)
Deduct related provision for losses - (133) - (493) - 360
--------- ------- --------- ------- --------- --------
Realization of value in excess of
provision for losses 3,065 816 5,646 2,096 (2,581) (1,280)
Add back related provision for losses - 133 - 493 - (360)
--------- ------- --------- ------- --------- --------
3,065 949 5,646 2,589 (2,581) (1,640)
--------- ------- --------- ------- --------- --------
Total equipment sales $ 124,630 $ 2,964 $ 169,328 $ 4,894 $ (44,698) $ (1,930)
========= ======= ========= ======= ========= ========
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
February 28, 1999 compared to the three months ended February 28, 1998 by
$24.3 million. Equipment sales to private investors for the three months
ended February 28, 1998 included $13.6 million of sales that were derived
from a one-time portfolio acquisition of $69.8 million. Residual values and
other receivables arising from equipment under lease sold to private
investors, net increased primarily due to approximately $3.2 million of
receivables arising from equipment under lease sold to private investors.
The majority of these amounts have been collected.
During the three and nine months ended February 28, 1999, other equipment
sales revenue related to equipment leased to three lessees accounted for
71% and 40%, respectively, of total other equipment sales revenue. During
the three and nine months ended February 28, 1998, other equipment sales
revenue related to one lessee accounted for 31% and 32%, respectively of
total other equipment sales revenue.
12 of 21
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 nine months
ended February 28, 1999 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 1998 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 nine months ended February 28, 1999 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.
13 of 21
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 Nine Months Ended
February 28, February 28,
-------------------- ---------------------
1999 1998 1999 1998
-------- ------- -------- --------
Leasing revenue $ 11,008 $ 6,804 $ 28,657 $ 15,353
Leasing costs and expenses (7,520) (4,782) (19,104) (10,435)
-------- -------- -------- --------
Leasing margin $ 3,488 $ 2,022 $ 9,553 $ 4,918
======== ======== ======== ========
Leasing margin ratio 32% 30% 33% 32%
======== ======== ======== ========
The increase in leasing revenue and leasing costs during the three and nine
months ended February 28, 1999 compared to the three and nine months ended
February 28, 1998 is primarily due to growth in the Company's lease
portfolio, a significant portion of which will subsequently be sold. During
the three and nine months ended February 28, 1999 and February 28, 1998 no
lessee accounted for more than 10% 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 Nine Months Ended
February 28, February 28,
------------------ -----------------
1999 1998 1999 1998
------- ------- ------- ------
Fees and distributions from the PIFs $ 284 $ 791 $ 1,128 $ 2,769
Management fees from private programs 367 181 978 294
Sale of installment note 423 - 423 -
Other 341 98 1,274 207
------- ------- ------- -------
$ 1,415 $ 1,070 $ 3,803 $ 3,270
======= ======= ======= =======
In February 1999, the Company sold an installment note for $669,000 to the
parent company of the debtor. The note had a carrying value of $246,000 and
the Company recorded a gain of $423,000. The installment note was received
by the Company during the fiscal year ended May 31, 1995, in settlement of
certain litigation related to a lessee default.
14 of 21
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations, continued
I. Results of Operations, continued
---------------------
OPERATING AND OTHER EXPENSES (for CAI without CATG)
The aggregate amount of operating and other expenses increased
approximately $288,000 and $1,184,000 for the three and nine months ended
February 28, 1999, compared to the three and nine months ended February 28,
1998, 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 and support
personnel and costs associated with the conversion of the Company's leasing
software.
Interest Expense, Net (for CAI without CATG)
Interest expense, net consists of the following:
Three Months Ended Nine Months Ended
February 28, February 28,
------------------ -------------------
1999 1998 1999 1998
------- ------- ------- --------
Interest income $ (391) $ (445) $ (2,015) $ (2,337)
Non-recourse interest expense 1,814 1,148 6,014 3,815
------- ------- -------- --------
Net non-recourse interest expense 1,423 703 3,999 1,478
Recourse interest expense 856 693 2,661 1,648
------- ------- -------- --------
Interest expense, net $ 2,279 $ 1,396 $ 6,660 $ 3,126
======= ======= ======== ========
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 and nine months ended
February 28, 1999 compared to the three months ended February 28, 1998
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 taxes are provided on income from continuing operations at the
appropriate federal and state statutory rates applicable to such earnings.
Income tax expense differs from the amounts computed by applying the U.S.
Federal Income tax rate of 34% to pre-tax income from continuing operations
as a result of the following:
15 of 21
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations, continued
I. Results of Operations, continued
---------------------
INCOME TAXES, continued
Three Months Ended Nine Months Ended
February 28, February 28,
------------------ -----------------
1999 1998 1999 1998
----- ----- ---- -----
Computed "expected" tax expense $ 191 $ 234 $ 300 $ 631
State tax provisions, net of federal benefits 75 41 95 111
Reduction in valuation allowance for
deferred income tax assets (78) (103) (178) (278)
----- ----- ----- -----
Income tax expense $ 188 $ 172 $ 217 $ 464
===== ===== ===== =====
The reduction in the valuation allowance for deferred income tax assets
reflects 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 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 nine months of activity for the nine months ended
February 28, 1999 compared to four months of activity for the nine month
periods ended February 28, 1998.
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 from equipment leases, 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 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 Securitization Facility by approximately $6.6 million.
16 of 21
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations, continued
II. Liquidity and Capital Resources, continued
-------------------------------
During the three months ended February 28, 1999, the Company expanded its
commitments for work capital and lease warehouse financing:
* On December 23, 1998 the Company renewed its senior, secured debt
facility (the "Senior Facility"). Under the terms of the renewal, the
term of the Senior Facility expires November 26, 2000 and the maximum
amounts allowable under the Warehouse Credit Facility and the Working
Capital Facility were increased to $61,250,000 and $6,900,000,
respectively. The remaining terms of the Senior Facility are
substantially unchanged.
* On December 20, 1998, the Company obtained $15 million in committed
non-recourse financing from NationsBanc Leasing Corporation. The loan
is secured by lease transactions and CAII may use the committed credit
in its discretion to finance additional leases under a warehousing
arrangement. The loan was underwritten primarily on the underlying
credit quality of the leases pledged as collateral under the facility.
The interest rate option associated with the facility is prime rate
minus 0.25% or LIBOR plus 2.5% (7.50% & 7.46% at February 28, 1999,
respectively). The Company is required to pay a non-usage fee of 0.2%
of the unused commitment quarterly. The outstanding balance under the
facility at February 28,1999 was $2 million.
The facility contains general operating and reporting requirements,
however, no formal financial covenants are required of CAII. As of
February 28, 1999, CAII was in compliance with the terms of the
facility.
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.
17 of 21
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 1998 Form 10-K
when and where applicable.
Item 3. Quantitative and Qualitative Disclosures About Market Risk
Not applicable
18 of 21
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
19 of 21
Item No. Exhibit Index
- -------- -------------
10.73 Fourth Amendment to Loan and Security Agreement dated as of December 22,
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.
10.74 Warehousing Loan and Security Agreement dated as of December 20, 1998 by
and between Capital Associates International, Inc. as borrowers and
NationsBanc Leasing Corporation as Lender with respect to a $15 million
Lease-Collateralized Loan Facility.
27 Financial Data Schedule
20 of 21
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: April 19, 1999 By: /s/Anthony M. DiPaolo
--------------------------------------
Anthony M. DiPaolo,
Senior Vice-President and
Chief Financial Officer
21 of 21