SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
[x] Annual report pursuant to section 13 or 15(d) of the Securities Exchange
Act of 1934
For the fiscal year ended May 31, 1996
[ ] 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
Securities registered pursuant to Section 12(b) of the Act: None
Securities registered pursuant to Section 12(g) of the Act: Common Stock, $.008
par value
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
-----
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [ X ]
The approximate market value of stock held by non-affiliates was $3,701,250
based upon 1,410,000 shares held by such persons and the closing price on July
22, 1996 of $2.625. The number of shares outstanding of the Registrant's $.008
par value common stock at July 22, 1996 was 4,993,994.
Documents incorporated by reference
Certain portions of Registrant's definitive proxy statement to be filed within
120 days after the end of the Registrant's fiscal year pursuant to Regulation
14A are incorporated by reference in Part III, Items 10, 11, 12 and 13 of this
report.
Page One of 25 Pages Exhibit Index Begins on Page 22
2 of 25
<PAGE>
PART I
Item 1. Business
--------
Capital Associates, Inc. ("CAI" or the "Company"), was incorporated as a holding
company in October 1986. Its principal operating subsidiary, Capital Associates
International, Inc. ("CAII"), was incorporated in December 1976. The Company is
principally engaged in (1) buying, selling, leasing and remarketing new and used
equipment, (2) managing equipment on and off-lease, (3) sponsoring,
co-sponsoring, managing and co-managing publicly- registered income funds and
(4) arranging equipment-related financing.
Historical Business and Fiscal Year 1996 Significant Accomplishments
- --------------------------------------------------------------------
During fiscal years 1996, 1995, 1994 and 1993, the Company reported net income
of $604,000, $1,116,000, $710,000 and $1,396,000, respectively, representing
sixteen consecutive profitable quarters. The Company's profits over the previous
four years were achieved primarily as a result of (1) expanding and improving
expertise and efficiency in its lease originations, asset management,
remarketing and leased equipment sales activities, (2) the sale of other
corporate assets and the settlement of litigation and (3) a substantial
reduction of operating expenses and improved back office efficiency.
In December 1994, the Company entered into a new recourse bank debt facility
("Bank Facility") providing it with the liquidity to finance leased equipment
purchases until such leases are sold or permanently financed with non-recourse
debt. This enabled the Company to resume investment in its own lease portfolio
and to continue growth in lease originations and sales to the Company's private
third party investors ("private investors") and to its managed or co-managed
public income funds ("PIFs").
During fiscal year 1992 the Company reported a net loss of $6,177,000 due in
large part to changes in the Company's business in response to the Tax Reform
Act of 1986 and its resulting elimination of certain tax benefits associated
with equipment leasing. Until the Company entered into its new Bank Facility in
December 1994, in order to be in compliance with its earlier bank agreement, it
used substantially all of its cash flows after payment of operating expenses to
repay its recourse debt, and therefore the Company did not then have the funds
to invest in new leases for its own lease portfolio. As a result, the Company's
lease portfolio and related revenue declined significantly during this period.
During fiscal year 1996, as a result of continuing emphasis on improving lease
originations, operating efficiencies and competitive costs of capital, the
Company:
* originated leases exceeding $190 million of equipment cost which was
approximately twice the previous year's volume
* raised $26 million through the offering of Class A Limited Partner Units in
Capital Preferred Yield Fund III
* began the offering of Class A Limited Partner Units in Capital Preferred
Yield Fund IV, the Company's seventh public income fund
* improved operating efficiencies for the fourth straight year resulting in
reduced operating expenses
* established several strategic alliances with new funding sources which
reduced the cost of transaction funding
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<PAGE>
Item 1. Business, continued
--------
Historical Business and Fiscal Year 1996 Significant Accomplishments, continued
- --------------------------------------------------------------------
* favorably resolved legal proceedings in which it was involved, including
settling the Hemmeter litigation which had been ongoing since last fiscal
year for approximately $4 million
* sold the note receivable on the one remaining jet aircraft for $4.5 million
thereby reducing a concentration of credit risk
Significant factors impacting the Company's profitability in the future include
the ability to develop and retain the field sales force, the amount of new
capital available to the Company, the cost of that capital and the ability to
increase lease origination levels while achieving profitability targets. The
Company continues to explore possible sources of new capital including, for
example, obtaining new or additional recourse debt, securitizing lease
transactions, selling equipment leases originated by the Company to private
investors and/or entering into strategic alliances/combinations with other
leasing or financial services companies. The Company intends to operate
profitably by continuing to (1) generate leasing margin from investing in its
own lease portfolio, (2) remarket equipment for a profit, (3) sell a majority of
its lease originations for fee income to its PIFs and various private investors
including joint venture partners and other strategic alliances, and (4) minimize
its operating costs.
Leasing Activities
- ------------------
All of the Company's lease transactions are net leases with a specified
noncancelable lease term. These noncancelable leases have a "hell-or-high-water"
provision which requires the lessee to make all lease payments under all
circumstances and which requires the lessee to insure the equipment against
casualty loss, and pay all related maintenance expenses and property, sales and
other taxes. The Company originates two basic types of leases, direct financing
leases ("DFLs") and operating leases ("OLs"). DFLs transfer substantially all
benefits and risks of equipment ownership to the lessee and, in accordance with
generally accepted accounting principles ("GAAP"), the primary distinguishing
factor between these two types of leases is the present value of the rents in
relation to the cost of the leased equipment. In the case of a DFL, the Company
is contractually entitled to recover at least 90% of its original investment in
the equipment from the present value of the initial lease rentals. In the case
of an OL, the Company is contractually entitled to recover less than 90% of its
original investment in the equipment from the present value of the initial lease
rentals. As of May 31, 1996, the Company's net investment in DFLs was
approximately $15 million and its net investment in OLs was approximately $45
million. See Note 1 to Notes to Consolidated Financial Statements for a
discussion of the Company's lease accounting policies.
Leases are originated for the Company's own account, its PIFs and private
investors. The Company's lease origination strategy is transaction driven. With
each lease origination opportunity, the Company evaluates both the prospective
lessee and the equipment to be leased. With respect to each potential lessee,
the Company evaluates the lessee's creditworthiness as well as the importance of
the equipment to the lessee's business. With respect to the equipment, the
Company evaluates the equipment's remarketability, upgrade potential and the
probability that the equipment will continue to be installed in place at the end
of the initial lease term because, typically, remarketing equipment in place
produces better residual returns than equipment sold or leased to a third party.
3 of 25
<PAGE>
Item 1. Business, continued
--------
Leasing Activities, continued
- ------------------
The Company leases equipment to lessees in diverse industries throughout the
United States. To minimize credit risk, the Company generally leases equipment
to (1) lessees that have a credit rating of not less than Baa as determined by
Moody's Investor Services, Inc., or comparable credit ratings as determined by
other recognized credit rating services, or (2) companies, which although not
rated by a recognized credit rating service or rated below Baa, are believed by
the Company to be sufficiently creditworthy to satisfy the financial obligations
under the lease. As of May 31, 1996, approximately 91% of the equipment owned by
the Company was leased to companies that meet the above criteria. A significant
percentage of the remaining 9% was related to the Hemmeter litigation (see
Footnote 15 to Notes to Consolidated Financial Statements).
Over the past five fiscal years, the Company has diversified its own equipment
lease portfolio (as well as the equipment portfolio it manages for private
investors and the PIFs) to include all types of equipment that meet the
Company's underwriting standards with emphasis on (i) materials handling
equipment, (ii) office furniture and store fixtures, (iii) circuit board and
semiconductor manufacturing, production and testing equipment and (iv) machine
tool and factory automation equipment.
The Company only purchases equipment that is subject to relatively short-term
leases (generally seven years or less). The Company finances such equipment
purchases with the proceeds of borrowings under the Working Capital Facility or
Warehouse Facility components of its Bank Facility or internally generated funds
pending (1) the sale of the equipment to a strategic funding partner, joint
venture partner, private investor or PIF, or (2) the permanent non-recourse
financing of the equipment or the securitization of the equipment/lease held for
its own account. In the case of leases held for the Company's account, the
typical lease transaction requires a cash investment by the Company of 5% to 30%
of the original equipment cost, commonly known in the industry as an "equity
investment", and all permanent non-recourse borrowings related to the
transaction are secured by a first lien on the equipment and the related lease
rental payments. The Company's equity investment is typically financed with
either proceeds from borrowings under its Working Capital Facility or internally
generated funds. The Company recovers its equity investment from renewal rents
received and/or sales proceeds realized from the equipment after repayment in
full of the related permanent non-recourse debt or securitization funding.
During the period from fiscal year 1992 through fiscal year 1995, the level of
the Company's lease originations was less than $100 million each year. During
that period, the Company sold substantially all new lease originations to its
PIFs and private investors and retained very few lease originations for its own
account. Since the closing of the Company's Bank Facility, the Company has
resumed originating more leases for its own account. Lease originations of
$191.8 million for fiscal year 1996 were financed through $67.1 million of sales
to the PIFs, $81.9 million of sales to private investors, and the remaining
$42.8 million of leases, which were held for the Company's account (a
significant portion of which will be sold during fiscal year 1997), were
financed through the use of the Company's cash, accounts payable, non-recourse
bank debt and recourse bank debt under its Warehouse Facility.
During fiscal year 1996, payments from one lessee accounted for 11% of revenue
from leasing activities. No payments from any single lessee during fiscal years
1995 or 1994 accounted for more than 10% of the Company's consolidated revenue
from leasing activities. During fiscal years 1996, 1995 and 1994, revenue from
leasing activities was $10.2 million, $7.7 million and $13.4 million,
respectively.
4 of 25
<PAGE>
Item 1. Business, continued
--------
Underwriting Standards
- ----------------------
All initial leases are subject to review under the Company's underwriting
standards. Each potential lessee is assigned a credit risk rating of 1 (the
highest rating) through 6 (the lowest rating), based on the application of
specific criteria during the credit review process. The Company originates
leases for its own account that have a credit rating of 1, 2 or 3. The Company
originates leases for its PIFs consistent with each PIF's own lease origination
standards, which are similar to those of the Company.
The Company's Transaction Review Committee, which is composed of members of
senior management, (1) reviews and approves all material aspects of lease
transactions, the credit ratings assigned to lessees and certain pricing and
residual value assumptions, (2) advises on lease documentation requirements and
deal structuring guidelines, (3) monitors asset quality on an on-going basis in
order to estimate and assess the net realizable value at the end of the lease
term for the Company's equipment and for reviewing and approving the quarterly
Asset Quality Report and (4) revises and updates the underwriting standards,
when and as necessary. Generally, all transactions over $3,000,000 must also be
approved by the Executive Committee of the Board of Directors.
Remarketing Activities
- ----------------------
Remarketing activities consist of (1) lease portfolio management (i.e., managing
equipment under lease) and (2) asset management (i.e., managing off-lease
equipment). One of the Company's principal goals is to minimize off-lease
equipment by proactively managing such equipment while it is under lease (e.g.,
renewing or extending the lease, or re-leasing, upgrading or adding to the
equipment before the end of the initial lease term) because generally,
remarketing equipment in place produces better residual returns than equipment
sold or re-leased to a third-party. However, if the Company is unsuccessful in
keeping the equipment in place, it will attempt to sell or re-lease the off-
lease equipment to a different lessee, or sell the off-lease equipment to
equipment brokers or dealers. No payments from any one customer during fiscal
years 1996, 1995 and 1994 accounted for more than 10% of the Company's
consolidated revenue from remarketing activities. Revenue from remarketing
activities was $3.0 million, $4.6 million and $9.3 million during fiscal years
1996, 1995 and 1994, respectively.
The Company attempts to maximize the remarketing proceeds from, and to minimize
the warehousing costs for, off- lease equipment by (1) employing qualified and
experienced remarketing personnel, (2) developing equipment remarketing
expertise in order to maximize the profit from sales of off-lease equipment, (3)
minimizing the amount of off-lease equipment stored at independently operated
equipment warehouses and thereby reducing warehousing costs, (4) leasing and
operating its own general equipment warehouse to further reduce warehousing
costs, (5) eliminating scrap inventory from the warehouses and (6) conducting
on-site equipment inspections. The Company further supports these activities by
carefully monitoring the residual values of its equipment portfolio and
maintaining adequate reserves on its books, when and as needed, to reflect
anticipated future reductions in such values due to obsolescence and other
factors.
Private Investor Programs, Equity Syndications and PIFs
- -------------------------------------------------------
The Company sells ownership interests in leased equipment to private investors
for fee income. In accordance with GAAP, the Company records sales revenue and
costs of sales on what is known as a "broad" basis, meaning equipment sales
revenue is equal to the sales price of the equipment and equipment sales cost is
equal to the carrying value of the equipment. In the event the Company
warehouses a transaction prior to sale, the Company records leasing revenue and
expenses. During fiscal year 1996, revenue from the sale of leases with one
lessee accounted
5 of 25
<PAGE>
Item 1. Business, continued
--------
Private Investor Programs, Equity Syndications and PIFs, continued
- -------------------------------------------------------
for 88% of revenue from the sale of equipment to private investors. No revenue
from the sales of leases with any single lessee accounted for more than 10% of
revenue from the sale of equipment to private investors during fiscal years 1995
or 1994. Revenue from the sale of equipment under lease to private investors was
$91.0 million, $24.7 million and $43.0 million during fiscal years 1996, 1995
and 1994, respectively.
The Company currently sponsors or co-sponsors seven PIFs. The Company sells a
significant portion of the equipment it acquires for lease to its PIFs. No
revenue from the sale of equipment leased to any single lessee accounted for
more than 10% of revenue from the sale of equipment to the Company's PIFs during
fiscal years 1996, 1995 or 1994. Revenue from the sale of equipment under lease
to the PIFs was $72.2 million, $43.6 million and $70.1 million during fiscal
years 1996, 1995 and 1994, respectively.
Various subsidiaries and affiliates of the Company act as the general partners
or co-general partners of the PIFs. In addition, CAII contributes cash and/or
equipment to each PIF in exchange for a Class B limited partner interest ("Class
B interest"). Public investors purchase Class A limited partnership units
("Class A Units") for cash, which the PIFs use to purchase equipment on-lease to
lessees. The Company receives (1) fees for performing various services for the
PIFs (subject to certain dollar limits) including acquisition fees and on-going
management fees, (2) reimbursement for organizational and offering expenses
incurred in selling the Class A Units (subject to certain dollar limits), (3)
Class B interest cash distributions from each PIF (subordinated to the cash
returns on the Class A Units) and (4) general partner cash distributions.
Capital Preferred Yield Fund IV began selling units to investors during April
1996 and is the only PIF currently offering Class A Units for sale to the
public. In the aggregate, the seven PIFs have sold $321 million of Class A Units
to the public through May 31, 1996. Up to $48.8 million of Class A Units will be
offered for sale to the public during fiscal year 1997. CAII's maximum remaining
obligation to make Class B partner cash contributions is $0.5 million.
Competition
- -----------
The Company competes mainly on the basis of its lease rates, terms offered in
its leasing transactions, reliability in meeting its commitments and customer
service. Lease rates are determined primarily by the Company's funding costs and
equipment residuals resulting from its remarketing capability. The Company's
continued ability to compete effectively may be materially affected by the
availability of financing, the costs of such financing, and the marketplace for
public income fund investments. The Company competes with a large number of
equipment lessors, many of which have greater financial resources, greater
economies of scale and lower costs of capital than the Company.
Employees
- ---------
The Company had 96 employees as of May 31, 1996 versus 92 employees as of May
31, 1995, none of whom were represented by a labor union. The Company believes
that its employee relations are good.
6 of 25
<PAGE>
Item 2. Properties
----------
The Company leases office facilities (approximately 20,000 square feet) in
Lakewood, Colorado (a suburb of Denver). These facilities house the Company's
administrative, financing and marketing operations. The Lakewood, Colorado lease
is for a term of 5 years, with 4 years remaining in the term, and with a base
rent, as of May 31, 1996, of approximately $27,000 per month, plus a pro-rata
share of building costs and expenses. The Lakewood, Colorado facility adequately
provides for present and future needs, as currently planned. In addition, the
Company leases a warehouse facility and regional marketing offices at an
aggregate rental of approximately $13,000 per month.
Item 3. Legal Proceedings
-----------------
The Company is involved in the following legal proceedings:
a. THE MBANK LITIGATION. See Footnote 15 to Notes to Consolidated Financial
Statements for a description of the MBank Litigation.
b. PAINEWEBBER CLASS ACTION. The matter was resolved, at no cost to the
Company, in late 1995.
c. NATIONAL ASSOCIATION OF SECURITIES DEALERS, INC. ARBITRATION, MARTINEZ V.
CAI SECURITIES CORPORATION, NASD ARBITRATION NO. 96-00055. In February
1996, CAI Securities Corporation, a wholly-owned subsidiary of the Company,
received a Statement of Claim in this arbitration. Claimant alleged certain
misrepresentations by CAI Securities Corporation in connection with the
sale of units of Leastec Income Fund V, a limited partnership whose general
partner is an affiliate of the Company. The NASD dismissed the claims in
May 1996 and denied claimant's request for reconsideration in June 1996.
d. HEMMETER LITIGATION. See Footnote 15 to Notes to Consolidated Financial
Statements for a description of the Hemmeter Litigation.
e. The Company is also involved in 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 4. Submission of Matters to a Vote of Security Holders
---------------------------------------------------
There were no matters submitted to a vote of security holders during the three
months ended May 31, 1996.
Item 5. Market for the Registrant's Common Stock and Related Stockholder Matters
The Company's common stock trades on the Nasdaq National Market under the
symbol: CAII.
In December 1995, the Nasdaq Stock Market, Inc. ("Nasdaq") affirmed the
Company's eligibility for continued listing on the Nasdaq National Market.
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<PAGE>
PART II
The following table sets forth the high and low sales prices of the Company's
common stock for the periods indicated, according to published sources. High and
low sales prices shown reflect inter-dealer quotations without retail markups,
markdowns or commissions and do not necessarily represent actual transactions.
1997 HIGH LOW
First Quarter (through July 22, 1996) 4 3/8 2 1/8
1996 HIGH LOW
First Quarter 2 3/8 1 1/4
Second Quarter 2 1/8 1 1/2
Third Quarter 1 7/8 1 3/8
Fourth Quarter 3 5/16 1 5/8
1995 HIGH LOW
First Quarter 1 7/8 1 1/4
Second Quarter 1 7/8 1 1/4
Third Quarter 1 5/8 15/16
Fourth Quarter 1 5/8 7/8
On July 22, 1996, the date on which trading activity last occurred, the closing
sales price of the Company's stock was $2.625. On July 22, 1996, there were
approximately 210 shareholders of record and at least 700 beneficial
shareholders of the Company's outstanding common stock.
No dividends were paid during the periods indicated. The Company does not
anticipate that it will pay cash dividends on its common stock in the
foreseeable future. See Note 9 to Notes to Consolidated Financial Statements for
a discussion of restrictions on CAII's ability to transfer funds to the Company
which, in turn, limits the Company's ability to pay dividends on its outstanding
Common Stock.
Item 6. Selected Financial Data
-----------------------
The table on the following page sets forth selected consolidated financial data
for the periods indicated derived from the Company's consolidated financial
statements. The data should be read in conjunction with Item 7, Management's
Discussion and Analysis of Financial Condition and Results of Operations, and
the Company's consolidated financial statements and notes thereto appearing
elsewhere herein.
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<PAGE>
<TABLE>
<CAPTION>
Income Statement Data
- ---------------------
(in thousands, except per share and number of shares data)
Year Ended May 31,
-------------------------------------------------------------
1996 1995 1994 1993 1992
--------- --------- --------- --------- ---------
<S> <C> <C> <C> <C> <C>
Revenue:
Equipment sales $ 166,242 $ 81,370 $ 122,469 $ 96,233 $ 78,752
Leasing 10,212 7,672 13,368 26,003 45,726
Interest 6,716 11,386 15,027 15,526 26,012
Other 3,511 4,516 4,101 3,638 4,386
--------- --------- --------- --------- ---------
186,681 104,944 154,965 141,400 154,876
--------- --------- --------- --------- ---------
Costs and expenses:
Equipment sales 161,797 70,866 114,440 85,423 72,737
Leasing 5,466 3,893 5,511 12,148 30,493
Operating and other expenses 7,450 11,603 12,307 14,060 16,833
Provision for losses 430 2,940 1,315 2,070 2,150
Employee stock option buyout 557 - - - -
Termination of Stockholders' Agreement 325 - - - -
Interest - non-recourse debt 7,705 12,548 18,370 22,091 36,820
Interest - recourse debt 2,145 1,618 1,839 3,282 6,140
--------- --------- --------- --------- ---------
185,875 103,468 153,782 139,074 165,173
--------- --------- --------- --------- ---------
Income (loss) before income taxes 806 1,476 1,183 2,326 (10,297)
Income tax expense (benefit) 202 360 473 930 (4,120)
--------- --------- --------- --------- ---------
Net income (loss) $ 604 $ 1,116 $ 710 $ 1,396 $ (6,177)
========= ========= ========= ========= =========
Earnings (loss) per common and dilutive common equivalent share:
Primary:
Net income (loss) per share $ .12 $ .21 $ .13 $ .27 $ (1.39)
Fully diluted:
Net income (loss) per share $ .11 $ .21 $ .13 $ .26 $ (1.39)
Weighted average number of common and dilutive common equivalent
shares outstanding used in computing earnings per share:
Primary 5,186,000 5,325,000 5,451,000 5,153,000 4,443,000
Fully diluted 5,393,000 5,337,000 5,451,000 5,444,000 4,443,000
Balance Sheet Data
- ------------------
(in thousands) May 31,
-------------------------------------------------------------
1996 1995 1994 1993 1992
--------- --------- --------- --------- ---------
Total assets $ 127,511 $ 158,956 $ 209,725 $ 280,635 $ 392,172
Recourse bank debt 17,538 24,520 18,767 37,857 58,984
Obligations under capital leases and deferred
gain arising from sale-leaseback transactions 8,421 21,024 32,337 42,496 51,618
Discounted lease rentals 55,328 77,192 128,505 168,065 237,538
Stockholders' equity 22,881 22,490 21,099 20,303 18,539
</TABLE>
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<PAGE>
Item 7. Management's Discussion and Analysis of Financial Condition and Results
of Operations
I. Results of Operations
---------------------
During fiscal years 1996, 1995, 1994 and 1993, the Company reported net
income of $604,000, $1,116,000, $710,000 and $1,396,000, respectively,
representing sixteen consecutive profitable quarters. The Company began
growing its own lease portfolio during the latter half of fiscal year 1995
and continued growing its portfolio during fiscal year 1996 (see schedule
below). The Company intends to continue growing its own lease portfolio.
The changes in the Company's equipment under lease during fiscal year 1996
consisted of the following (in thousands):
<TABLE>
<CAPTION>
Discounted lease
Direct finance rentals, net of
leases, operating discounted lease
leases, net and rentals assigned Net investment
equipment held to lenders arising in lease
for sale or re-lease from equipment sales portfolio
-------------------- -------------------- --------------
<S> <C> <C> <C>
As of May 31, 1995 $ 39,372 $ (11,909) $ 27,463
Leases added to the Company's lease
portfolio (a significant portion of
which will be sold during fiscal year
1997) financed through the use of the
Company's cash, accounts payable,
non-recourse bank debt and recourse
bank debt under its Warehouse Facility 42,811 (13,742) 29,069
Leases sold to private investors (9,869) - (9,869)
Related provision for losses (430) - (430)
Change as a result of portfolio run-off (11,455) 5,821 (5,634)
---------- --------- ----------
As of May 31, 1996 $ 60,429 $ (19,830) $ 40,599
========== ========= ==========
</TABLE>
In growing the portfolio discussed above, operating results are subject to
fluctuations resulting from several factors, including seasonality of lease
originations, variations in the relative percentages of the Company's
leases entered into during the period which are classified as DFLs or OLs,
or are sold for fee income as well as the level of fee income obtained from
the sale of leases in excess of lease equipment cost. The Company will
adjust the mix of OLs and DFLs and volume of leases sold to private
investors from time to time, when and as the Company determines that it
would be in its best interests, taking into account profit opportunities,
portfolio concentration and residual risk.
During the four fiscal years preceding fiscal year 1996, leasing revenue
and assets declined as a result of the fact that the Company used a
substantial portion of its cash flow to repay its prior recourse debt
facility, and until the Company closed the new Bank Facility in December
1994, the Company did not have the funds necessary to significantly add to
its leasing portfolio.
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<PAGE>
Item 7. Management's Discussion and Analysis of Financial Condition and Results
of Operations
I. Results of Operations, continued
---------------------
However, the Company's assets adjusted for accounting gross-ups required in
accordance with GAAP have increased during fiscal years 1996 and 1995. The
Company's assets adjusted for accounting gross-ups are calculated as
follows (in thousands):
<TABLE>
<CAPTION>
May 31,
---------------------------------------------
1996 1995 1994
---------- ---------- ----------
<S> <C> <C> <C>
Total assets $ 127,511 $ 158,956 $ 209,725
Less accounting gross-ups:
Notes receivable arising from sale-leaseback transactions (8,409) (21,037) (32,417)
Discounted lease rentals assigned to lenders arising from
equipment sale transactions (35,498) (65,283) (111,593)
--------- --------- ---------
Assets adjusted for accounting gross-ups $ 83,604 $ 72,636 $ 65,715
========= ========= =========
</TABLE>
The gross-up asset balances have decreased because the Company has not (i)
entered into a sale-leaseback transaction since fiscal year 1991 or (ii)
added significant discounted lease rentals assigned to lenders arising from
equipment sale transactions since fiscal year 1994. For further discussion,
see Footnote 1 to Notes to Consolidated Financial Statements.
In the ordinary course of business, the Company will continue to (1) sell
new lease originations to its PIFs (to the extent the PIFs have funds
available for such purpose) or private investors and (2) sell seasoned
lease transactions (previously originated leases held in the Company's
portfolio) to private investors. Presented below is a schedule showing new
lease originations volume and the placement of new lease originations by
fiscal year (in thousands).
<TABLE>
<CAPTION>
Year ended May 31,
--------------------------------------------
1996 1995 1994
<S> <C> <C> <C>
---------- -------- --------
Placement:
Equipment under lease sold to PIFs $ 67,000 $ 44,000 $ 66,000
Equipment under lease sold to private investors 82,000 25,000 29,000
Leases added to the Company's lease portfolio (a significant portion of
which will be/were sold during the subsequent
fiscal years) 43,000 27,000 -
--------- -------- ---------
Total lease origination volume $ 192,000 $ 96,000 $ 95,000
========= ======== =========
</TABLE>
Leasing is an alternative to financing equipment with debt. Therefore, 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.
Because the Company finances its lease transactions with recourse and
non-recourse debt, the ultimate profitability of leasing transactions is
dependent, in part, on the difference between the interest rate inherent in
the lease and the underlying debt rate ("rate spread"). Certain of the
Company's competitors have access to lower cost funds than the Company.
However, the Company has developed relationships with various private
investors and formed various strategic alliances with companies that have a
lower cost of capital enabling the Company to originate and sell leases at
competitive prices.
11 of 25
<PAGE>
Item 7. Management's Discussion and Analysis of Financial Condition and Results
of Operations
I. Results of Operations, continued
---------------------
Presented below are schedules showing condensed income statement categories
and analyses of changes in those condensed categories derived from the
Consolidated Statements of Income appearing on page F-4 of this report on
Form 10-K, prepared solely to facilitate the discussion of results of
operations (in thousands).
<TABLE>
<CAPTION>
Condensed Consolidated Condensed Consolidated
Statements of Income Statements of Income
for the years The effect on for the years The effect on
ended May 31, net income of ended May 31, net income of
------------------------- changes between ------------------------ changes between
1996 1995 years 1995 1994 years
---------- ---------- --------------- ----------- ---------- ---------------
<S> <C> <C> <C> <C> <C> <C>
Equipment sales margin $ 4,445 $ 4,404 $ 41 $ 4,404 $ 8,029 $ (3,625)
MBank sales margin - 6,100 (6,100) 6,100 - 6,100
Leasing margin (net of
interest expense on
discounted lease rentals) 3,757 2,617 1,140 2,617 4,514 (1,897)
Other income 3,511 4,516 (1,005) 4,516 4,101 415
Operating and other expenses (7,450) (11,603) 4,153 (11,603) (12,307) 704
Provision for losses (430) (2,940) 2,510 (2,940) (1,315) (1,625)
Employee stock option buyout (557) - (557) - - -
Termination of Stockholders'
Agreement (325) - (325) - - -
Interest expense on recourse debt (2,145) (1,618) (527) (1,618) (1,839) 221
Income taxes (202) (360) 158 (360) (473) 113
--------- --------- -------- ---------- --------- --------
Net income $ 604 $ 1,116 $ (512) $ 1,116 $ 710 $ 406
========= ========= ======== ========== ========= ========
</TABLE>
EQUIPMENT SALES
Equipment sales revenue (and the related equipment sales margin) consists
of the following (in thousands):
<TABLE>
<CAPTION>
Year Ended May 31,
------------------------------------------- Increase
1996 1995 (Decrease)
--------------------- ------------------ --------------------
Revenue Margin Revenue Margin Revenue Margin
------- ------ ------- ------ ------- ------
<S> <C> <C> <C> <C> <C> <C>
Transactions during initial lease term:
Equipment under lease sold to PIFs $ 72,202 $ 1,539 $ 43,638 $ 1,047
Equipment under lease sold to private investors 91,007 1,303 24,700 423
-------- -------- -------- --------
163,209 2,842 68,338 1,470 $ 94,871 $ 1,372
-------- -------- -------- -------- -------- --------
Transactions subsequent to initial lease termination:
Sales of off-lease equipment 2,121 859 2,505 1,269
Sales-type leases 359 191 1,227 765
Excess collections (cash collections in excess
of the associated residual value from equipment
under lease sold to private investors) 553 553 900 900
-------- -------- -------- --------
3,033 1,603 4,632 2,934 (1,599) (1,331)
Deduct related provision for losses - (430) - (1,940)* - 1,510
-------- -------- -------- -------- -------- --------
Realizations of value in excess of provision for
losses 3,033 1,173 4,632 994 (1,599) 179
Add back related provision for losses - 430 - 1,940 - (1,510)
-------- -------- -------- -------- -------- --------
Total equipment sales $166,242 $ 4,445 $ 72,970 $ 4,404 $ 93,272 $ 41
======== ======== ======== ======== ======== ========
<FN>
* Excludes $1,000 of bankrupt lessee credit losses occurring prior to the
expiration of the initial lease term (none for fiscal years 1996 or 1994)
</FN>
</TABLE>
12 of 25
<PAGE>
Item 7. Management's Discussion and Analysis of Financial Condition and Results
of Operations
I. Results of Operations, continued
---------------------
EQUIPMENT SALES, continued
<TABLE>
<CAPTION>
Year Ended May 31,
------------------------------------------------ Increase
1996 1995 (Decrease)
-------------------- ------------------------ --------------------
Revenue Margin Revenue Margin Revenue Margin
------- ------ ------- ------ ------- ------
<S> <C> <C> <C> <C> <C> <C>
Transactions during initial lease term:
Equipment under lease sold to PIFs $ 43,638 $ 1,047 $ 70,085 $ 1,774
Equipment under lease sold to
private investors 24,700 423 43,037 1,257
--------- -------- -------- --------
68,338 1,470 113,122 3,031 $ (44,784) $ (1,561)
Transactions subsequent to initial lease
termination:
Sales of off-lease equipment 2,505 1,269 4,759 2,021
Sales-type leases 1,227 765 2,672 1,061
Excess collections (cash collections in
excess of the associated residual value
from equipment under lease sold to
private investors) 900 900 1,916 1,916
-------- -------- -------- --------
4,632 2,934 9,347 4,998 (4,715) (2,064)
Deduct related provision for losses - (1,940)* - (1,315) - (625)
-------- -------- -------- -------- --------- --------
Realizations of value in excess of
provision for losses 4,632 994 9,347 3,683 (4,715) (2,689)
Add back related provisions for losses - 1,940 - 1,315 - 625
-------- -------- -------- -------- --------- --------
Total equipment sales $ 72,970 $ 4,404 $122,469 $ 8,029 $ (49,499) $ (3,625)
======== ======== ======== ======== ========= ========
<FN>
* See explanation above.
</FN>
</TABLE>
Equipment Sales to PIFs
-----------------------
Equipment sales to PIFs increased during fiscal year 1996 as compared to
fiscal year 1995 principally because more leases were identified and closed
as a result of the increased productivity of the field lease originations
team (see further discussion below).
Equipment sales to the PIFs were lower during fiscal year 1995 as compared
to fiscal year 1994 primarily because the PIFs were more fully leveraged
during fiscal year 1995 and, therefore, had less available borrowing
capacity to acquire additional equipment.
Equipment Sales to Private Investors
------------------------------------
Equipment sales to private investors increased during fiscal year 1996 as
compared to fiscal year 1995 principally because more leases were
identified and closed as a result of increased productivity of the field
lease originations team. The increased volume of the field lease
originators is primarily due to the Company's efforts to improve its
marketing activities, including focusing on customer relationships and
vertical integration (i.e., the development of specialized equipment and
remarketing expertise) into material handling equipment. In this regard,
lease originations from one customer relationship (comprised of leases of
material handling equipment and machine tools) accounted for approximately
one-half of the total lease originations volume for fiscal year 1996.
13 of 25
<PAGE>
Item 7. Management's Discussion and Analysis of Financial Condition and Results
of Operations
I. Results of Operations, continued
---------------------
EQUIPMENT SALES, continued
Equipment Sales to Private Investors, continued
------------------------------------
Equipment sales to private investors margin as a percentage of equipment
sales revenue decreased primarily because the Company records leasing
revenue while it uses its Bank Facility to hold leases pending sale to
private investors.
Equipment sales to private investors during fiscal year 1995 were less than
in the prior year primarily because lease originations identified for sale
to private investors were less than the prior year.
Remarketing of the Portfolio and Related Provision for Losses
-------------------------------------------------------------
The Company has been successful in realizing gains on the remarketing of
its equipment after the initial lease term for the past sixteen consecutive
quarters. The remarketing of equipment for an amount greater than its book
value is reported as equipment sales margin (if the equipment is sold) or
as leasing margin (if the equipment is re-leased). The realization of less
than the carrying value of equipment (which is typically not known until
remarketing after the expiration of the initial lease term) is recorded as
provision for losses. As shown in the tables above, the realizations from
sales exceeded the provision for losses for fiscal years 1996, 1995 and
1994, even without considering realizations from remarketing activities
recorded as leasing margin.
Residual values are established equal to the estimated value to be received
from the equipment following termination of the lease. In estimating such
values, the Company considers all relevant facts regarding the equipment
and the lessee, including, for example, the likelihood that the lessee will
re-lease the equipment. The nature of the Company's leasing activities is
that it has credit exposure and residual value exposure and, accordingly,
in the ordinary course of business it will incur losses arising from these
exposures. The Company performs ongoing quarterly assessments of its assets
to identify other than temporary losses in value.
Margins from remarketing 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. As shown in the table above,
(1) because the Company sold substantially all new lease originations to
its PIFs and retained very few lease originations for its own account
during the fiscal years preceding fiscal year 1995, and (2) in accordance
with GAAP, the Company does not consolidate the results of its PIFs, fewer
leases have matured and less equipment has been available for remarketing
each quarter since May 31, 1993. For this reason, remarketing revenue and
the related margin declined. Remarketing revenue and margin are expected to
decline further as maturing leases continue to decrease. 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).
14 of 25
<PAGE>
Item 7. Management's Discussion and Analysis of Financial Condition and Results
of Operations
I. Results of Operations, continued
---------------------
Remarketing of the Portfolio and Related Provision for Losses, continued
-------------------------------------------------------------
A summary of the Company's fiscal year 1996 and 1995 allowance for losses
follows (in thousands):
Fiscal Year Ended May 31,
-----------------------------
1996 1995
------------ ------------
Balance, at beginning of period $ 4,118 $ 9,018
Provision for losses 430 2,940 - D
-------- --------
4,548 11,958
-------- --------
Deduct chargeoffs:
Retained residuals 2,027 - A 5,830 - E
Leased equipment 1,849 - B 2,010 - F
Less litigation settlement recoveries (750)- C -
-------- --------
Net chargeoffs 3,126 7,840
-------- --------
Balance, at end of period $ 1,422 $ 4,118
======== ========
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 majority of fiscal year 1996 chargeoffs were related to allowances
for losses recorded in prior periods. In addition, fiscal year 1996
chargeoffs included the following significant activity:
A - Approximately $170,000 to write down the carrying value of
certain retained residuals to fair market value based upon
current third-party quotes and $355,000 to write down the
carrying value of a helicopter retained residual to fair
market value due to the passage of time without remarketing
prospects.
B - Approximately $170,000 for equipment originally expected
to remain with the lessee upon lease termination which the
Company now believes will be returned and $539,000 related
to the sale for $4.5 million of a note receivable on a jet
aircraft with a $5 million carrying value. The Company
recently determined that it would be in its best interest to
sell this note receivable and reinvest the proceeds in
another income producing asset or assets. The Company had
originally anticipated that it would hold the related note
to term, in which case the Company would have received the
full carrying value of the aircraft.
C - Related to a settlement of litigation involving equipment
with approximately $3 million of net book value (see
Footnote 15 to Notes to Consolidated Financial Statements).
15 of 25
<PAGE>
Item 7. Management's Discussion and Analysis of Financial Condition and Results
of Operations
I. Results of Operations, continued
---------------------
Remarketing of the Portfolio and Related Provision for Losses, continued
-------------------------------------------------------------
The majority of fiscal year 1995 chargeoffs were also related to allowances
for losses recorded in prior years. In addition, fiscal year 1995
chargeoffs included the following significant activity:
D - $750,000 for litigation involving equipment with a net book
value of approximately $3 million (see Footnote 15 to Notes
to Consolidated Financial Statements) and $250,000 for
litigation with another lessee. Remainder discussed in E and
F below.
E - Approximately $550,000 to write down the carrying value of
IBM equipment retained residuals to fair market value based
upon current third-party quotes. In prior years, the Company
and one of its PIFs have suffered substantial losses with
respect to IBM equipment.
F - Approximately $500,000 for equipment originally expected
to remain with the lessee upon lease termination which was
returned to the Company and $400,000 to write down the
carrying value of one of the Company's aircraft to fair
market value because of the deteriorating financial
condition of the lessee.
MBANK SALE PROCEEDS
The parties in the MBank litigation settled their claims to the cash
collateral for the original MBank lease and the Company received
approximately $10.8 million (including $2.2 million the Company has agreed
to refund to BankOne, Texas N.A.). The Company recorded $6.1 million in
equipment sales margin from the MBank sale (i.e., net proceeds of
approximately $8.4 million less a carrying value of approximately $2.3
million). On September 12, 1995, the Company deposited the $2.2 million of
the settlement that it had agreed to refund to BankOne in an escrow account
(included in cash and cash equivalents in the accompanying Consolidated
Balance Sheets) pending resolution of on-going claims. For a discussion of
this matter, see Footnote 15 to Notes to Consolidated Financial Statements.
LEASING MARGIN
Leasing margin consists of the following (in thousands):
Fiscal Years Ended May 31,
------------------------------------
1996 1995 1994
-------- -------- ----------
Leasing revenue $ 10,212 $ 7,672 $ 13,368
Leasing costs and expenses (5,466) (3,893) (5,511)
Net non-recourse interest expense
on related discounted lease rentals (989) (1,162) (3,343)
-------- -------- --------
Leasing margin $ 3,757 $ 2,617 $ 4,514
======== ======== ========
Leasing margin ratio 37% 34% 34%
== == ==
16 of 25
<PAGE>
Item 7. Management's Discussion and Analysis of Financial Condition and Results
of Operations
I. Result of Operations, continued
--------------------
LEASING MARGIN, continued
The increase in leasing revenue, leasing costs and expenses and leasing
margin during fiscal year 1996, as compared to fiscal year 1995, was
primarily due to growth in the Company's lease portfolio. These revenue and
expense amounts are expected to increase further as the Company continues
to grow its lease portfolio. Net interest expense on discounted lease
rentals (i.e., leases funded with non-recourse debt) did not grow
proportionately because the Company is using its Bank Facility to finance
(1) certain leases held for its own account and (2) leases held pending
sale to the PIFs and private investors.
Leasing margin and related leasing revenue and costs and expenses decreased
during fiscal year 1995 as compared to fiscal year 1994 primarily for the
reasons discussed above under Remarketing of the Portfolio and Related
Provision for Losses.
OTHER INCOME
Other Income consists of the following (in thousands):
<TABLE>
<CAPTION>
Fiscal years ended May 31,
--------------------------------------
1996 1995 1994
-------- -------- --------
<S> <C> <C> <C>
Fees and distributions from the Company-sponsored PIFs $ 2,958 $ 2,908 $ 3,293
Gain on sale of the investment in Corporate Express, Inc. stock - 671 -
Cancellation of option agreement to acquire certain mining equipment - 444 -
Interest on income tax refunds - 178 431
Interest on MBank settlement and hold back 227 - -
Recovery of sales and property tax amounts previously expensed 118 371 330
Other 208 (56) 47
------- ------- -------
$ 3,511 $ 4,516 $ 4,101
======= ======= =======
</TABLE>
OPERATING AND OTHER EXPENSES
Operating and Other Expenses decreased $4.2 million (36%) for fiscal year
1996 as compared to fiscal year 1995. The decrease included (i) $1.5
million of capitalized initial direct costs due to lease origination
volume, (ii) $700,000 related to on-going efforts to minimize costs, and
(iii) a $400,000 reimbursement to the Company from its PIFs for insurance
costs related to prior fiscal years. The decrease also included the
following significant expense reductions:
* $550,000 of legal fees primarily related to the MBank litigation and
the Hemmeter litigation.
* $300,000 of warehouse and other lease portfolio and asset management
costs.
* $400,000 of current insurance costs.
* $200,000 difference between estimated fiscal year 1995 incentive
compensation and actual payments as modified by the Company's Board of
Directors.
* $150,000 of costs associated with the Company's prior recourse debt
facility.
Operating and other expenses decreased approximately $0.7 million (6%) for
fiscal year 1995 compared to fiscal year 1994 due to on-going efforts to
minimize costs.
17 of 25
<PAGE>
Item 7. Management's Discussion and Analysis of Financial Condition and Results
of Operations
I. Result of Operations, continued
--------------------
EMPLOYEE STOCK OPTION BUYOUT
Effective on May 31, 1996, the Company purchased a portion of outstanding
employee stock options in order to make options outstanding as a percentage
of shares outstanding consistent with that of other companies. See Note 13
to Notes to Consolidated Financial Statements for a discussion of the
employee stock option buyout.
TERMINATION OF STOCKHOLDERS' AGREEMENT EXPENSE
See Note 12 to Notes to Consolidated Financial Statements for a discussion
of (1) the termination of the Stockholders' Agreement, (2) the termination
of the Company's obligation to continue to make premium payments on certain
key-man life insurance policies and (3) the payments the Company received
from the two stockholders to whom the policies were assigned.
INTEREST INCOME AND EXPENSE
Interest income arises when equipment financed with non-recourse debt is
sold to investors. The accompanying Consolidated Statements of Income
reflect an equal amount of non-recourse interest expense. The decline in
interest income (and the related non-recourse interest expense) is due to a
decline in the average outstanding balance of non-recourse debt with
respect to equipment sold to investors.
Net non-recourse interest expense on related discounted lease rentals
decreased due to a decrease in the average outstanding balance of related
discounted lease rentals. However, it is anticipated that net non-recourse
interest expense on related discounted lease rentals will increase in the
future as the Company adds additional leases financed with non-recourse
debt to its portfolio.
Recourse interest expense increased during fiscal year 1996, as compared to
fiscal year 1995. As discussed above, the Company is financing more lease
originations with its Bank Facility.
INCOME TAXES
As shown in the table in Note 11 to Notes to the Consolidated Financial
Statements, the Company's significant deferred tax assets consist of an ITC
carryforward of $1.9 million (which expires from 1996 through 2001) and
alternative minimum tax ("AMT") credits of $3.3 million (which are not
subject to expiration). These tax assets are available to offset federal
income tax liability. However, the amount of ITC and AMT credit
carryforward that may be utilized to reduce tax liability is significantly
limited due to the computation of AMT liability. As a result of this
limitation on the ITC carryforward, the Company has established a valuation
allowance for deferred tax assets to reflect the uncertainty that the ITC
carryforward will be fully utilized prior to expiration. During fiscal
years 1996 and 1995, the valuation allowance was reduced by $120,000 and
$230,000, respectively, to reflect utilization of ITC carryforward for
which a valuation allowance had previously been provided.
Income tax expense is provided on income at the appropriate statutory rates
applicable to such earnings. The appropriate statutory federal and state
income tax rate for fiscal years 1996, 1995 and 1994 was 40%. Adjustments
to the valuation allowance are recognized as a separate component of the
provision for income tax expense. Consequently, the actual income tax rate
for fiscal years 1996 and 1995 was less than the effective rate of 40%
primarily due to the reduction in the valuation allowance.
18 of 25
<PAGE>
Item 7. Management's Discussion and Analysis of Financial Condition and Results
of Operations
I. Result of Operations, continued
--------------------
INCOME TAXES, continued
As discussed in Note 12 to Notes to Consolidated Financial Statements, a
transaction was completed in which the Company's largest shareholder
obtained more than fifty percent of the ownership and voting rights of the
Company within a three year period ("a change in control"). Upon a change
in control, provisions of the Internal Revenue Code limit the amount of ITC
carryforwards and AMT carryforwards that could be utilized to reduce income
tax liability in any year. However, the Company had previously established
a valuation allowance for deferred taxes due to uncertainty that the full
amount of the ITC carryforward would be utilized prior to expiration and
therefore, the change in control and any resulting limitation on the ITC
and AMT carryforward is not expected to reduce the recoverability of the
amount of the deferred income tax assets, net of the valuation allowance.
II. Liquidity and Capital Resources
-------------------------------
The Company's activities are principally funded by proceeds from sales of
on-lease equipment (to its PIFs and private investors), non-recourse debt,
recourse bank debt (see Note 9 to Notes to Consolidated Financial
Statements), rents, fees and distributions from its PIFs, sales or
re-leases of equipment after the expiration of the initial lease terms and
other cash receipts from non-recurring items such as settlements of legal
proceedings. 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.
On August 23, 1995, the Company received $10.8 million in settlement of its
claims in the MBank Litigation which was included in net cash from
operating activities in the accompanying Consolidated Statements of Cash
Flows. On September 12, 1995, the Company deposited $2.2 million of the
settlement proceeds in an escrow account with Norwest Bank, N.A., pending
resolution of Bank One's ongoing claims to the MBank Equipment. The Company
used the balance of the settlement proceeds, i.e., $8.6 million less $1.1
million of income taxes, to paydown the Working Capital Facility and
Warehouse Facility components of its Bank Facility. For a discussion of
this matter, see Note 15 to Notes to Consolidated Financial Statements.
The Company's Bank Facility, which was scheduled to mature on January 31,
1996, has been extended, without material changes, through November 30,
1996.
During July 1995, the Company and certain of its PIFs entered into an
agreement with a lender to finance up to $50 million of lease receivables
as part of a lease securitization program. Under this program, the
Company's financing obligations are collateralized by the leased equipment
and related rentals, and the Company has no recourse liability to the
lender for repayment of the debt. In addition, this securitized debt
vehicle provides an attractive interest rate. Aggregate closings through
May 31, 1996 were $14.4 million for the Company and its PIFs.
The Company completed the offering of units of its sixth PIF, CPYF III, for
sale to the public in April 1996. During fiscal year 1996, the Company sold
a total of $26.4 million of Class A units of CPYF III (bringing total sales
of Class A units of CPYF III to $50 million, the maximum offering amount).
The Company began offering units of a succeeding program, CPYF IV, for sale
during April 1996. During fiscal year 1997, the Company has up to $48.8
million of Class A units in CPYF IV available for sale, which will
represent a source of liquidity and acquisition fee income for the Company.
Three of the Company's PIFs, including CPYF IV, are using a portion
19 of 25
<PAGE>
Item 7. Management's Discussion and Analysis of Financial Condition and Results
of Operations
II. Liquidity and Capital Resources, continued
-------------------------------
of their available cash to purchase additional equipment from the Company.
The Company expects to sell approximately $85 million of equipment to these
PIFs during fiscal year 1997. Four of the Company's PIFs are in their
liquidation stage and are no longer purchasing material amounts of
equipment.
Inflation has not had a significant impact upon the operations of the
Company.
III. Business Plan
-------------
The Company believes that it has the necessary funding capability for
fiscal year 1997 to (1) continue to build its lease origination function
and increase its lease origination volume by expanding its field sales
force and by marketing its ability to customize products that meet customer
needs, (2) continue to modestly increase the size of its own lease
portfolio, (3) originate/acquire additional leases for sales to PIFs and
private investors and (4) build and strengthen its residual remarketing
expertise in identified equipment types such as material handling equipment
by "vertical integration" of individuals or companies with requisite
equipment expertise.
The Company's operating results may be affected by the availability of
additional sources of capital and the related costs of such capital. The
cost of funds for many of the Company's competitors is lower than the
Company's cost of funds. Therefore, the Company has expanded its debt and
equity placement capabilities with lower cost of capital sources including
private investors, private partnerships, a private income fund with an off
shore investor and other strategic alliances. These funding sources should
provide funds at a cost necessary to facilitate the Company's
competitiveness in the lease originations market.
IV. "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 Parts I and II of this report when and where applicable.
Item 8. Financial Statements and Supplementary Data
-------------------------------------------
See the Index to Financial Statements and Schedule appearing at Page F-1 of this
Report.
Item 9. Disagreements on Accounting and Financial Disclosure
----------------------------------------------------
None.
PART III
Item 10. Directors and Executive Officers
--------------------------------
The information required by this Item is incorporated by reference to the
Company's definitive proxy statement to be filed within 120 days after the
Company's fiscal year end.
20 of 25
<PAGE>
Item 11. Executive Compensation
----------------------
The information required by this Item is incorporated by reference to the
Company's definitive proxy statement to be filed within 120 days after the
Company's fiscal year end.
Item 12. Security Ownership of Certain Beneficial Owners and Management
--------------------------------------------------------------
The information required by this Item is incorporated by reference to the
Company's definitive proxy statement to be filed within 120 days after the
Company's fiscal year end.
Item 13. Certain Relationships and Related Transactions
----------------------------------------------
The information required by this Item is incorporated by reference to the
Company's definitive proxy statement to be filed within 120 days after the
Company's fiscal year end.
PART IV
Item 14. Exhibits, Financial Statement Schedule and Reports on Form 8-K
--------------------------------------------------------------
(a) and (d) Financial Statements and Schedule
---------------------------------
The financial statements and schedule listed on the accompanying Index of
Financial Statements and Schedule (page F-1) are filed as part of this Annual
Report.
(b) Reports on Form 8-K
-------------------
None
(c) Exhibits
--------
Included as exhibits are the items listed in the Exhibit Index. The Company will
furnish to its shareholders of record as of the record date for its 1996 Annual
Meeting of Stockholders, a copy of any of the exhibits listed below upon payment
of $.25 per page to cover the costs to the Company of furnishing the exhibits.
21 of 25
<PAGE>
Item No. Exhibit Index
- -------- -------------
3.1 Certificate of Incorporation of Capital Associates, Inc. (the
"Company"), incorporated by reference to Exhibit 3.1 of the Company's
registration statement on Form S-1 (No. 33-9503).
3.2 Bylaws of the Company, incorporated by reference to Exhibit 3.2 of the
Annual Report on Form 10-K for the fiscal year ended May 31, 1991 (the
"1991 10-K").
4.2(a) Certificate of Incorporation as filed on October 17, 1986,
incorporated by reference to 4.2(a) of the December 15, 1995 Form S-3.
4.2(b) Certificate of Amendment to Certificate of Incorporation, as filed on
March 3, 1987, incorporated by reference to 4.2(a) of the December 15,
1995 Form S-3.
4.2(c) Certificate of Amendment of Certificate of Incorporation, as filed on
November 2, 1995, incorporated by reference to 4.2(a) of the December
15, 1995 Form S-3.
10.1 Amended and Restated Stock Option Plan of the Company incorporated by
reference to Exhibit 10.1 of the Annual Report on Form 10-K for the
fiscal year ended May 31, 1992 (the "1992 10-K").
10.2 Form of Stock Option Agreement between the Company and the directors
of the Company (the "Option Agreement"), incorporated by reference to
Exhibit 19.12 of the Quarterly Report on Form 10-Q for the quarter
ended February 28, 1991 (the "February 1991 10-Q").
10.3(a) Amended and Restated Exhibit A to the Option Agreement between the
Company and James D. Edwards, incorporated by reference to Exhibit
19.1 of the Quarterly Report on Form 10-Q for the quarter ended August
31, 1991 (the "August 1991 10-Q").
10.3(c) Amended and Restated Exhibit A to the Option Agreement between the
Company and William B. Patton, Jr., incorporated by reference to
Exhibit 19.1 of the August 1991 10-Q.
10.3(d) Amended and Restated Exhibit A to the Option Agreement between the
Company and Peter F. Schabarum, incorporated by reference to Exhibit
19.1 of the August 1991 10-Q.
10.4 Defined Contribution Plan and Trust, incorporated by reference to
Exhibit 10.2 of the Annual Report on Form 10-K for the fiscal year
ended May 31, 1990 (the "1990 10-K").
10.5(a) Stockholder's Agreement dated October 27, 1982 among the Company,
Richard Kazan, Jack M. Durliat, and Gary M. Jacobs, as amended,
incorporated by reference to exhibit 10.3 to the Company's
registration statement on Form S-1 (No. 33-9503).
10.5(b) Amendment to Stockholder's Agreement dated August 1, 1990,
incorporated by reference to Exhibit 10.3(b) of the 1990 10-K.
10.6 Form of Indemnification Agreement by and between the Company and its
directors, incorporated by reference to Exhibit 10.16 of the 1990
10-K.
22 of 25
<PAGE>
Item No. Exhibit Index
- -------- -------------
10.8(a) Executive Employment Agreement, executed October 25, 1991 and
effective as of September 7, 1991, by and between Dennis J. Lacey, the
Company and Capital Associates International, Inc. ("CAII") (the
"Lacey Employment Agreement"), incorporated by reference to Exhibit
19.1 of the Quarterly Report on Form 10-Q for the quarter ended
November 30, 1991 (the "November 1991 10-Q").
10.8(b) Amendment No. 1 to the Lacey Employment Agreement dated as of
September 7, 1992, incorporated by reference to Exhibit 19.1 of the
Quarterly Report on Form 10-Q for the fiscal quarter ended November
30, 1992 (the "November 1992 10-Q").
10.8(c) Amendment No. 2 to the Lacey Employment Agreement dated as of April 9,
1993, incorporated by reference to exhibit 10.8(c) to the Annual
Report on Form 10-K for the fiscal year ended May 31, 1993 (the "1993
10-K").
10.8(d) Form of Amendment No. 3 to the Lacey Employment Agreement dated as of
April 20, 1993, incorporated by reference to exhibit 10.8(d) to the
1993 10-K.
10.8(e) First Amended and Restated Lacey Employment Agreement dated as of June
15, 1993, incorporated by reference to exhibit 10.8(c) to the 1993
10-K.
10.10(a) Crisis Recovery Employee Incentive Bonus plan dated as of December 2,
1991, incorporated by reference to Exhibit 19.3 of the November 1992
10-Q.
10.10(b) Capital Associates, Inc. Incentive Program to Enhance Earnings Growth
dated June 27, 1993, incorporated by reference to exhibit 10.10(b) to
the 1993 10-K.
10.40 Purchase Agreement, dated as of December 30, 1991 by and among CAII,
the Company and Bank One, Texas, N.A., incorporated by reference to
Exhibit 19.11 of the November 1991 10-Q.
10.41 Form of Consulting Agreement, dated as of April 30, 1993 by and among
the Company CAII and William B. Patton, Jr., incorporated by reference
to Exhibit 10.41 of the 1993 10-K.
10.42 Amendment to Stockholders' Agreement, dated as of June 1, 1994, by and
between the Company, Durliat, Jacobs and Kazan, incorporated by
reference to Exhibit 10.42 of the 1994 10-K.
10.43 Confidentiality and Standstill Agreement, dated as of June 1, 1994, by
and between the Company and Kazan, incorporated by reference to
Exhibit 10.43 of the 1994 10-K.
10.44 Indemnification Agreement, dated as of January 14, 1994, by and
between the Company and Jacobs, incorporated by reference to Exhibit
10.44 of the 1994 10-K.
10.45 Form of Stock Option Agreement between the Company and the directors
of the Company (with a grant date of August 27, 1993 for Kazan,
Patton, Edwards and Schabarum and a grant date of January 14, 1994 for
Jacobs), incorporated by reference to Exhibit 10.45 of the 1994 10-K.
23 of 25
<PAGE>
Item No. Exhibit Index
- -------- -------------
10.48 Form of Credit and Security Agreement, dated as of November 30, 1994,
by and among CAII, Norwest Bank Colorado, National Association
("Norwest"), Norwest Equipment Finance, Inc., and First Interstate
Bank of Denver, N.A. ("First Interstate") (the "New Lenders"),
incorporated by reference to Exhibit 10.48 of the February 1995 10-Q.
10.49 Settlement Agreement and Release of Liens and Claims, dated as of
December 2, 1994, by and among the Company, CAII, each of the
Company's and CAII's wholly-owned subsidiaries, Mellon Bank, N.A., as
Agent, and the Lenders, incorporated by reference to Exhibit 10.49 of
the February 1995 10-Q.
10.50 Termination Agreement effective as of August 31, 1995 by and among
Jack Durliat, Gary M. Jacobs and CAI and CAII, incorporated by
reference to Exhibit 10.50 of the November 30, 1995 Form 10-Q.
10.51 Second Amendment to Credit Agreement and Notes, dated as of January
31, 1996, by and among Capital Associates International, Inc.,
borrower, the Lenders (as defined therein), Norwest Bank Colorado,
National Association, as Agent and Norwest Equipment Finance, Inc., as
Collateral Agent, incorporated by reference to Exhibit 10.51 of the
February 29, 1996 Form 10-Q.
10.52 Assignment and Assumption, dated as of February 2, 1996, between The
Daiwa Bank, Limited, Assignor, and The Sumitomo Bank, Limited,
Assignee, incorporated by reference to Exhibit 10.52 of the February
29, 1996 Form 10-Q.
11 Statement regarding Computation of Per Share Earnings
21 List of Subsidiaries
23 Consent of KPMG Peat Marwick LLP
27 Financial Data Schedule
24 of 25
<PAGE>
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) 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.
Dated: July 30, 1996 By /s/John E. Christensen
-----------------------
John E. Christensen
Senior Vice President and Chief Financial Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, this report
has been signed below by the following persons in the capacities indicated and
on the dates listed.
Signature Title
--------- -----
/s/James D. Walker Chairman of the Board and Director
- ------------------
James D. Walker
/s/William H. Buckland Director
- ----------------------
William H. Buckland
/s/James D. Edwards Director
- -------------------
James D. Edwards
/s/Gary M. Jacobs Director
- -----------------
Gary M. Jacobs
/s/Dennis J. Lacey President, Chief Executive Officer and Director
- ------------------
Dennis J. Lacey
/s/William B. Patton, Jr. Director
- -------------------------
William B. Patton, Jr.
/s/Robert A. Sharpe Director
- -------------------
Robert A. Sharpe
/s/Joseph F. Bukofski Assistant Vice President and Controller
- ---------------------
Joseph F. Bukofski (Principal Accounting Officer)
Each of the above signatures is
affixed as of July 30, 1996
25 of 25
<PAGE>
INDEX OF FINANCIAL STATEMENTS
AND SCHEDULE
Page
----
Financial Statements
- --------------------
Independent Auditors' Report F-2
Consolidated Balance Sheets as of
May 31, 1996 and 1995 F-3
Consolidated Statements of Income for
the Years Ended May 31, 1996, 1995 and 1994 F-4
Consolidated Statements of Changes in
Stockholders' Equity for the Years
Ended May 31, 1996, 1995 and 1994 F-5
Consolidated Statements of Cash Flows for
the Years Ended May 31, 1996, 1995 and 1994 F-6
Notes to Consolidated Financial Statements F-7 to F-23
Schedule
- --------
Independent Auditors' Report F-24
Schedule II - Valuation and Qualifying
Accounts and Reserves for the Years
Ended May 31, 1996, 1995 and 1994 F-25
F - 1
<PAGE>
INDEPENDENT AUDITORS' REPORT
The Stockholders and Directors
Capital Associates, Inc.:
We have audited the accompanying consolidated balance sheets of Capital
Associates, Inc. and subsidiaries as of May 31, 1996, and 1995 and the related
consolidated statements of income, changes in stockholders' equity, and cash
flows for each of the years in the three-year period ended May 31, 1996. These
financial statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements based on
our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the financial position of Capital Associates,
Inc. and subsidiaries as of May 31, 1996 and 1995 and the results of their
operations and their cash flows for each of the years in the three year period
ended May 31, 1996, in conformity with generally accepted accounting principles.
KPMG Peat Marwick LLP
/s/KPMG Peat Marwick LLP
------------------------
Denver, Colorado
July 16, 1996
F - 2
<PAGE>
CAPITAL ASSOCIATES, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(Dollars in thousands, except shares and par value)
ASSETS
<TABLE>
<CAPTION>
May 31,
---------------------------
1996 1995
--------- ---------
<S> <C> <C>
Cash and cash equivalents $ 2,851 $ 923
Receivable from affiliated limited partnerships 1,849 741
Accounts receivable, net 945 106
MBank receivable - 10,800
Equipment held for sale or re-lease 177 66
Residual values, net, and other receivables arising
from equipment under lease sold to private investors 3,374 5,608
Net investment in direct finance leases 14,967 19,319
Leased equipment, net 45,285 19,987
Investment in affiliated limited partnerships 8,759 10,316
Other 3,497 2,970
Deferred income taxes 1,900 1,800
Notes receivable arising from sale-leaseback transactions 8,409 21,037
Discounted lease rentals assigned to lenders arising
from equipment sale transactions 35,498 65,283
--------- ---------
$ 127,511 $ 158,956
========= =========
LIABILITIES AND STOCKHOLDERS' EQUITY
Recourse bank debt $ 17,538 $ 24,520
Accounts payable - equipment purchases 14,071 2,753
Accounts payable and other liabilities 9,272 10,977
Obligations under capital leases arising from sale-leaseback transactions 8,421 21,024
Discounted lease rentals 55,328 77,192
--------- ---------
104,630 136,466
---------- ---------
Commitments and contingencies (Notes 10, 15 and 16)
Stockholders' equity:
Common stock, $.008 par value, 15,000,000 shares
authorized, 5,139,000 and 5,107,000 shares issued 32 63
Additional paid-in capital 17,026 16,961
Retained earnings 6,121 5,517
Treasury stock, at cost (298) (51)
--------- ---------
Total stockholders' equity 22,881 22,490
--------- ---------
$ 127,511 $ 158,956
========= =========
</TABLE>
The accompanying notes are an integral part
of these consolidated financial statements.
F - 3
<PAGE>
CAPITAL ASSOCIATES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
(Dollars in thousands, except shares and per share data)
<TABLE>
<CAPTION>
Year Ended May 31,
-----------------------------------------
1996 1995 1994
---------- --------- ----------
<S> <C> <C> <C>
Revenue:
Equipment sales to affiliated limited partnerships $ 72,202 $ 43,638 $ 70,085
Other equipment sales 94,040 29,332 52,384
MBank sale - 8,400 -
Leasing 10,212 7,672 13,368
Interest 6,716 11,386 15,027
Other 3,511 4,516 4,101
--------- --------- ---------
Total revenue 186,681 104,944 154,965
--------- --------- ---------
Costs and expenses:
Equipment sales 161,797 68,566 114,440
MBank sale - 2,300 -
Leasing 5,466 3,893 5,511
Operating and other expenses 7,450 11,603 12,307
Provision for losses 430 2,940 1,315
Employee stock option buyout 557 - -
Termination of Stockholders' Agreement 325 - -
Interest:
Non-recourse debt 7,705 12,548 18,370
Recourse debt 2,145 1,618 1,839
--------- --------- ---------
Total costs and expenses 185,875 103,468 153,782
--------- --------- ---------
Net income before income taxes 806 1,476 1,183
Income tax expense 202 360 473
--------- --------- ---------
Net income $ 604 $ 1,116 $ 710
========= ========= =========
Earnings per common and dilutive common equivalent share:
Primary $ .12 $ .21 $ .13
========= ========= =========
Fully diluted $ .11 $ .21 $ .13
========= ========= =========
Weighted average number of common and dilutive common
equivalent shares outstanding used in computing
earnings per share:
Primary 5,186,000 5,325,000 5,451,000
========= ========= =========
Fully diluted 5,393,000 5,337,000 5,451,000
========= ========= =========
</TABLE>
The accompanying notes are an integral part
of these consolidated financial statements.
F - 4
<PAGE>
CAPITAL ASSOCIATES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
(Dollars in thousands)
<TABLE>
<CAPTION>
Common Stock Additional Treasury Stock
--------------------- Paid-in Retained -----------------
Shares Amount Capital Earnings Shares Cost Total
------ ------ ---------- -------- ------ ---- -----
<S> <C> <C> <C> <C> <C> <C> <C>
Balance at June 1, 1993 4,843,000 $ 59 $ 16,604 $ 3,691 16,000 $ (51) $ 20,303
Sale of common stock under
incentive stock option plan 12,000 - 10 - - - 10
Issuance of shares to officer 25,000 1 56 - - - 57
Income tax benefit from stock
compensation - - 19 - - - 19
Net income - - - 710 - - 710
--------- ----- -------- -------- ------- ------ --------
Balance at May 31, 1994 4,880,000 60 16,689 4,401 16,000 (51) 21,099
Sale of common stock under:
- incentive stock option plan 82,000 1 14 - - 15
- non-qualified stock option plan 145,000 2 200 - - 202
Income tax benefit from stock
compensation - - 58 - - 58
Net income - - - 1,116 - - 1,116
--------- ----- -------- -------- ------- ------ --------
Balance at May 31, 1995 5,107,000 63 16,961 5,517 16,000 (51) 22,490
Sale of common stock under:
- incentive stock option plan 27,000 - 19 - - - 19
- non-qualified stock option plan 5,000 - 6 - - - 6
Income tax benefit from stock
compensation - - 9 - - - 9
One-for-two reverse stock split - (31) 31 - - - -
Purchase of treasury shares - - - - 129,000 (247) (247)
Net income - - - 604 - - 604
--------- ----- -------- -------- ------- ------ --------
Balance at May 31, 1996 5,139,000 $ 32 $ 17,026 $ 6,121 145,000 $ (298) $ 22,881
========= ===== ======== ======== ======= ====== ========
</TABLE>
The accompanying notes are an integral part
of these consolidated financial statements.
F - 5
<PAGE>
CAPITAL ASSOCIATES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Dollars in thousands)
<TABLE>
<CAPTION>
Year Ended May 31,
-----------------------------------
1996 1995 1994
-------- -------- ---------
<S> <C> <C> <C>
Cash flows from operating activities:
Net income $ 604 $ 1,116 $ 710
-------- -------- --------
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization 6,182 4,860 6,613
Recovery of investment in direct financing leases 6,362 6,913 13,840
Cost of sales 8,995 4,813 14,634
Provision for losses 430 2,940 1,315
Deferred income taxes (100) (2,630) (670)
Deferred financing costs (118) (594) -
Margin on MBank sale - (6,100) -
MBank sale proceeds 10,800 - -
Gain on sale of a portion of the investment in Corporate Express, Inc. - (671) -
Sales-type lease margin (191) (765) (1,062)
Decrease (increase) in accounts receivable (1,947) 1,062 2,131
Other (1,427) 3,390 (1,709)
-------- -------- --------
Total adjustments 28,986 13,218 35,092
-------- -------- --------
Net cash provided by operating activities 29,590 14,334 35,802
-------- -------- --------
Cash flows from investing activities:
Equipment purchased for leasing (23,979) (17,000) (3,446)
Investment in leased office facility and in capital expenditures (393) (178) (416)
Net receipts from affiliated public income funds ("PIFs") 1,222 1,961 2,811
Sale of a portion of the investment in Corporate Express, Inc. - 677 -
-------- -------- --------
Net cash used for investing activities (23,150) (14,540) (1,051)
-------- -------- --------
Cash flows from financing activities:
Proceeds from discounting of lease rentals 8,513 2,306 4,916
Principal payments on discounted lease rentals (5,821) (9,219) (21,725)
Proceeds from sales of common stock 25 217 10
Purchase of treasury shares (247) - -
Net borrowings (payments) on revolving credit facilities (2,649) 13,638 28
Payments on Term Loan (4,333) (7,885) (19,118)
-------- -------- --------
Net cash used for financing activities (4,512) (943) (35,889)
-------- -------- --------
Net increase (decrease) in cash and cash equivalents 1,928 (1,149) (1,138)
Cash and cash equivalents at beginning of year 923 2,072 3,210
-------- -------- --------
Cash and cash equivalents at end of year $ 2,851 $ 923 $ 2,072
======== ======== ========
Supplemental schedule of cash flow information:
Recourse interest paid $ 2,145 $ 1,535 $ 1,867
Non-recourse interest paid 983 1,112 3,055
Income taxes paid 2,264 1,444 809
Income tax refunds received 83 923 1,623
Supplemental schedule of non-cash investing and financing activities:
Discounted lease rentals assigned to lenders arising from equipment sales
transactions 14,095 3,123 36,612
Assumption of discounted lease rentals in lease acquisitions 19,324 5,550 15,795
Increase in residual values and other receivables relating to equipment sale
transactions 897 2,727 1,876
Cancellation of discounted lease rentals related to bankrupt lessee - 518 -
Cancellation of option agreement:
Decrease in accounts payable and other liabilities - 1,197 -
Decrease in other receivables relating to equipment sale transactions - 573 -
MBank sale:
Increase in accounts receivable - 10,800 -
Increase in accounts payable - 2,400 -
Decrease in other assets - 2,300 -
</TABLE>
The accompanying notes are an integral part
of these consolidated financial statements.
F - 6
<PAGE>
CAPITAL ASSOCIATES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. Summary of Significant Accounting Policies
------------------------------------------
GENERAL ACCOUNTING PRINCIPLES
-----------------------------
NATURE OF OPERATIONS
Capital Associates, Inc. ("CAI" or the "Company") was incorporated as a
holding company in October 1986. Its principal operating subsidiary,
Capital Associates International, Inc. ("CAII"), is primarily engaged in
(1) buying, selling, leasing, and remarketing new and used equipment, (2)
managing equipment on and off lease, (3) sponsoring, co-sponsoring,
managing and co-managing publicly-registered income funds and (4)
arranging equipment-related financing. The principal market for the
Company's activities is the United States.
USE OF ESTIMATES
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the
financial statements and the reported amounts of revenue and expenses
during the reporting period. For leasing entities, this includes the
estimate of residual values, as discussed below. Actual results could
differ from those estimates.
PRINCIPLES OF CONSOLIDATION
The consolidated financial statements include the accounts of CAI and its
subsidiaries. Intercompany accounts and transactions are eliminated in
consolidation.
The Company has investments in affiliated public income funds (the "PIFs",
consisting of both general partnership and subordinated limited
partnership interests) and other 50%-or-less owned entities. Such
investments are primarily accounted for using the equity method.
The parent company's assets consist solely of its investments in
subsidiaries and it has no liabilities separate from its subsidiaries.
CASH AND CASH EQUIVALENTS
Cash and cash equivalents include highly liquid investments with a
maturity of three months or less.
INCOME TAXES
The Company accounts for income taxes under the provisions of Statement of
Financial Accounting Standards No. 109, Accounting for Income Taxes ("SFAS
No. 109"). Under the asset and liability method of SFAS No. 109, deferred
tax assets and liabilities are recognized for the future tax consequences
attributable to differences between the financial statement carrying
amounts of existing assets and liabilities and their respective tax bases.
Deferred tax assets and liabilities are measured using enacted tax rates
expected to apply to taxable income in the years in which those temporary
differences are expected to be recovered or settled. Under SFAS No. 109,
the effect on deferred tax assets and liabilities of a change in tax rates
is recognized in income in the period that includes the enactment date.
F - 7
<PAGE>
CAPITAL ASSOCIATES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. Summary of Significant Accounting Policies, continued
------------------------------------------
GENERAL ACCOUNTING PRINCIPLES, continued
-----------------------------
EQUIPMENT HELD FOR SALE OR RE-LEASE
Equipment held for sale or re-lease, recorded at the lower of cost or
market value expected to be realized, consists of equipment previously
leased to end users which has been returned to the Company following lease
expiration.
EARNINGS PER COMMON AND DILUTIVE COMMON EQUIVALENT SHARE
Primary and fully diluted earnings per common and dilutive common
equivalent share are computed by dividing net income by the weighted
average number of shares of common stock and dilutive common stock
equivalents (consisting solely of common stock options) outstanding during
the period. Fiscal year 1996 dilutive common stock equivalents were
reduced by the effect of the employee stock option buyout discussed in
Footnote 13 to Notes to Consolidated Financial Statements.
RECLASSIFICATIONS
Certain reclassifications have been made to prior years' financial
statements to conform to the current year's presentation.
RECENTLY ISSUED FINANCIAL ACCOUNTING STANDARDS
Statement of Financial Accounting Standards No. 123, Accounting for
Stock-based Compensation, was issued in October 1995. The Company will be
required to adopt the new standard no later than fiscal year 1997,
although early adoption is permitted. This standard establishes the fair
value based method (the "SFAS 123 Method") rather than the intrinsic value
based method as the preferred accounting methodology for stock based
compensation arrangements. Entities are allowed to (i) continue to use the
intrinsic value based methodology in their basic financial statement and
provide in the footnotes pro forma net income and earnings per share
information as if the SFAS 123 Method had been adopted, or (ii) adopt the
SFAS 123 Method. The SFAS 123 Method will result in higher recorded
compensation cost for the Company. The Company is continuing to evaluate
whether or not it will change to the recognition provisions of SFAS 123.
The Company adopted Statement of Financial Accounting Standards No. 121,
Accounting for the Impairment of Long-lived Assets and for Long-lived
Assets to be Disposed Of ("SFAS No. 121"), effective June 1, 1995. SFAS
No. 121 requires that long-lived assets, including operating leases, and
certain identifiable intangibles to be held and used by an entity be
reviewed for impairment whenever events or changes in circumstances
indicate that the carrying amount of an asset may not be recoverable. In
performing the review for recoverability, the entity should estimate the
future cash flows expected to result from the use of the asset and its
eventual disposition. If the sum of the expected future cash flows
(undiscounted and without interest charges) is less than the carrying
amount of the asset, an impairment loss is recognized. Otherwise, an
impairment loss is not recognized. Measurement of an impairment loss for
long-lived assets, including operating leases, and identifiable
intangibles held by the Company is based on the fair value of the asset
calculated by discounting the expected future cash flows at an appropriate
interest rate. The adoption of this statement did not have a material
effect on the Company's financial condition or results of operations.
F - 8
<PAGE>
CAPITAL ASSOCIATES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. Summary of Significant Accounting Policies, continued
------------------------------------------
GENERAL ACCOUNTING PRINCIPLES, continued
-----------------------------
EQUIPMENT LEASING AND SALES
Lease Accounting - Statement of Financial Accounting Standards No. 13,
Accounting for Leases, requires that a lessor account for each lease by
either the direct financing, sales-type or operating lease method. Direct
financing and sales-type leases are defined as those leases which transfer
substantially all of the benefits and risks of ownership of the equipment
to the lessee. The Company currently utilizes (i) the direct financing or
the operating lease method for substantially all of the Company's lease
originations and (ii) the sales-type or the operating lease method for
substantially all lease activity for an item of equipment subsequent to
the expiration of the initial lease term. For all types of leases, the
determination of profit considers the estimated value of the equipment at
lease termination, referred to as the residual value. After the
origination of a lease, the Company may engage in financing of lease
receivables on a non-recourse basis (i.e., "non-recourse debt" or
"discounted lease rentals") and/or equipment sale transactions to reduce
or recover its investment in the equipment.
The Company's accounting methods and their financial reporting effects are
described below:
LEASE INCEPTION
DIRECT FINANCING LEASES ("DFLS") - The cost of equipment is recorded as
net investment in DFLs. Leasing revenue, which is recognized over the
term of the lease, consists of the excess of lease payments plus the
estimated residual value over the equipment's cost. Earned income is
recognized monthly to provide a constant yield and is recorded in
leasing revenue in the accompanying statements of income. Initial direct
costs ("IDC") are capitalized and amortized over the lease term in
proportion to the recognition of earned income. Amortization of IDC is
recorded as leasing costs in the accompanying statements of income.
Residual values are established at lease inception equal to the
estimated value to be received from the equipment following termination
of the initial lease (which in certain circumstances includes
anticipated re-lease proceeds) as determined by the Company. In
estimating such values, the Company considers all relevant information
and circumstances regarding the equipment and the lessee.
OPERATING LEASES ("OLS") - The cost of equipment is recorded as leased
equipment and is depreciated on a straight-line basis over the lease
term to an amount equal to the estimated residual value at the lease
termination date. Leasing revenue consists principally of monthly
rentals. IDC are capitalized and amortized over the lease term in
proportion to the recognition of rental income. Depreciation expense and
amortization of IDC are recorded as leasing costs in the accompanying
statements of income. Residual values are established at lease inception
equal to the estimated value to be received from the equipment following
termination of the initial lease (which in certain circumstances
includes anticipated re-lease proceeds) as determined by the Company. In
estimating such values, the Company considers all relevant information
and circumstances regarding the equipment and the lessee. Because
revenue, depreciation expense and the resultant profit margin before
interest expense are recorded on a straight-line basis, and interest
expense on discounted lease rentals is incurred on the interest method,
profit is skewed toward lower returns in the early years of the term of
an OL and higher returns in later years.
F - 9
<PAGE>
CAPITAL ASSOCIATES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. Summary of Significant Accounting Policies, continued
------------------------------------------
GENERAL ACCOUNTING PRINCIPLES, continued
-----------------------------
EQUIPMENT LEASING AND SALES, continued
TRANSACTIONS SUBSEQUENT TO LEASE INCEPTION
NON-RECOURSE DISCOUNTING OF RENTALS - The Company may assign the future
rentals from leases to financial institutions at fixed interest rates on
a non-recourse basis. In return for such assigned future rentals, the
Company receives the discounted value of the rentals in cash. In the
event of default by a lessee, the financial institution has a first lien
on the underlying leased equipment, with no further recourse against the
Company. Cash proceeds from such financings are recorded on the balance
sheet as discounted lease rentals. As lessees make payments to financial
institutions, leasing revenue and interest expense are recorded.
SALES TO PRIVATE INVESTORS OF EQUIPMENT UNDER LEASE - The Company may
sell title to leased equipment that in some cases is subject to existing
discounted lease rentals in equipment sale transactions with third-party
investors. In such transactions, the investors obtain ownership of the
equipment as well as rights to equipment rentals. Upon sale, the Company
records equipment sales revenue equal to the sales price of the
equipment which may include a residual interest retained by the Company
(recorded as an asset at present value using an appropriate interest
rate) and records equipment sales cost equal to the carrying value of
the related assets (including remaining unamortized IDC). Income is
recorded on residual interests retained by the Company after cumulative
cash collections on such residuals exceed the recorded asset amount.
Fees for remarketing equipment associated with such transactions are
reflected in operations as realized.
Other accounts arising from private equity sales include:
DISCOUNTED LEASE RENTALS, ETC. - Pursuant to FASB Technical Bulletin
No. 86-2, although private investors and PIFs may acquire the
equipment sold to them by the Company subject to the associated
non-recourse debt (i.e., discounted lease rentals), the debt is not
removed from the balance sheet unless such debt has been legally
assumed by the third-party investors. If not legally assumed, a
corresponding asset ("discounted lease rentals assigned to lenders
arising from equipment sale transactions") is recorded representing
the present value of the end user rentals receivable relating to such
transactions. Interest income is recorded on the discounted lease
rentals and an equal amount of interest expense on the related
liability is recorded in the accompanying statements of income.
SALE-LEASEBACK TRANSACTIONS - In sale-leaseback transactions, the
Company leases equipment, obtains non-recourse financing on the
equipment, sells the equipment to a third party and leases the
equipment back from the third party. Income in a sale-leaseback
transaction is deferred and principally amortized over the leaseback
term in proportion to the reduction in the leased asset. For
financial reporting purposes, a note receivable from the third-party,
a capital lease obligation equal to the present value of the
leaseback payments and a deferred gain are recorded at the time of
the transaction. Amortization of the deferred gain is generally
recorded as a reduction of leasing costs and expenses in the
accompanying statements of income unless the estimated residual value
of the underlying equipment has experienced an other than temporary
decline in value, in which case amortization ceases. The Company has
not entered into a sale/leaseback transaction since fiscal year 1991.
F - 10
<PAGE>
CAPITAL ASSOCIATES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. Summary of Significant Accounting Policies, continued
------------------------------------------
GENERAL ACCOUNTING PRINCIPLES, continued
-----------------------------
EQUIPMENT LEASING AND SALES, continued
INTEREST INCOME - Interest income, as shown in the accompanying
statements of income, includes (i) interest on discounted lease
rentals assigned to lenders arising from equipment sale transactions
and (ii) interest on notes receivable arising from sale-leaseback
transactions.
SALES TO PIFS - Upon the sale of equipment to its PIFs, the Company
records equipment sales revenue equal to the sales price of the
equipment (including any acquisition fees earned) and costs of sales
equal to the carrying value of the related assets (including
remaining unamortized IDC). Fees for services the Company performs
for the PIFs are recognized at the time the services are performed.
TRANSACTIONS SUBSEQUENT TO INITIAL LEASE TERMINATION
After the initial term of equipment under lease expires, the equipment
is either sold or released. When the equipment is sold, the remaining
net book value of equipment sold is removed and gain or loss recorded.
When the equipment is released, the Company utilizes the sales-type
method (described below) or the OL method (described above).
SALES-TYPE LEASES
The excess of the present value of (i) future rentals and (ii) the
estimated residual value (collectively, "the net investment") over the
carrying value of the equipment subject to the sales-type lease is
reflected in operations at the inception of the lease. Thereafter, the
net investment is accounted for as a DFL, as described above.
ALLOWANCE FOR LOSSES
An allowance for losses is maintained at levels determined by management
to adequately provide for any other than temporary declines in asset
values. In determining losses, economic conditions, the activity in used
equipment markets, the effect of actions by equipment manufacturers, the
financial condition of lessees, the expected courses of action by lessees
with regard to leased equipment at termination of the initial lease term,
and other factors which management believes are relevant, are considered.
Asset chargeoffs are recorded upon the termination or remarketing of the
underlying assets. Assets are reviewed quarterly to determine the adequacy
of the allowance for losses.
The Company evaluates the realizability of the carrying value of its
investment in its PIFs based upon all estimated future cash flows from the
PIFs. As a result of such analyses, certain distributions have been
accounted for as a recovery of cost instead of income.
2. Residual Values and Other Receivables Arising from Equipment Under Lease
--------------------------------------------------------------------------
Sold to Private Investors
-------------------------
As of May 31, 1996 and 1995, the equipment types for which the Company
recorded the present value of the estimated residual values and other
receivables arising from private sales of equipment under lease were (in
thousands):
F - 11
<PAGE>
CAPITAL ASSOCIATES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
2. Residual Values and Other Receivables Arising from Equipment Under Lease
--------------------------------------------------------------------------
Sold to Private Investors, continued
-------------------------
Description 1996 1995
----------- -------- --------
Mining, manufacturing and material handling $ 1,798 $ 786
Furniture and fixtures 1,220 1,284
Aircraft 136 396
Other miscellaneous equipment 190 404
------- -------
Total equipment residuals 3,344 2,870
Notes receivable due directly from investors 30 2,678
End user rentals under existing leases
assigned to the Company by investors - 60
------- -------
$ 3,374 $ 5,608
======= =======
Residual values and other receivables arising from equipment under lease
sold to private investors were net of an allowance for doubtful accounts
of $258,000 and $1,654,000 as of May 31, 1996 and 1995, respectively.
In certain sale transactions, the Company agreed to certain hold backs
related to the lessee's performance. Pursuant to such agreements, a
portion of the sales proceeds was placed in an interest-bearing escrow
account until such time as the performance objectives are met. Escrowed
amounts related to these transactions were $645,000 and $206,000 at May
31, 1996 and May 31, 1995, respectively and are included in Other Assets
in the accompanying Consolidated Balance Sheets.
3. Net Investment in DFLs
----------------------
The components of the Company's net investment in DFLs as of May 31, 1996
and 1995 were (in thousands):
1996 1995
-------- ---------
Minimum lease payments receivable $ 15,234 $ 21,486
Estimated residual values 2,139 1,161
IDC 124 159
Less unearned income (2,530) (3,487)
-------- --------
$ 14,967 $ 19,319
======== ========
F - 12
<PAGE>
CAPITAL ASSOCIATES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
4. Leased Equipment, net
----------------
The Company's investment in equipment under OLs, by major classes, as of
May 31, 1996 and 1995 were (in thousands):
1996 1995
-------- ---------
Material handling $ 29,793 $ 7,151
Other technology and communication equipment 8,807 5,536
Aircraft 4,901 4,125
Other 4,451 4,274
Furniture and fixtures 3,825 2,460
IBM processors and peripheral computer equipment 3,220 3,329
Mining equipment 15 3,989
IDC 487 239
-------- --------
55,499 31,103
Less accumulated depreciation (9,094) (8,700)
Less allowance for losses (1,120) (2,416)
-------- --------
$ 45,285 $ 19,987
======== ========
Depreciation on leased equipment was $5,205,000, $3,771,000 and $5,209,000
for fiscal years 1996, 1995 and 1994, respectively.
5. Future Minimum Lease Payments
-----------------------------
Future minimum lease payments receivable from noncancelable leases on
equipment owned by the Company as of May 31, 1996, are as follows (in
thousands):
Years Ending May 31 DFLs OLs
------------------- --------- --------
1997 $ 7,781 $ 13,317
1998 3,305 10,331
1999 2,215 7,356
2000 1,570 5,195
Thereafter 363 7,465
--------- --------
$ 15,234 $ 43,664
========= ========
6. Notes Receivable and Obligations Under Capital Leases Arising from
--------------------------------------------------------------------------
Sale-leaseback Transactions
---------------------------
In sale-leaseback transactions, the leaseback payments are generally equal
in amount to the principal and interest payments due under the note
receivable and, accordingly, the notes receivable and obligations under
capital leases arising from sale-leaseback transactions do not represent
future net cash inflows or outflows of the Company.
F - 13
<PAGE>
CAPITAL ASSOCIATES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
6. Notes Receivable and Obligations Under Capital Leases Arising from
--------------------------------------------------------------------------
Sale-leaseback Transactions, continued
---------------------------
Aggregate maturities of notes receivable and obligations under capital
leases arising from sale-leaseback transactions outstanding as of May 31,
1996 are as follows (in thousands):
Notes
Years Ending May 31 Receivable Obligations
---------- -----------
1997 $ 7,666 $ 7,673
1998 743 748
------- -------
$ 8,409 $ 8,421
======= =======
Notes receivable and obligations arising from sale-leaseback transactions
bear interest at rates ranging from 10% to 12%.
7. Significant Customer and Concentration of Credit Risk
-----------------------------------------------------
One customer accounted for 42% of the Company's revenues in fiscal year
1996. No customer accounted for at least 10% of the Company's revenues in
fiscal years 1995 or 1994.
The Company leases various types of equipment to companies in diverse
industries throughout the United States. To minimize credit risk, the
Company generally leases equipment to (i) companies that have a credit
rating of not less than Baa as determined by Moody's Investor Services,
Inc., or comparable credit ratings as determined by other recognized
credit rating services, or (ii) companies, which although not rated by a
recognized credit rating service or rated below Baa, are believed by the
Company to be sufficiently creditworthy to satisfy the financial
obligations under the lease.
At May 31, 1996, equipment under OLs and DFLs owned by the Company was
leased to companies with the following credit ratings:
Percentage of the
net book value of
Credit Rating equipment under lease
------------- ---------------------
Baa (or equivalent) or above 91%
Below Baa (or equivalent) 1
In bankruptcy (see Footnote 15 to Notes to
Consolidated Financial Statements) 8
----
100%
====
8. Discounted Lease Rentals
------------------------
Discounted lease rentals outstanding at May 31, 1996 bear interest at
rates between 5% to 17%. Aggregate maturities of such non-recourse
obligations are (in thousands):
F - 14
<PAGE>
CAPITAL ASSOCIATES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
8. Discounted Lease Rentals, continued
------------------------
Years Ending May 31:
1997 $ 28,870
1998 15,664
1999 7,648
2000 3,146
--------
$ 55,328
9. Recourse Bank Debt
------------------
The Company extended its recourse bank debt and revolving credit
facilities (the "Bank Facility") on January 31, 1996. The lender group
currently consists of Norwest Bank Colorado, National Association, Agent,
Norwest Equipment Finance, Inc., Collateral Agent, Wells Fargo Bank, N.A.,
The Sumitomo Bank, Limited and The First National Bank of Boston. The
Borrower under the Bank Facility is Capital Associates International, Inc.
("CAII"), a wholly-owned subsidiary of the Company.
The Bank Facility consists of three components, a term loan facility (the
"Term Loan"), a revolving working capital credit facility (the "Working
Capital Facility") and a revolving warehousing credit facility (the
"Warehouse Facility"). The principal terms of the three facilities are as
follows (in thousands):
<TABLE>
<CAPTION>
Working Capital
Term Loan Facility Warehouse Facility Total Borrowings
----------------- ----------------- ------------------ ----------------
<S> <C> <C> <C>
Maturity Date November 30, 1997 November 30, 1996 November 30, 1996 N/A
Maximum amount $ 13,000 $ 5,000 lesser of $ 32,000 N/A
or borrowing base
Borrowings at May 31, 1996 6,500 0 11,038 $ 17,538
-------- -------- -------- =========
Potential availability at May 31, 1996 N/A $ 5,000 $ 20,962 N/A
======== ======== ========
Borrowings at May 31, 1995 $ 10,833 $ 1,531 $ 12,156 $ 24,520
======== ======== ======== =========
Interest rate at May 31, 1996 Prime* plus .75%** Prime* plus .75% Prime* plus .50%
<FN>
* Agent's Prime at May 31, 1996 was 8.25%.
** As required by the Bank Facility, CAII has acquired, at its own
cost (of $59,500), a 36-month interest rate cap contract at 10.5%
with respect to 50% of the principal balance of the Term Loan.
</FN>
</TABLE>
Principal reductions under the Term Loan are scheduled to occur as follows
(in thousands):
Fiscal year ending May 31, 1997 $ 4,333
Fiscal year 1998 through November 30, 1997 2,167
--------
$ 6,500
========
F - 15
<PAGE>
CAPITAL ASSOCIATES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
9. Recourse Bank Debt, continued
------------------
The Bank Facility (1) is collateralized by all of CAII's assets and (2) is
senior, in order of priority, to all of CAII's indebtedness, subject to
certain limited exceptions. The Company and certain of the Company's and
CAII's subsidiaries have guaranteed CAII's obligations under the Bank
Facility and have pledged all of their assets, with limited exceptions, to
collateralize their guarantees. The Bank Facility restricts CAII's ability
to pay dividends or loan or advance funds to the Company.
As of May 31, 1996, the Company was in compliance with the terms of the
Bank Facility.
10. Related Parties
---------------
PIFs:
The Company sponsors or co-sponsors seven PIFs that purchase equipment
under lease from the Company. The Company, through its PIF general partner
subsidiaries, acts as either a general partner or co-general partner of
each PIF for which it receives general partner distributions and
management fees. The Company, through CAII, also acts as the Class B
limited partner of each PIF for which it receives Class B limited partner
distributions. The Class B limited partner is required to make
subordinated limited partnership investments in the PIFs. The Class B
limited partner has a maximum remaining obligation to make further cash
contributions of approximately $0.5 million for all of the existing PIFs
(which relates solely to CPYF IV). Also, as of May 31, 1996, the Company
sold approximately $1 million of equipment under lease to CPYF IV for a
note receivable that was paid on June 13, and July 11, 1996. Amounts
related to the PIFs were as follows (in thousands):
1996 1995 1994
------ ------ ------
Equipment sales margin $1,539 $1,047 $1,774
Fees and distributions 2,958 2,908 3,293
Investment contributions in subordinated
limited partnership interests 260 230 200
11. Income Taxes
------------
The components of the income tax expense (benefit) charged to continuing
operations were (in thousands):
1996 1995 1994
------- ------- -------
Current:
Federal $ 653 $ 1,990 $ 1,000
State and local (351) 1,000 143
------- ------- -------
302 2,990 1,143
------- ------- -------
Deferred:
Federal (501) (1,800) (400)
State and local 401 (830) (270)
------- ------- -------
(100) (2,630) (670)
------- ------- -------
Total tax provision $ 202 $ 360 $ 473
======= ======= =======
F - 16
<PAGE>
CAPITAL ASSOCIATES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
11. Income Taxes, continued
------------
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:
1996 1995 1994
------ ------ ------
Computed "expected" tax expense $ 272 $ 502 $ 402
State tax provisions, net of federal benefits 50 88 71
Reduction in valuation allowance for deferred
income tax assets (120) (230) -
----- ----- -----
$ 202 $ 360 $ 473
===== ===== =====
Income taxes are provided on income from continuing operations at the
appropriate federal and state statutory rates applicable to such earnings.
The effective tax rate for the fiscal years ended May 31, 1996 and 1995
was 40%.
Components of income tax expense attributable to net income before income
taxes is as follows (in thousands):
<TABLE>
<CAPTION>
1996 1995 1994
------- ------- -------
<S> <C> <C> <C>
Current:
Taxes on net income before carryforwards $ 832 $ 9,390 $ 8,593
Benefit of loss carryforwards utilized - (5,800) (7,050)
Benefit of investment tax credit ("ITC")
carryforward utilized (530) (600) (400)
------- ------- -------
302 2,990 1,143
------- ------- -------
Deferred:
Tax effect of net change in temporary differences (510) (7,200) (7,850)
Loss carryforwards utilized - 5,800 7,050
ITC carryforward utilized 530 600 400
Alternative Minimum Tax ("AMT"), net of
utilization of investment tax credit carryforward - (1,600) (1,100)
Increase (decrease) in valuation allowance for
deferred income tax assets (120) (230) 830
------- ------- -------
(100) (2,630) (670)
------- ------- -------
Provision for income taxes $ 202 $ 360 $ 473
======= ======= =======
</TABLE>
Significant components of the Company's deferred tax liabilities and
assets as of May 31, 1996 and 1995, were as follows (in thousands):
F - 17
<PAGE>
CAPITAL ASSOCIATES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
11. Income Taxes, continued
------------
<TABLE>
<CAPTION>
1996 1995
-------- --------
<S> <C> <C>
Deferred income tax liabilities:
Direct finance leases accounted for as operating leases
for income tax purposes, and equipment depreciation
for tax purposes in excess of financial reporting depreciation $ 2,000 $ 2,400
Residual values and other receivables arising from equipment under lease
sold to private investors recognized for financial
reporting purposes, but not for tax reporting purposes 1,300 1,000
-------- --------
Total deferred income tax liabilities 3,300 3,400
-------- --------
Deferred income tax assets:
Other assets and liabilities, net 1,800 900
Investment tax credit carryforwards 1,900 7,400
AMT credit carryforwards 3,300 3,300
-------- --------
Total deferred income tax assets 7,000 11,600
Valuation allowance for deferred income tax assets (1,800) (6,400)
-------- --------
Net deferred income tax assets 5,200 5,200
-------- --------
Net deferred income tax asset (liability) $ 1,900 $ 1,800
======== ========
</TABLE>
The Company has established a valuation allowance for deferred taxes due
to the uncertainty that the full amount of the ITC carryforward will be
utilized prior to expiration. 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 deferred tax assets. The reduction
in the valuation allowance recorded in fiscal 1996 and 1995 of $120,000
and $230,000 respectively, represents the utilization of an ITC
carryforward for which a valuation allowance had previously been provided.
At May 31, 1996, the Company had an ITC carryforward of $6.9 million,
which expires from 1997 through 2001, and AMT credits of $3.3 million. Due
to a change in control, described below, provisions of the Internal
Revenue Code limit the annual future ITC carryforward and AMT credit
carryforward utilization to $370,000 per year. As a result, the Company
will only be able to utilize $1.9 million of ITC before the remaining
credits expire. Because of this limitation of the utilization of ITC, the
related deferred income tax asset in the amount of $4.5 million was
written-off against the valuation allowance. Under present federal tax
law, AMT credits may be carried forward indefinitely and may be utilized
to reduce regular tax liability to an amount equal to AMT liability.
F - 18
<PAGE>
CAPITAL ASSOCIATES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
12. Common and Preferred Stock
--------------------------
The Company has authority to issue 2,500,000 shares of preferred stock at
$0.008 par value. At May 31, 1996, no shares of preferred stock had been
issued.
TERMINATION OF STOCKHOLDERS' AGREEMENT
Effective as of August 31, 1995, two principal stockholders of the Company
(the "Principal Stockholders") and the Company, constituting all of the
remaining parties to the Stockholders' Agreement agreed to terminate the
Stockholders' Agreement. In connection therewith, the Company notified the
Principal Stockholders that it intended to cease making premium payments
for the key-man life insurance maintained by the Company to fund its
obligation to repurchase the Principal Stockholders' Company common stock
upon the occurrence of certain events and, in accordance with the terms of
the Stockholders' Agreement, the Principal Stockholders exercised their
options to acquire such insurance policies for fifty percent (50%) of
their net cash surrender values (which totaled approximately $650,000 at
August 31, 1995) resulting in an expense to the Company of approximately
$325,000. In November 1995, the Principal Stockholders paid to the Company
$347,097 (which included premiums paid by the Company through November
1995) for the insurance policies maintained by the Company on the
Principal Stockholders' lives. During fiscal year 1995, the Company paid
premiums of $88,535 with respect to the life insurance policies covering
the Principal Stockholders.
REVERSE SPLIT
On November 2, 1995, after obtaining the necessary Board of Director and
stockholder approvals, the Company amended its Certificate of
Incorporation to effect a reverse split of its common stock pursuant to
which each share of common stock issued and outstanding immediately prior
to the effective date of the reverse split was automatically reclassified
as, and changed into, one-half (1/2) share of common stock. The reverse
split did not change (1) the par value of the common stock (which remains
$.008 per share after the reverse split), (2) the authorized number of
shares of common stock (which remains at 15,000,000 shares after the
reverse split) or (3) the voting rights of the common stock (which remain
at one vote per share of common stock after the reverse split). Fractional
shares of common stock created in the reverse split were redeemed for cash
pursuant to the formula set forth in the Certificate of Amendment to the
Certificate of Incorporation of the Company. Accordingly, all share and
per share data, as appropriate, reflect the effects of this reverse split
for all periods presented.
CHANGE IN CONTROL OF REGISTRANT
On November 10, 1995, MCC Financial ("MCC") acquired voting control of the
Company through a private stock transaction and the delivery of proxies
for shares of common stock subject to purchase in the future pursuant to
agreements (the "Stock Purchase Agreements") executed by and between MCC
and the Company's Principal Stockholders.
Pursuant to these Stock Purchase Agreements, MCC acquired 65,120 shares of
common stock for a purchase price of $3.30 per share or an aggregate
amount of $214,896. In addition, MCC acquired the right to purchase an
additional 1,245,000 shares of common stock in the future for an aggregate
purchase price of approximately $4.5 million.
F - 19
<PAGE>
CAPITAL ASSOCIATES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
12. Common and Preferred Stock, continued
--------------------------
CHANGE IN CONTROL OF REGISTRANT, continued
On January 9 and 10, 1996, MCC completed the purchase of 550,000 shares of
common stock for a purchase price of $3.30 per share or an aggregate
amount of $1,815,000.
13. Stock Options
-------------
The Company has a qualified incentive stock option plan whereby stock
options may be granted to employees to purchase shares of the Company's
common stock at prices equal to 100% of the estimated fair value at the
date of grant. The Company has a non-qualified plan covering all directors
except the CEO. Common stock received through the exercise of qualified
incentive stock options which are sold by the optionee within two years of
grant or one year of exercise result in a tax deduction for the Company
equivalent to the taxable gain recognized by the optionee.
Effective on May 31, 1996, the Company purchased 401,000 of the
outstanding options issued to current employees at a cost to the Company
of $557,000, which was equal to the difference of $2.45 and the exercise
price of each option purchased.
The following table summarizes the activity in this plan for the periods
indicated:
<TABLE>
<CAPTION>
Options Exercise Price Options
Outstanding Per Share Exercisable
------------ --------------- -----------
<S> <C> <C> <C>
Outstanding at May 31, 1993 1,176,000 0.1250 - 2.2500 668,000
=======
Exercised (12,000) 0.6800 - 1.1250
Granted 28,000 1.6250 - 2.4376
Canceled (60,000) 0.6800 - 2.2500
---------
Outstanding at May 31, 1994 1,132,000 0.1250 - 2.4376 841,000
=======
Exercised (227,000) 0.1250 - 2.1250
Granted 246,000 1.2500 - 1.3200
Canceled (104,000) 0.6800 - 2.3750
---------
Outstanding at May 31, 1995 1,047,000 0.6800 - 2.4376 835,000
=======
Exercised (32,000) 0.6800 - 1.1250
Granted 130,000 1.3756 - 1.9062
Canceled (51,000) 0.6800 - 2.2500
Purchased (401,000) 0.6800 - 2.2500
---------
Outstanding at May 31, 1996 693,000 0.6800 - 2.4376 641,000
========= =======
</TABLE>
F - 20
<PAGE>
CAPITAL ASSOCIATES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
14. Quarterly Financial Data (unaudited)
------------------------
Summarized quarterly financial data for the years ended May 31, 1996 and
1995 are (in thousands, except per share data):
Total Net Income Per Common and
Fiscal year 1996: Revenue Income Common Equivalent Share
---------------- ------- ------ -----------------------
First quarter $ 31,210 $ 57 $ .01
Second quarter 33,718 60 .01
Third quarter 59,089 136 .03
Fourth quarter 62,664 351 .07
Total Net Income Per Common and
Fiscal year 1995: Revenue Income Common Equivalent Share
---------------- ------- ------ -----------------------
First quarter $ 18,769 $ 163 $ .03
Second quarter 24,396 71 .01
Third quarter 29,471 54 .01
Fourth quarter 32,308 828 .16
15. Legal Proceedings
-----------------
MBANK LITIGATION. The MBank Litigation was settled on August 16, 1995 with
the exception of the claims asserted by Bank One, N.A., ("Bank One") in
its first amended complaint ("Bank One's Amended Complaint"). Bank One's
Amended Complaint does not assert any money damage claims against the
Company. The Company has filed a motion requesting dismissal of the claims
asserted against the Company in Bank One's Amended Complaint. As of July
16, 1996, the court has not ruled on (i) the Company's motion or (2) the
pending summary judgment motions of Bank One and FDIC concerning ownership
of the equipment.
On August 23, 1995, the Company received $10.8 million in settlement of
its claims in connection with the MBank Litigation. In accordance with the
terms of the settlement, on August 28, 1995, the Company delivered $2.2
million to Bank One in repayment of the monies received from Bank One in
1992 (along with interest thereon). On September 8, 1995, Bank One, which
is pursuing its lawsuit to obtain title to the MBank Equipment, rejected
the tender and returned the $2.2 million to the Company (while purporting
to reserve all rights to make a claim to such funds in the future). On
September 12, 1995, the Company deposited the $2.2 million returned by
Bank One in an escrow account with Norwest Bank, N.A., pending resolution
of Bank One's ongoing claims.
HEMMETER LITIGATION. In June 1995, Grand Palais Riverboat, Inc. (the
"Lessee"), failed to make lease payments due under its lease with the
Company. In July 1995, the Lessee filed for bankruptcy protection. In
October 1995, the Company obtained a judgment against the Guarantors
(Hemmeter Enterprises, Inc., two subsidiaries and two individual
guarantors) for the amounts due under the lease plus fees and late
charges, in the total amount of approximately $4 million. In November
1995, the corporate Guarantors filed for bankruptcy protection.
F - 21
<PAGE>
CAPITAL ASSOCIATES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
15. Legal Proceedings, continued
-----------------
In the fourth quarter of fiscal year 1996, the Company finalized a
settlement agreement with the corporate Guarantors in connection with the
payment of the Company's judgment and settlement of other pending claims
by the Company. Pursuant to the settlement agreement, the Company received
two promissory notes, one payable over two and one-half years and one
payable over five years, for the judgment amount plus interest at 9% per
annum. Payments received by the Company from the sale of the equipment on
lease to the Lessee (discussed in the following paragraph) are to be
credited against payments due under the five-year note.
During the fourth quarter of fiscal year 1996, the Company finalized an
agreement to sell the equipment which had been leased to the Lessee to the
purchaser of the Lessee's riverboat gaming operations for approximately
$2.5 million. The purchase price will be paid pursuant to the terms of an
eighteen month promissory note in monthly installments (or in a lump-sum
payment of approximately $2.3 million to be paid not later than August 1,
1996 in full satisfaction of the note) and is secured by a first priority
security interest in the equipment.
OTHER LITIGATION. The Company is also involved in 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.
16. Commitments
-----------
The Company leases office space under long-term non-cancelable operating
leases. The leases contain renewal options and provide for annual
escalation for utilities, taxes and service costs. Rent expense was
$425,000, $783,000 and $625,000 for fiscal years 1996, 1995 and 1994,
respectively.
Minimum future rental payments required by such leases are as follows (in
thousands):
Year Ending May 31,
1997 $ 429
1998 377
1999 350
2000 321
-------
$ 1,477
=======
17. Disclosures about Fair Value of Financial Instruments
-----------------------------------------------------
The following disclosure of the estimated fair value of financial
instruments was made in accordance with Statements of Financial Standards
No. 107 ("SFAS No. 107"), Disclosures about Fair Value of Financial
Instruments. SFAS No. 107 specifically excludes certain items from its
disclosure requirements such as the Company's investment in leased assets.
Accordingly, the aggregate fair value amounts presented are not intended
to represent the underlying value of the net assets of the Company.
F - 22
<PAGE>
CAPITAL ASSOCIATES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
17. Disclosures about Fair Value of Financial Instruments, continued
-----------------------------------------------------
The carrying amounts at May 31, 1996 for cash and cash equivalents,
accounts receivable, residual values and other receivables arising from
equipment under lease sold to private investors, recourse bank debt and
accounts payable and other liabilities approximate their fair values due
to the short maturity of these instruments, or because the related
interest rates approximate current market rates.
As of May 31, 1996, discounted lease rentals and discounted lease rentals
assigned to lenders arising from equipment sale transactions of
$55,328,000 and $35,498,000, respectively, have fair values of $54,460,000
and $34,941,000, respectively. The fair values were estimated utilizing
market rates of comparable debt having similar maturities and credit
quality as of May 31, 1996.
F - 23
<PAGE>
INDEPENDENT AUDITORS' REPORT
The Stockholders and Directors
Capital Associates, Inc.:
Under date of July 16, 1996, we reported on the consolidated balance sheets of
Capital Associates, Inc. and subsidiaries as of May 31, 1996 and 1995, and the
related consolidated statements of income, changes in stockholders' equity, and
cash flows for each of the years in the three year period ended May 31, 1996, as
contained in the Company's annual report on Form 10-K for the year 1996. In
connection with our audits of the aforementioned consolidated financial
statements, we also have audited the related financial statement schedule as
listed in the accompanying index. This financial statement schedule is the
responsibility of the Company's management. Our responsibility is to express an
opinion on this financial statement schedule based on our audits.
In our opinion, the related financial statement schedule, when considered in
relation to the basic consolidated financial statements taken as a whole,
presents fairly, in all material respects, the information set forth therein.
KPMG Peat Marwick LLP
/s/KPMG Peat Marwick LLP
------------------------
Denver, Colorado
July 16, 1996
F - 24
<PAGE>
CAPITAL ASSOCIATES, INC. AND SUBSIDIARIES
SCHEDULE II - VALUATION AND QUALIFYING
ACCOUNTS AND RESERVES
for the years ended May 31, 1996, 1995 and 1994
(in thousands)
<TABLE>
<CAPTION>
COLUMN A COLUMN B COLUMN C COLUMN D COLUMN E
-------- ---------- ------------------------------- ------------- ------------
Balance at Charged to Charged Balance
Beginning Costs and to Other at End of
Description of Period Expenses Accounts Deductions(1) Period
----------- ---------- ---------- --------- ------------- ------------
<S> <C> <C> <C> <C> <C>
Year ended May 31, 1996:
Allowance for doubtful accounts:
- - residual values and other receivables
arising from equipment under lease
sold to private investors $ 1,654 $ 524 $ - $ (1,920) $ 258
- - accounts receivable 48 - - (4) 44
Allowance for losses:
- - leased equipment 2,416 (94)(2) - (1,202) 1,120
------- ------- ------- -------- --------
$ 4,118 $ 430 $ - $ (3,126) $ 1,422
======= ======= ======= ======== ========
Year ended May 31, 1995:
Allowance for doubtful accounts:
- - residual values and other receivables
arising from equipment under lease
sold to private investors $ 6,934 $ 532 $ - $ (5,812) $ 1,654
- - accounts receivable 343 - (260) (35) 48
Allowance for losses:
- - leased equipment 1,741 2,408 - (1,733) 2,416
------- ------- ------- -------- --------
$ 9,018 $ 2,940 $ (260) $ (7,580) $ 4,118
======= ======= ======= ======== ========
Year ended May 31, 1994:
Allowance for doubtful accounts:
- - residual values and other receivables
arising from equipment under lease
sold to private investors $ 8,719 $ 82 $ - $ (1,867) $ 6,934
- - accounts receivable 593 - - (250) 343
Allowance for losses:
- - investment in affiliated public income
funds - 130 - (130) -
- - leased equipment 4,153 1,103 - (3,515) 1,741
------- ------- ------- -------- --------
$13,465 $ 1,315 $ - $ (5,762) $ 9,018
======= ======= ======= ======== ========
<FN>
(1) Principally charge-offs of assets against the established allowances.
(2) Includes $750,000 recovery from litigation settlement.
</FN>
</TABLE>
See accompanying independent auditors' report.
F - 25
<PAGE>
Exhibit 11
CAPITAL ASSOCIATES, INC. AND SUBSIDIARIES
COMPUTATION OF PRIMARY EARNINGS PER SHARE
<TABLE>
<CAPTION>
Year Ended May 31,
----------------------------------------------
1996 1995 1994
---------- ---------- ----------
<S> <C> <C> <C>
Shares outstanding at
beginning of period 5,091,000 4,864,000 4,827,000
Repurchases of common stock (129,000) - -
Shares issued during the
period (weighted average) 25,000 188,000 29,000
Dilutive shares contingently issuable
upon exercise of options
(weighted average) 999,000 953,000 1,126,000
Less shares assumed to have been purchased
for treasury with assumed proceeds
from exercise of stock options
(weighted average) (626,000) (680,000) (531,000)
Effect of employee stock option buyout (174,000) - -
--------- ----------- ---------
Total shares, primary 5,186,000 5,325,000 5,451,000
========= =========== =========
Net Income $ 604,000 $ 1,116,000 $ 710,000
========= =========== =========
Income per common and common
equivalent share, primary $ .12 $ .21 $ .13
========= =========== =========
</TABLE>
F - 26
<PAGE>
Exhibit 11
CAPITAL ASSOCIATES, INC. AND SUBSIDIARIES
COMPUTATION OF FULLY DILUTED EARNINGS PER SHARE
<TABLE>
<CAPTION>
Year Ended May 31,
----------------------------------------------
1996 1995 1994
---------- ---------- ----------
<S> <C> <C> <C>
Shares outstanding at
beginning of period 5,091,000 4,864,000 4,827,000
Repurchases of common stock (129,000) - -
Shares issued during the
period
(weighted average) 25,000 188,000 29,000
Dilutive shares contingently issuable
upon exercise of options
(weighted average) 999,000 953,000 1,126,000
Less shares assumed to have been purchased
for treasury with assumed proceeds
from exercise of stock options
(weighted average) (338,000) (668,000) (531,000)
Effect of employee stock option buyout (255,000) - -
--------- ----------- ---------
Total shares, fully diluted 5,393,000 5,337,000 5,451,000
========= =========== =========
Net Income $ 604,000 $ 1,116,000 $ 710,000
========= =========== =========
Income per common and common
equivalent share, fully diluted $ .11 $ .21 $ .13
========= =========== =========
</TABLE>
F - 27
Exhibit 21
LIST OF SUBSIDIARIES
OF
CAPITAL ASSOCIATES, INC.
Name Place of Incorporation
---- ----------------------
Capital Associates International, Inc. Colorado
CAI Equipment Leasing I Corporation Colorado
CAI Equipment Leasing II Corporation Colorado
CAI Equipment Leasing III Corporation Colorado
CAI Equipment Leasing IV Corporation Colorado
CAI Equipment Leasing V Corporation Colorado
CAI Leasing Canada, Limited Alberta, Canada
CAI Partners Management Company Colorado
CAI Securities Corporation California
CAI - UBK Equipment Corporation Colorado
Capital Equipment Corporation Colorado
Whitewood Corporation Colorado
CAI Lease Securitization-I Corporation Delaware
Exhibit 23
Independent Auditors' Consent
The Board of Directors
Capital Associates, Inc.:
We consent to incorporation by reference in the registration statements on Forms
S-8 (No. 33-59570 and No. 33- 68514) and Form S-3 (No. 33-65059) of Capital
Associates, Inc. of our reports dated July 16, 1996 relating to the consolidated
balance sheets of Capital Associates, Inc. and subsidiaries as of May 31, 1996
and 1995 and the related consolidated statements of income, changes in
shareholders' equity and cash flows and related schedules for the three years
then ended, which reports appear in the May 31, 1996 Annual Report on Form 10-K
of Capital Associates, Inc.
KPMG Peat Marwick LLP
/s/KPMG Peat Marwick LLP
------------------------
Denver, Colorado
July 16, 1996
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
The schedule contains summary financial information extracted from the
consolidated balance sheets and consolidated statements of income and is
qualified in its entirety by reference to such financial statements.
</LEGEND>
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 12-MOS
<FISCAL-YEAR-END> MAY-31-1996
<PERIOD-END> MAY-31-1996
<CASH> 2,851
<SECURITIES> 0
<RECEIVABLES> 2,794
<ALLOWANCES> 44
<INVENTORY> 177
<CURRENT-ASSETS> 0
<PP&E> 45,285
<DEPRECIATION> 0
<TOTAL-ASSETS> 127,511
<CURRENT-LIABILITIES> 0
<BONDS> 0
0
0
<COMMON> 32
<OTHER-SE> 22,849
<TOTAL-LIABILITY-AND-EQUITY> 104,630
<SALES> 166,242
<TOTAL-REVENUES> 186,681
<CGS> 161,797
<TOTAL-COSTS> 185,875
<OTHER-EXPENSES> 7,450
<LOSS-PROVISION> 430
<INTEREST-EXPENSE> 9,850
<INCOME-PRETAX> 806
<INCOME-TAX> 202
<INCOME-CONTINUING> 604
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 604
<EPS-PRIMARY> .12
<EPS-DILUTED> .11
</TABLE>
