SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
[x] Quarterly report pursuant to section 13 or 15(d) of the Securities Exchange
Act of 1934
For the quarterly period ended February 28, 1998
[ ] Transition report pursuant to section 13 or 15(d) of the Securities Exchange
Act of 1934.
Commission file number 0-15525
CAPITAL ASSOCIATES, INC.
------------------------------------------------------
(Exact name of registrant as specified in its charter)
DELAWARE 84-1055327
(State or other jurisdiction of (IRS Employer Identification No.)
incorporation or organization)
7175 WEST JEFFERSON AVENUE, LAKEWOOD, COLORADO 80235
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (303) 980-1000
Indicate by check mark whether the Registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes X No
----- -----.
The number of shares outstanding of the Registrant's $.008 par value common
stock at April 10, 1998, was 5,122,119.
Exhibit Index - Page 19
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<PAGE>
CAPITAL ASSOCIATES, INC. AND SUBSIDIARIES
INDEX
PAGE
PART I. FINANCIAL INFORMATION NUMBER
Item 1. Financial Statements (Unaudited)
Consolidated Balance Sheets - February 28, 1998
and May 31, 1997 3
Consolidated Statements of Income - Three and Nine
Months Ended February 28, 1998 and 1997 4
Consolidated Statements of Cash Flows - Nine Months
Ended February 28, 1998 and 1997 5
Notes to Consolidated Financial Statements 6 - 8
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations 9 - 17
PART II. OTHER INFORMATION
Item 1. Legal Proceedings 18
Item 5. Other 18
Item 6. Exhibits and Reports on Form 8-K 18
Exhibit Index 19
Signature 20
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<PAGE>
CAPITAL ASSOCIATES, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(Unaudited)
(Dollars in thousands)
ASSETS
February 28, May 31,
1998 1997
------------ --------
Cash and cash equivalents $ 2,770 $ 6,194
Receivables from affiliated limited partnerships 475 726
Accounts receivable, net 5,330 417
Equipment held for sale or re-lease 812 1,242
Residual values and other receivables arising from
equipment under lease sold to private investors 3,509 4,334
Net investment in direct finance leases 26,366 7,700
Leased equipment, net 107,799 71,443
Investments in affiliated limited partnerships 3,716 6,642
Deferred income taxes 2,300 2,300
Other assets 5,557 3,674
Discounted lease rentals assigned to lenders
arising from equipment sale transactions 26,413 41,845
-------- --------
$185,047 $146,517
======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY
Recourse bank debt $ 41,010 $ 20,712
Accounts payable - equipment purchases 36,996 30,231
Other liabilities 12,932 10,607
Discounted lease rentals 69,175 61,466
-------- --------
160,113 123,016
-------- --------
Stockholders' equity:
Common stock 32 32
Additional paid-in capital 16,897 16,897
Retained earnings 8,245 6,854
Treasury stock (240) (282)
-------- --------
Total stockholders' equity 24,934 23,501
-------- --------
$185,047 $146,517
======== ========
The accompanying notes are an integral part
of these consolidated financial statements.
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<PAGE>
CAPITAL ASSOCIATES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
(Unaudited)
(Dollars in thousands, except earnings per share)
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
-------------------------------- ---------------------------
February 28, February 28, February 28, February 28,
1998 1997 1998 1997
------------ ------------ ------------ ------------
<S> <C> <C> <C> <C>
Revenue:
Equipment sales to affiliated
limited partnerships $ 14,857 $ 25,674 $ 38,560 $ 55,751
Other equipment sales 59,133 43,073 138,066 108,112
Leasing 6,804 3,492 15,353 11,228
Interest 445 1,060 2,337 3,290
Other 1,070 703 3,270 2,199
--------- --------- --------- ---------
Total revenue 82,309 74,002 197,586 180,580
--------- --------- --------- ---------
Costs and expenses:
Equipment sales 71,603 67,132 155,606 160,128
Equipment acquired from
affiliated limited partnership - - 15,338 -
Leasing 4,782 2,183 10,435 6,462
Operating and other 3,289 2,190 8,382 6,873
Provision for losses 100 235 500 340
Interest:
Non-recourse debt 1,148 1,435 3,815 4,416
Recourse debt 700 430 1,655 1,452
--------- --------- --------- ---------
Total costs and expenses 81,622 73,605 195,731 179,671
--------- --------- --------- ---------
Net income before income taxes 687 397 1,855 909
Income tax expense 172 99 464 227
--------- --------- --------- ---------
Net income $ 515 $ 298 $ 1,391 $ 682
========= ========= ========= =========
Earnings per common share:
Basic $ 0.10 $ 0.06 $ 0.27 $ 0.14
========= ========= ========= =========
Assuming dilution $ 0.10 $ 0.06 $ 0.26 $ 0.13
========= ========= ========= =========
Weighted average number of common
shares outstanding:
Basic 5,077,000 5,005,000 5,071,000 5,001,000
========= ========= ========= =========
Assuming dilution 5,371,000 5,384,000 5,398,000 5,335,000
========= ========= ========= =========
</TABLE>
The accompanying notes are an integral part
of these consolidated financial statements.
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<PAGE>
CAPITAL ASSOCIATES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
(Dollars in thousands)
<TABLE>
<CAPTION>
Nine Months Ended
--------------------------
February 28,
1998 1997
---------- ----------
<S> <C> <C>
Net cash provided by operating activities $ 30,889 $ 28,803
---------- ----------
Cash flows from investing activities:
Equipment purchased for leasing, net (61,489) (23,776)
Investment in leased office facility and capital expenditures (454) (333)
Net receipts from affiliated limited partnerships 3,177 1,416
---------- ----------
Net cash used for investing activities (58,766) (22,693)
---------- ----------
Cash flows from financing activities:
Proceeds from discounting of lease rentals 13,613 10,566
Principal payments on discounted lease rentals (9,458) (9,273)
Proceeds from sales of common stock - 9
Purchase of non-employee stock options - (138)
Net borrowings (payments) on revolving credit facilities 19,840 (388)
Net borrowings (payments) on Term Loan 458 (3,250)
---------- ----------
Net cash provided by (used for) financing activities 24,453 (2,474)
---------- ----------
Net (decrease) increase in cash and cash equivalents (3,424) 3,636
Cash and cash equivalents at beginning of period 6,194 2,851
---------- ----------
Cash and cash equivalents at end of period $ 2,770 $ 6,487
========== ==========
Supplemental schedule of cash flow information:
Recourse interest paid $ 1,655 $ 1,452
Non-recourse interest paid 1,496 1,124
Income taxes paid 859 106
Income tax refunds received 70 316
Supplemental schedule of non-cash investing and financing activities:
Discounted lease rentals assigned to lenders arising from
equipment sales transactions 942 22,499
Assumption of discounted lease rentals in lease acquisitions 18,498 20,732
Fair value of assets acquired, including cash 5,375 -
Liabilities assumed and incurred in acquisition 4,142 -
</TABLE>
The accompanying notes are an integral part
of these consolidated financial statements.
5 of 20
<PAGE>
CAPITAL ASSOCIATES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
1. Basis of Presentation
---------------------
The accompanying unaudited consolidated financial statements have been
prepared in accordance with generally accepted accounting principles for
interim financial information and the instructions to Form 10-Q and Rule
10-01 of Regulation S-X. Accordingly, they do not include all of the
information and disclosures required by generally accepted accounting
principles for annual financial statements. In the opinion of management,
all adjustments (consisting only of normal recurring adjustments)
considered necessary for a fair presentation have been included. For
further information, please refer to the financial statements of Capital
Associates, Inc. (the "Company"), and the related notes, included within
the Company's Annual Report on Form 10-K for the fiscal year ended May 31,
1997 (the "1997 Form 10-K"), previously filed with the Securities and
Exchange Commission.
The balance sheet at May 31, 1997 has been derived from the audited
financial statements included in the Company's 1997 Form 10-K.
2. Acquisition
-----------
Effective November 1, 1997, CAII acquired all of the outstanding shares of
DBL, Inc. d/b/a Connecting Point. DBL, Inc. has been renamed (and is doing
business as) Capital Associates Technology Group ("CATG"). The purchase
price consisted of $1,200,000 in cash (paid in December 1997) and a
$2,140,000 four year note. The Company may be required to make additional
payments of up to $221,750 per year ending October 31, 2001, contingent
upon the results of CATG's operations over the course of that period. CATG
is a desktop information technology solutions integrator and equipment
reseller.
The $2,140,000 note payable to the sellers (included in Other Liabilities)
earns interest at the rate of 10% per annum and is payable in monthly
installments of $58,000 beginning December 12, 1997 through November 12,
2000, and $42,056.86 beginning December 12, 2000 and continuing through
November 12, 2001. Interest expense for the quarter ended February 28,
1998 was approximately $51,000. The note is secured by a second lien in
all the assets of CATG.
The acquisition has been accounted for using the purchase method of
accounting, and accordingly, the purchase price was allocated to the
assets purchased and the liabilities assumed based on their fair values at
the date of acquisition. The excess of the purchase price over the fair
values of the net assets acquired of approximately $2.0 million (which
will increase for any future contingent cash payment), has been recorded
as goodwill (included in other assets), and is being amortized on a
straight-line basis over 15 years. The amount of goodwill amortized during
the quarter ended February 28, 1998 was approximately $33,000.
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<PAGE>
CAPITAL ASSOCIATES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
2. Acquisition, continued
-----------
The Company's Consolidated Statements of Operations reflect the results of
operations for Connecting Point for the period from acquisition through
February 28, 1998, which was not significant.
3. Recourse Bank Debt
------------------
On November 26, 1997, the Company obtained a new $60 million senior,
secured debt facility (the "Senior Facility") in the form of a term loan
("Term Loan"), an acquisition term loan ("Acquisition Term Loan"), working
capital revolving credit loans ("Working Capital Facility") and warehouse
revolving credit loans ("Warehouse Credit Facility"). The lender group
consists of the agent bank, CoreStates Bank, N.A., and participating
lenders, BankBoston, N.A., Colorado National Bank, Norwest Bank Colorado,
N.A., and European America Bank (the "Lender Group"). The term of the
Senior Facility expires on November 25, 1998 and may be renewed annually
in Lender's sole discretion. Interest on the Senior Facility is tied to
the Lender Group's prime rate or the LIBOR rate (8.5% and 5.68%,
respectively at February 28, 1998) plus the Applicable Margin. The
principal terms of the Warehouse Credit Facility and Working Capital
Facility are as follows:
Warehouse Working
(Dollars in thousands) Credit Facility Capital Facility
--------------- ----------------
Maximum Amount $ 51,000 $ 5,000
Borrowings at February 28, 1998 38,385 0
Potential availability at
February 28, 1998 12,615 5,000
Applicable Prime Rate Margin 0.0% .25%
Applicable LIBOR Rate Margin 2.5% 2.75%
The Term Loan amount is $2.8 million and has an amortization term of four
years with a balloon payment of $1.4 million after two years. The
Acquisition Term Loan commitment is $1.2 million and is expected to be
funded by the Lender Group during the fourth quarter of fiscal year 1998.
The Acquisition Term Loan has an amortization term of four years. The
proceeds will provide permanent funding for the CATG acquisition discussed
in Footnote 2 of the Notes to Consolidated Financial Statements. Both
loans bear interest at Prime plus .75%.
The Company is required to pay a quarterly commitment fee equal to .375%
of the unused portion of the Working Capital Facility and the Warehouse
Credit Facility. The Senior Facility contains certain provisions which
limit the Company as to additional indebtedness, sale of assets, liens,
guarantees, and distributions. Additionally, the Company must maintain
certain specified financial ratios. The Senior Facility replaces the
terminated Bank Facility, which expired under its terms as of November 30,
1997.
7 of 20
<PAGE>
CAPITAL ASSOCIATES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
4. Stockholders Equity
-------------------
In February 1997, the Financial Accounting Standards Board issued
Statement of Financial Accounting Standards No. 128, Earnings Per Share
("Statement 128"), effective for periods ending after December 15, 1997.
Statement 128 changes the computation and presentation requirements for
earnings per share for entities with publicly held common stock or
potential common stock. Under such requirements the Company is required to
present both basic earnings per share and diluted earnings per share.
Basic earnings per share is computed by dividing income available to
common stockholders by the weighted average number of common shares
outstanding during the period. Diluted earnings per share is computed by
dividing income available to common stockholders by all dilutive potential
common shares outstanding during the period. The adoption of Statement 128
by the Company as of December 31, 1997, did not have a material effect on
previously presented income per share amounts for 1996.
The following is a reconciliation of the weighted average number of common
shares basic to the weighted average number of common shares assuming
dilution:
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
---------------------------- ---------------------------
February 28, February 28, February 28, February 28,
1998 1997 1998 1997
------------ ------------ ------------ ------------
<S> <C> <C> <C> <C>
Weighted average number of common
shares - basic 5,077,000 5,005,000 5,071,000 5,001,000
Common stock options (utilizing
treasury stock method) 294,000 379,000 327,000 334,000
--------- --------- --------- ---------
Weighted average number of common
shares-assuming dilution 5,371,000 5,384,000 5,398,000 5,335,000
========= ========= ========= =========
</TABLE>
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<PAGE>
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations
I. Results of Operations
---------------------
GENERAL COMMENTS
Operating results are subject to fluctuations resulting from several
factors, including (i) the seasonality of lease originations, (ii)
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 and (iii) the level of fee income obtained from the sale of
leases in excess of lease equipment cost. The Company will adjust its 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, residual risk and its fiduciary duty to originate leases
for its PIFs.
Because the Company finances certain of its lease transactions with
recourse and non-recourse debt, the ultimate profitability of leasing
transactions is dependent, in part, on the difference between the interest
rate inherent in the lease and the underlying debt rate. Certain of the
Company's competitors have access to lower cost funds. However, the
Company has developed relationships with various private investors and
formed various strategic alliances with investors that have a lower cost
of capital enabling the Company to originate and sell leases at
competitive prices. As a result of the low interest rate environment and
resulting low lease rates, the Company sells the majority of leases it
originates to private investors having a lower cost of capital than the
Company.
LEASE ORIGINATIONS
Presented below is a schedule showing volume and placement of new lease
originations during the nine months ended February 28, 1998 and February
28, 1997, respectively (in thousands):
Nine Months Ended
---------------------------
February 28, February 28,
1998 1997
------------ ------------
Placement of lease originations:
Equipment under lease sold to
private investors $ 112,533 $ 75,790
Equipment under lease sold to PIFs 36,801 52,880
Leases added to the Company's lease
portfolio (a significant portion
of which will subsequently be sold) 93,684 45,061
--------- ---------
Total lease origination volume $ 243,018 $ 173,731
========= =========
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.
9 of 20
<PAGE>
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations, continued
I. Results of Operations, continued
---------------------
LEASE ORIGINATIONS, continued
The Company is able to originate a certain amount of leases with higher
lease rates. Such leases are generally sold to the PIF's because, as PIF
sponsor, the Company has a fiduciary responsibility to maximize investor
returns and does so by blending the higher yielding transactions with
investment grade credit quality leases having lower rates. However, in the
present market environment, there are a limited number of higher yielding
transactions which meet the Company's target for credit quality and
consequently, the volume of leases available for sale to the PIF's is
limited. The Company's response to these conditions has been to limit the
amount of funds it raises from PIF investors. During February 1998, the
remaining Class A units of Capital Preferred Yield Fund-IV, L.P. were sold
to the public. The Company has elected not to organize additional PIFs.
Consequently, future equipment sales to PIF's will reflect only the
reinvestment needs of existing PIFs and therefore are expected to comprise
a smaller percentage of total placements of new lease originations.
The Company continues to evaluate additional sources of capital (including
sources such as securitization, a private debt placement and/or a public
debt stock offering) which would provide the liquidity necessary to
significantly add leases to its own portfolio. The goal of such financing
would be to lower the Company's cost of capital and expand the
availability of capital. The Company believes this will enable it to
originate leases for its own portfolio which have competitive market lease
rates and good credit quality. The Company believes that in the present
market there are significant opportunities to originate leases having
these characteristics. However, the Company's present capital structure
(i.e., both cost of capital and amount available) precludes taking full
advantage of market opportunities for such leases. Should the Company be
successful in identifying and closing on new sources of capital (for which
no assurance can be given), it intends to grow its own lease portfolio.
INTERIM FINANCIAL RESULTS
Presented below are schedules showing condensed income statement
categories and analyses of changes in those condensed categories derived
from the Consolidated Statements of Income prepared solely to facilitate
the discussion of results of operations that follows (in thousands):
<TABLE>
<CAPTION>
Condensed Condensed
Consolidated Consolidated
Statements of Income The effect on Statements of Income The effect on
for the three months net income for the nine months net income
ended February 28, of changes ended February 28, of changes
--------------------- between --------------------- between
1998 1997 years 1998 1997 years
-------- -------- ------------- -------- --------- -------------
<S> <C> <C> <C> <C> <C> <C>
Equipment sales margin $ 2,387 $ 1,615 $ 772 $ 5,682 $ 3,735 $ 1,947
Leasing margin (net of interest
expense on discounted lease rentals) 1,319 934 385 3,440 3,640 (200)
Other income 1,070 703 367 3,270 2,199 1,071
Operating and other expenses (3,289) (2,190) (1,099) (8,382) (6,873) (1,509)
Provision for losses (100) (235) 135 (500) (340) (160)
Interest expense on recourse debt (700) (430) (270) (1,655) (1,452) (203)
Income taxes (172) (99) (73) (464) (227) (237)
-------- -------- -------- -------- -------- ---------
Net income $ 515 $ 298 $ 217 $ 1,391 $ 682 $ 709
======== ======== ======== ======== ======== =========
</TABLE>
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<PAGE>
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations, continued
I. Results of Operations, continued
---------------------
INTERIM FINANCIAL RESULTS, continued
EQUIPMENT SALES
Equipment sales revenue and the related equipment sales margin consists of
the following (in thousands):
<TABLE>
<CAPTION>
Three Months Ended
------------------------------------------ Increase
February 28, 1998 February 28, 1997 (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 $ 14,857 $ 315 $ 25,674 $ 553 $ (10,817) $ (238)
Equipment under lease sold to private investors 50,139 557 38,629 447 11,510 110
-------- -------- -------- -------- --------- ------
64,996 872 64,303 1,000 $ 693 $ (128)
-------- -------- -------- -------- --------- ------
Transactions subsequent to initial lease term
(remarketing revenue):
Sales of off-lease equipment 2,442 473 4,223 394 (1,781) 79
Sales-type leases 262 98 10 10 252 88
Excess collections (cash collections in excess of
the associated residual value from equipment
under lease sold to private investors) 331 331 211 211 110 120
-------- -------- -------- -------- --------- ------
3,035 902 4,444 615 (1,409) 287
Deduct related provision for losses - (100) - (235) - 135
-------- -------- -------- -------- --------- ------
Realization of value in excess of provision for losses 3,035 802 4,444 380 (1,409) 422
Add back related provision for losses - 100 - 235 - (135)
-------- -------- -------- -------- --------- ------
3,035 902 4,444 615 (1,409) 287
-------- -------- -------- -------- --------- ------
CATG sales 5,959 613 - - 5,959 613
-------- -------- -------- -------- --------- ------
Total equipment sales $ 73,990 $ 2,387 $ 68,747 $ 1,615 $ 5,243 $ 772
======== ======== ======== ======== ========= ======
Nine Months Ended
------------------------------------------ Increase
February 28, 1998 February 28, 1997 (Decrease)
-------------------- -------------------- ------------------
Revenue Margin Revenue Margin Revenue Margin
--------- --------- --------- -------- -------- ------
Transactions during initial lease term:
Equipment under lease sold to PIFs $ 38,560 $ 845 $ 55,751 $ 1,195 $ (17,191) $ (350)
Equipment under lease sold to private investors 125,122 1,460 102,647 1,404 22,475 56
-------- ------- -------- ------- --------- ------
163,682 2,305 158,398 2,599 $ 5,284 $ (294)
-------- ------- -------- ------- --------- ------
Transactions subsequent to initial lease term
(remarketing revenue):
Sales of off-lease equipment 3,824 931 4,995 668 (1,171) 263
Sales-type leases 318 154 71 69 247 85
Excess collections (cash collections in excess of
the associated residual value from equipment
under lease sold to private investors) 1,504 1,504 399 399 1,105 1,105
-------- ------- -------- ------- --------- ------
5,646 2,589 5,465 1,136 181 1,453
Deduct related provision for losses - (500) - (340) - (160)
-------- ------- -------- ------- --------- ------
Realization of value in excess of provision for losses 5,646 2,089 5,465 796 181 1,293
Add back related provision for losses - 500 - 340 - 160
-------- ------- -------- ------- --------- ------
5,646 2,589 5,465 1,136 181 1,453
-------- ------- -------- ------- --------- ------
CATG sales 7,298 788 - - 7,298 788
-------- ------- -------- ------- --------- ------
Total equipment sales $176,626 $ 5,682 $163,863 $ 3,735 $ 12,763 $1,947
======== ======= ======== ======= ========= ======
</TABLE>
11 of 20
<PAGE>
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations, continued
I. Results of Operations, continued
---------------------
EQUIPMENT SALES TO PIF'S
------------------------
Equipment sales to the PIFs decreased and are expected to decrease further
because three of the PIFs are in their planned liquidation stage. Once a
PIF enters the liquidation stage, it no longer acquires equipment under
lease. Presently, two PIFs are actively acquiring leases compared to four
PIFs which were actively acquiring leases during fiscal 1997.
In February 1998, the Company sold the remaining publicly offered units in
Capital Preferred Yield Fund-IV, L.P. The Company has elected not to
organize additional PIFs. As such, equipment sales to the PIFs will
continue to decline in the future.
Equipment Sales to Private Investors
------------------------------------
Equipment sales to private investors increased 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 (i) 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) and (ii) the development of strategic alliances
with investors having lower cost of capital enabling the Company to
originate and sell leases at competitive prices.
During the three months ended February 28, 1998 and 1997, payments from
one lessee accounted for 9% and 12%, respectively, of total leasing
revenue and 10% and 12% for the nine months ended February 28, 1998 and
1997, respectively. In addition, other equipment sales revenue related to
equipment leased to that lessee accounted for 31% and 57% of total other
equipment sales revenue during the three months ended February 28, 1998
and 1997, respectively and 32% and 81% for the nine months ended February
28, 1998 and 1997, respectively.
Remarketing of the Portfolio and Related Provision for Losses
-------------------------------------------------------------
The Company has successfully realized gains on the remarketing of its
portfolio of equipment after the initial lease term for the past
twenty-three consecutive quarters. The remarketing of equipment for an
amount greater than its book value is reported as part of equipment sales
margin (if the equipment is sold) or leasing margin (if the equipment is
re-leased). The realization of less than the carrying value of equipment
is recorded as provision for losses (which is typically not known until
remarketing after the expiration of the initial lease term). As shown in
the table above, the realizations from sales exceeded the provision for
losses during the three and nine months ended February 28, 1998 and
February 28, 1997 even without considering realizations from remarketing
activities recorded as leasing margin.
12 of 20
<PAGE>
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations, continued
I. Results of Operations, continued
---------------------
Remarketing of the Portfolio and Related Provision for Losses, continued
-------------------------------------------------------------
Residual values are established equal to the estimated values to be
received from equipment following termination of the leases. In estimating
such values, the Company considers all relevant facts regarding the
equipment and the lessees, including, for example, the equipment's
remarketability, upgrade potential and the probability that the equipment
will remain in place at the end of an initial lease term. The nature of
the Company's leasing activities is that it has credit and residual value
exposure and, accordingly, in the ordinary course of business, it will
incur losses arising from these exposures. The Company performs quarterly
assessments of its assets to identify other than temporary losses in
value. The Company's policy is to record allowances for losses as soon as
any other-than-temporary declines in asset values are known. However,
chargeoffs are recorded upon the termination or remarketing of the
underlying assets. As such, chargeoffs will primarily occur subsequent to
the recording of the allowances for losses.
The 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). Sales
of off-lease equipment decreased during the three and nine months ended
February 28, 1998 compared to the three and nine months ended February 28,
1997 primarily due to fewer leases maturing. Excess collections increased
during the nine months ended February 28, 1998 due to the sales of certain
equipment for which the Company held retained residual interests.
The provision for losses recorded during the three and nine months ended
February 28, 1998 primarily related to the following:
* Other-than-temporary declines in the value of equipment which occurred
primarily because lessees returned equipment to the Company at the end
of leases. The Company had previously expected to realize the carrying
value of such equipment through lease renewals and proceeds from sales
of the equipment to the original lessees. The fair market value of the
equipment re-leased or sold to third parties is considerably less than
was anticipated, and
* The anticipated sale of two off-lease commuter aircraft. The Company
engaged MCC Financial, an expert commuter aircraft remarketer, to
remarket the aircraft. That agent determined that the aircraft could
be released within a reasonable remarketing period for an amount that
would recover the Company's full carrying value over time, or sold for
cash immediately but at a book loss. The Company has elected to sell
the aircraft immediately after determining that the proceeds could be
more effectively redeployed in its vertical integration activities and
for the equity portion of a potential financing program for leases.
The provision for loss reflects sales offers the Company has received.
13 of 20
<PAGE>
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations, continued
I. Results of Operations, continued
---------------------
LEASING MARGIN
Leasing margin consists of the following (in thousands):
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
--------------------------- ---------------------------
February 28, February 28, February 28, February 28,
1998 1997 1998 1997
------------ ------------ ------------ ------------
<S> <C> <C> <C> <C>
Leasing revenue $ 6,804 $ 3,492 $ 15,353 $ 11,228
Leasing costs and expenses (4,782) (2,183) (10,435) (6,462)
Net non-recourse interest expense
on related discounted lease rentals (703) (375) (1,478) (1,126)
-------- -------- -------- --------
Leasing margin $ 1,319 $ 934 $ 3,440 $ 3,640
======== ======== ======== ========
Leasing margin ratio 19% 27% 22% 32%
======== ======== ======== ========
</TABLE>
The increase in leasing revenue and leasing costs during the three and
nine months ended February 28, 1998, compared to the three and nine months
ended February 28, 1997 is primarily due to growth in the Company's lease
portfolio.
Leasing margin ratio fluctuates based upon (i) the mix of direct finance
leases and operating leases, (ii) remarketing activities, (iii) the method
used to finance leases added to the Company's lease portfolio, and (iv)
the relative age and types of leases in the portfolio (operating leases
have a lower leasing margin early in the lease term, increasing as the
term passes and the majority of leases added to CAI's portfolio have been
operating leases). Interest expense arising from non-recourse bank debt
(discounted lease rentals) is reflected in leasing margin, but interest
arising from the warehouse facility is not reflected in leasing margin.
Leasing margin ratio decreased primarily as a result of a decrease in the
number of leases being renewed and a related decline in the amount of
remarketing rents.
OTHER INCOME
Other income consists of the following (in thousands):
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
--------------------------- ---------------------------
February 28, February 28, February 28, February 28,
1998 1997 1998 1997
------------ ------------ ------------ ------------
<S> <C> <C> <C> <C>
Fees and distributions from the
Company-sponsored PIFs $ 791 $ 562 $ 2,769 $ 1,791
Fees from private programs 181 - 294 -
Interest on income tax refunds - - - 103
Other 98 141 207 305
------- ------ ------- --------
$ 1,070 $ 703 $ 3,270 $ 2,199
======= ====== ======= ========
</TABLE>
14 of 20
<PAGE>
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations, continued
I. Results of Operations, continued
---------------------
OTHER INCOME, continued
The increase in fees and distributions from the Company-sponsored PIFs for
the nine months ended February 28, 1998 compared to the nine months ended
February 28, 1997 reflects a gain of approximately $890,000 related to the
sale of substantially all the leases owned by PaineWebber Preferred Yield
Fund and a similar type of loss of $100,000 on the Capital Preferred Yield
Fund.
As of December 31, 1997, two Company-sponsored PIF's had been liquidated
and two other PIF's had sold substantially all their assets. As a result
of the effective termination of operations of these PIFs, fees and
distributions from the Company-sponsored PIF's are expected to decline in
the future. As of December 31, 1997, there are three remaining
Company-sponsored PIF's actively engaged in leasing activities.
OPERATING AND OTHER EXPENSES
The aggregate amount of operating and other expenses increased
approximately $1,099,000 and $1,509,000 for the three and nine months
ended February 28, 1998, respectively, when compared to the three and nine
months ended February 28, 1997. Approximately $588,000 and $750,000,
respectively, of the increase is due to the acquisition of DBL, Inc.
described in Footnote 2 of Notes to Consolidated Financial Statements. The
remaining increase is due to the Company's investment in its marketing
infrastructure as the Company has 23 sales and marketing employees as of
February 28, 1998 compared to 14 as of February 28, 1997.
INCOME TAXES
Income tax expense is provided on income at the appropriate federal and
state statutory rates applicable to such earnings. The aggregate statutory
tax rate is 40%, adjusted for utilization of the Company's ITC
carryforward (see Note 10 to Notes to Consolidated Financial Statements in
the 1997 Form 10-K).
Inflation has not had a significant impact upon the operations of the
Company.
YEAR 2000 ISSUES
The Company has conducted a comprehensive review of its computer systems
to identify systems that could be affected by the Year 2000 issue. The
Year 2000 issue results from computer programs being written using two
digits rather than four to define the applicable year. Certain computer
programs which have time-sensitive software could recognize a date using
"00" as the year 1900 rather than the year 2000. This could result in
major system failures or miscalculations. Certain of the Company's
software have already been updated to software which correctly accounts
for the Year 2000. In addition, the Company is engaged in a system
conversion, whereby the Company's main lease tracking and accounting
software is being replaced with new systems which will account for the
Year 2000 correctly. The Company does not expect any other changes
required for the Year 2000 to have a material effect on its financial
position or results of operations. Amounts expended to date to address the
Year 2000 issue have been immaterial.
15 of 20
<PAGE>
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations, continued
II. Liquidity and Capital Resources
-------------------------------
The Company's activities are principally funded by proceeds from sales of
on-lease equipment (to its PIFs or private investors), non-recourse debt,
recourse bank debt (see Note 3 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 miscellaneous cash receipts. Management believes the Company's
ability to generate cash from operations is sufficient to fund operations,
as shown in the accompanying Consolidated Statements of Cash Flows.
The Company refinanced its bank facility. See Note 3 to Notes to
Consolidated Financial Statements for a description of the Company's Bank
Facility.
Two of the Company's sponsored PIFs are using a portion of their available
cash to purchase additional equipment from the Company. The Company
expects to sell a total of approximately $55 million of equipment to these
PIFs during fiscal year 1998. Five of the Company's PIFs are in their
liquidation stage and are no longer purchasing material amounts of
equipment. In February 1998, the Company sold the remaining units in
Capital Preferred Yield Fund-IV, L.P. to the public. The Company has
elected not to organize additional PIF's. As such, equipment sales to the
PIF's will decline in the future.
In recent years, the Company has established private syndication programs
in which it regularly originates and sells leases to certain investors.
Private syndication programs represent a recurring revenue stream for the
Company. The Company intends to continue to develop private syndication
programs because they represent a more efficient and predictable source of
sales revenue when compared to non-program sales of leases to private
investors. However, the Company expects that the majority of its equipment
sales revenue will continue to be generated through non-program sales of
leases to private investors.
The Company generally holds (warehouses) leases for a period of time
before arranging a sale to an investor. Warehoused leases are financed
with funds obtained under the Warehouse Facility portion of the Company's
recourse Bank Facility and through working capital generated by
operations. As the Company's volume of syndication sales has grown, it has
been able to increase the amount of financing available to warehouse
leases. The Company anticipates that it will be able to further expand its
warehouse financing capacity in the future as appropriate for the levels
of leases originated and sold.
However, there can be no assurance that the Company will be successful in
arranging such financing, in arranging additional private syndication
programs, or in selling leases to private investors. Should the Company
not be successful in achieving any of these objectives, equipment sales
revenue and related equipment sales margin may be negatively impacted.
16 of 20
<PAGE>
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations, continued
III. Acquisition
-----------
Effective November 1, 1997, the Company acquired all of the outstanding
shares of DBL, Inc., d/b/a Connecting Point. See Note 2 to Notes to
Consolidated Financial Statements for a description of the related
acquisition. The increase in Accounts Receivable, net and Other Assets,
was primarily due to the assets acquired from Connecting Point.
Connecting Point was acquired to obtain specific high technology equipment
expertise which is expected to provide the Company with (i) access to new
markets which will allow the Company to record higher residual values and
to support lease origination, (ii) greater confidence in pricing and
estimating residual values and (iii) the ability to provide enhanced
equipment expertise and evaluation services to our customers.
IV. New Accounting Pronouncements
-----------------------------
See RECENTLY ISSUED FINANCIAL ACCOUNTING STANDARDS under Note 1 to Notes
to Consolidated Financial Statements in the Company's 1997 Form 10-K for a
discussion about the impact of new accounting pronouncements on the
Company's financial position or results of operations.
INCOME PER SHARE
In February 1997, the Financial Accounting Standards Board issued
Statement of Financial Accounting Standards No. 128, Earnings Per Share
("Statement 128"), effective for periods ending after December 15, 1997.
Statement 128 changes the computation and presentation requirements for
earnings per share for entities with publicly held common stock or
potential common stock. Under such requirements the Company is required to
present both basic earnings per share and diluted earnings per share.
Basic earnings per share is computed by dividing income available to
common stockholders by the weighted average number of common shares
outstanding during the period. Diluted earnings per share is computed by
dividing income available to common stockholders by all dilutive potential
common shares outstanding during the period. The adoption of Statement 128
by the Company as of December 31, 1997, did not have a material effect on
previously presented income per share amounts for fiscal 1997.
V. "Safe Harbor" Statement Under the Private Securities Litigation Reform Act
--------------------------------------------------------------------------
of 1995
-------
The statements contained in this report which are not historical facts may
be deemed to contain forward-looking statements with respect to events,
the occurrence of which involve risks and uncertainties, and are subject
to factors that could cause actual future results to differ both adversely
and materially from currently anticipated results, including, without
limitation, the level of lease originations, realization of residual
values, the availability and cost of financing sources and the ultimate
outcome of any contract disputes. Certain specific risks associated with
particular aspects of the Company's business are discussed in detail
throughout Item 2 of this report and Parts I and II of the 1997 Form 10-K
when and where applicable.
17 of 20
<PAGE>
CAPITAL ASSOCIATES, INC. AND SUBSIDIARIES
PART II
OTHER INFORMATION
Item 1. Legal Proceedings
-----------------
(a) OTHER. The Company is involved in other routine legal proceedings
incidental to the conduct of its business. Management believes
that none of these legal proceedings will have a material adverse
effect on the financial condition or operations of the Company.
Item 5. Other
-----
Effective April 7, 1998, Dennis J. Lacey, the Company's President, CEO
and Director, resigned to pursue an opportunity outside the Company.
Mr. Lacey will remain as one of the Company's major shareholders.
James D. Walker, Chairman of the Board for the Company, has assumed the
additional duties of President and Chief Executive Officer. Mr. Walker
is one of the principal shareholders of MCC Financial Corporation, the
majority stockholder of the Company, holding approximately 57% of the
issued and outstanding common stock. Over the past two years, Mr.
Walker has worked closely with Mr. Lacey and Senior management of the
Company and participated in changes to the organization and the
strategic direction of the Company. Thus, no significant changes in the
Company's direction or organization are anticipated.
Item 6. Exhibits and Reports on Form 8-K
--------------------------------
a. Exhibits
--------
b. Reports on Form 8-K
-------------------
None
c. All other supporting schedules have been omitted because the
information required is included in the financial statements or
notes thereto or have been omitted as not applicable or not
required.
18 of 20
<PAGE>
Item No. Exhibit Index
- -------- -------------
27 Financial Data Schedule
19 of 20
<PAGE>
CAPITAL ASSOCIATES INC. AND SUBSIDIARIES
SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
CAPITAL ASSOCIATES, INC.
Registrant
Date: April 14, 1998 By: /s/Anthony M. DiPaolo
---------------------
Anthony M. DiPaolo,
Senior Vice-President and
Chief Financial Officer
20 of 20
<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> 9-MOS
<FISCAL-YEAR-END> MAY-31-1998
<PERIOD-END> FEB-28-1998
<CASH> 2,770
<SECURITIES> 0
<RECEIVABLES> 5,200
<ALLOWANCES> 130
<INVENTORY> 812
<CURRENT-ASSETS> 0
<PP&E> 107,799
<DEPRECIATION> 0
<TOTAL-ASSETS> 185,047
<CURRENT-LIABILITIES> 0
<BONDS> 0
0
0
<COMMON> 32
<OTHER-SE> 24,902
<TOTAL-LIABILITY-AND-EQUITY> 185,047
<SALES> 176,626
<TOTAL-REVENUES> 197,586
<CGS> 170,944
<TOTAL-COSTS> 195,731
<OTHER-EXPENSES> 8,382
<LOSS-PROVISION> 500
<INTEREST-EXPENSE> 5,470
<INCOME-PRETAX> 1,855
<INCOME-TAX> 464
<INCOME-CONTINUING> 1,391
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 1,391
<EPS-PRIMARY> .27
<EPS-DILUTED> .26
</TABLE>
