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 AUGUST 31, 1999
[ ] Transition report pursuant to section 13 or 15(d) of the Securities
Exchange Act of 1934.
Commission file number 0-15525
CAPITAL ASSOCIATES, INC.
------------------------------------------------------
(Exact name of registrant as specified in its charter)
DELAWARE 84-1055327
(State or other jurisdiction of (IRS Employer Identification No.)
incorporation or organization)
7175 WEST JEFFERSON AVENUE, LAKEWOOD, COLORADO 80235
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (303) 980-1000
Indicate by check mark whether the Registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes X No .
----- -----
The number of shares outstanding of the Registrant's $.008 par value common
stock at October 13, 1999 was 5,303,551.
Exhibit Index - Page 20
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<PAGE>
CAPITAL ASSOCIATES, INC. AND SUBSIDIARIES
INDEX
-----
PAGE
PART I. FINANCIAL INFORMATION NUMBER
Item 1. Financial Statements
Consolidated Balance Sheets - August 31, 1999
(Unaudited) and May 31, 1999 3
Consolidated Statements of Income - Three Months Ended
August 31, 1999 and 1998 (Unaudited) 4
Consolidated Statements of Cash Flows - Three Months Ended
August 31, 1999 and 1998 (Unaudited) 5
Notes to Consolidated Financial Statements 6-7
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations 8-17
Item 3. Quantitative and Qualitative Disclosures About Market Risk 17
PART II. OTHER INFORMATION
Item 1. Legal Proceedings 18
Item 5. Other Information 19
Item 6. Exhibits and Reports on Form 8-K 19
Exhibit Index 20
Signature 21
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<PAGE>
CAPITAL ASSOCIATES, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(Dollars in thousands)
ASSETS
August 31, May 31,
1999 1999
(Unaudited)
----------- ---------
Cash and cash equivalents $ 11,870 $ 7,926
Receivables from affiliated limited partnerships 344 744
Accounts receivable, net 10,050 7,992
Inventory 2,531 2,578
Residual values and other receivables arising from
equipment under lease sold to private investors, net 4,812 4,469
Net investment in direct finance leases 40,330 42,116
Leased equipment, net 158,661 150,338
Investments in affiliated limited partnerships 1,850 1,957
Deferred income taxes 3,400 3,400
Other assets 5,331 5,448
Discounted lease rentals assigned to lenders
arising from equipment sale transactions 21,439 19,773
--------- ---------
$ 260,618 $ 246,741
========= =========
LIABILITIES AND STOCKHOLDERS' EQUITY
Recourse debt $ 57,609 $ 50,060
Accounts payable - equipment purchases 22,634 29,806
Accounts payable and other liabilities 14,147 15,621
Discounted lease rentals 140,472 125,639
--------- ---------
234,862 221,126
--------- ---------
Stockholders' equity:
Common stock 42 42
Additional paid-in capital 16,844 16,829
Retained earnings 8,870 8,771
Treasury stock - (27)
--------- ---------
Total stockholders' equity 25,756 25,615
--------- ---------
$ 260,618 $ 246,741
========= =========
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)
Three Months Ended
August 31,
-----------------------
1999 1998
---------- ----------
Revenue:
Equipment sales to PIFs $ 10,773 $ 8,029
Other equipment sales 38,673 48,614
Leasing 16,504 9,115
Interest 496 879
Other 686 1,323
---------- ----------
Total revenue 67,132 67,960
---------- ----------
Costs and expenses:
Equipment sales to PIFs 10,527 7,865
Other equipment sales 36,353 47,164
Leasing 11,204 5,905
Operating and other expenses 5,012 3,668
Provision for losses 100 25
Interest:
Non-recourse debt 2,757 2,148
Recourse debt 1,017 1,028
---------- ----------
Total costs and expenses 66,970 67,803
---------- ----------
Net income before income taxes 162 157
Income tax expense 63 14
---------- ----------
Net income $ 99 $ 143
========== ==========
Earnings per common share:
Basic $ 0.02 $ 0.03
========== ==========
Diluted $ 0.02 $ 0.03
========== ==========
Weighted average number of common shares outstanding:
Basic 5,177,000 5,122,000
========== ==========
Diluted 5,363,000 5,463,000
========== ==========
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)
Three Months Ended
August 31,
-----------------------
1999 1998
---------- ----------
Net cash provided by operating activities $ 38,032 $ 44,373
-------- --------
Cash flows from investing activities:
Equipment purchased for leasing, net (54,609) (44,679)
Investment in leased office facility and in
capital expenditures (99) (62)
Net receipts from affiliated public income funds 107 277
-------- --------
Net cash used for investing activities (54,601) (44,464)
-------- --------
Cash flows from financing activities:
Proceeds from securitization 21,246 10,527
Principal payments on securitization (2,461) -
Proceeds from discounting of lease rentals 6,628 -
Principal payments on discounted lease rentals (9,372) (6,084)
Net proceeds from stock 42 -
Net borrowings (payments) on revolving credit
facilities 4,492 (18,739)
Net (payments) borrowings on Term Loan (62) 798
-------- --------
Net cash provided by (used for) financing activities 20,513 (13,498)
-------- --------
Net increase (decrease) in cash and cash equivalents 3,944 (13,589)
Cash and cash equivalents at beginning of period 7,926 17,684
-------- --------
Cash and cash equivalents at end of period $ 11,870 $ 4,095
======== ========
Supplemental schedule of cash flow information:
Recourse interest paid $ 1,017 $ 1,028
Non-recourse interest paid 2,757 2,148
Income taxes paid 24 42
Income tax refunds received 13 -
Supplemental schedule of non-cash investing and
financing activities:
Discounted lease rentals assigned to lenders
arising from equipment sale transactions 4,959 6,269
The accompanying notes are an integral part
of these consolidated financial statements.
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<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 consolidated financial statements
of Capital Associates, Inc. (the "Company"), and the related notes,
included within the Company's Annual Report on Form 10-K for the fiscal
year ended May 31, 1999 (the "1999 Form 10-K"), previously filed with the
Securities and Exchange Commission.
The balance sheet at May 31, 1999 was derived from the audited financial
statements included in the Company's 1999 Form 10-K.
2. Securitization Facility
-----------------------
The Company renewed the commitment for its securitization facility (the
"Securitization Facility") in August 1999. The Securitization Facility
includes a firm commitment allowing the Company to add leases during the
renewal term of 364 days. The Securitization Facility is comprised of a
senior loan with a maximum principal amount of $50,000,000 ("Senior Loan")
a junior loan with a maximum principal amount of $5,000,000 ("Junior Loan")
and a residual loan with a maximum principal amount of $10,000,000
("Residual Loan").
The Company had approximately $34 million outstanding under the Senior and
Junior Loans and approximately $7 million under the Residual Loan on August
31, 1999.
3. Business Units
--------------
The Company conducts business with external customers through the
operations of its Capital Associates ("Leasing") and Capital Associates
Technology Group ("Technology Group") business units. Certain legal,
accounting and finance, personnel and other administrative support services
are provided by employees of Leasing on behalf of Technology Group. For the
three months ended August 31, 1999, direct costs of $138,000 associated
with these services have been allocated from Leasing to Technology Group.
For the comparable period in fiscal 1999, services performed by Leasing on
behalf of Technology Group were $38,000.
In evaluating the financial performance of each business unit, management
focuses on revenue and net income before taxes, on total assets and
recourse debt. Interest expense, net for Technology Group includes interest
associated with the Term Loan utilized to finance the acquisition of CATG.
Recourse debt for Technology Group includes only amounts borrowed from
Deutsche Financial Services. Financial performance measurements for Leasing
and Technology Group are set forth below for each of the Company's business
units for the three months ended August 31, 1999 and 1998 (in thousands):
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<PAGE>
CAPITAL ASSOCIATES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
3. Business Units, continued
--------------
1999 1998
--------- ---------
Revenue:
Leasing $ 57,609 $ 60,733
Technology Group 9,523 6,957
--------- ---------
$ 67,132 $ 67,690
========= =========
Interest expense, net:
Leasing $ 3,176 $ 2,207
Technology Group 102 90
--------- ---------
$ 3,278 $ 2,297
========= =========
Net income before taxes:
Leasing $ 178 $ 108
Technology Group (16) 49
--------- ---------
$ 162 $ 157
========= =========
Total assets:
Leasing $ 252,677 $ 240,536
Technology Group 7,941 6,205
--------- ---------
$ 260,618 $ 246,741
========= =========
Recourse debt:
Leasing $ 53,765 $ 48,141
Technology Group 3,844 1,919
--------- ---------
$ 57,609 $ 50,060
========= =========
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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
Significant factors which may impact the Company's profitability in the
future include the amount and cost of capital available to the Company, its
success in developing and retaining the field sales force, and the ability
to increase lease origination levels while achieving profitability targets.
Several factors cause operating results to fluctuate, including (i) the
level of fee income obtained from the sale of leases in excess of lease
equipment cost, (ii) the seasonality of lease originations, (iii) the
volume of leases maturing in a particular period and the resulting gain on
remarketing, and (iv) variations in the relative percentages of the
Company's leases originated and held which are classified as DFLs or OLs.
The Company varies the volume of originated leases held relative to leases
sold to private investors when and as the Company determines that it would
be in its best interests, taking into account cash flow needs, profit
opportunities, portfolio concentration, residual risk and its fiduciary
duty to originate leases for its PIFs.
The Company originates leases with the intention of either selling the
lease to PIFs or private investors or holding the lease through maturity.
Leases originated and held for sale are referred to as "warehouse leases",
or "warehouse portfolio". Leases the Company intends to hold to maturity
are referred to as "Company-owned leases or "Company-owned portfolio". The
Company generally holds warehouse leases for one to six months before sale
to private investors. Leases held to maturity are generally more profitable
than leases sold to private investors (i.e., aggregate leasing margin
earned over the life of the lease is generally greater than the fee earned
from sale to private investors, which includes rents retained in excess of
interest expense during the holding period). However, the majority of the
Company's leases are ultimately sold to PIFs or private investors (i)
because the Company lacks the capital resources to hold until maturity all
leases it originates and (ii) in order to achieve profitable results of
operations, since revenue from a sale of a lease is recorded in the period
of sale while leasing revenue associated with a Company-owned lease is
recorded over time based on the underlying lease term. Many sales to
private investors are structured to enable the Company to share in some of
the additional profit associated with holding a lease to maturity (arising
from the remarketing of the lease equipment upon lease maturity). The
Company's strategy is to retain an interest in the residual value of leases
sold to private investors where it believes additional profit may be
available through remarketing upon lease maturity. The Company's retained
interest in leases it has sold to private investors is reflected in the
accompanying Consolidated Balance Sheets as "Residual value, net, arising
from equipment under lease sold to private investors", (also referred to as
"retained residuals"). Presented below is a schedule showing new lease
originations volume and placement of new lease originations for the three
months ended August 31, 1999 and August 31, 1998, respectively (in
thousands):
Three Months Ended
August 31,
------------------
1999 1998
-------- -------
Placement of lease originations:
Equipment under lease sold to PIFs $ 10,000 $ 3,000
Equipment under lease sold to private investors 22,000 23,000
Leases added to the Company's lease portfolio
(a significant portion of which will be/were
sold during the subsequent fiscal quarters) 27,000 26,000
-------- --------
Total lease origination volume $ 59,000 $ 52,000
======== ========
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<PAGE>
I. Results of Operations, continued
---------------------
GENERAL COMMENTS, continued
The Company continues to evaluate additional sources of capital which will
provide the liquidity necessary to add leases to its own portfolio. 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. Additionally, many such leases have been
sold to the PIFs because, as the PIF sponsor, the Company has a fiduciary
responsibility to maximize investor returns and does so by blending higher
yielding transactions with investment grade credit quality leases having
lower lease rates. Consequently, the Company has limited the amount of
funds it raises from PIF investors. During fiscal year 1998, the Company
completed the offering of units in its most recent PIF, Capital Preferred
Yield Fund-IV, L.P. (CPYF-IV). The Company has elected not to organize
additional PIFs and future equipment sales to PIF's are expected to
comprise a significantly smaller percentage of total placements of new
lease originations. Should the Company be successful in identifying and in
closing new sources of capital (for which no assurance can be given), it
intends to further 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 for the Company and
its Capital Associates Technology Group ("CATG") division. These schedules
are derived from the Consolidated Statements of Income and have been
prepared solely to facilitate the discussion of results of operations that
follows (in thousands):
Three Months Ended
August 31,
------------------
CAI CONSOLIDATED 1999 1998 Change
---------------- ------- ------- ------
Equipment sales margin $ 2,566 $ 1,614 $ 952
Leasing margin 5,300 3,210 2,090
Other income 686 1,323 (637)
Operating and other expenses (5,012) (3,668) (1,344)
Provision for losses (100) (25) (75)
Interest expense, net (3,278) (2,297) (981)
Income taxes (63) (14) (49)
------- ------- -------
Net income $ 99 $ 143 $ (44)
======= ======= =======
Three Months Ended
August 31,
------------------
CAI WITHOUT ITS CATG SUBSIDIARY 1999 1998 Change
------------------------------- -------- ------- ------
Equipment sales margin $ 1,536 $ 839 $ 697
Leasing margin 5,300 3,210 2,090
Other income 686 1,323 (637)
Operating and other expenses (4,068) (3,032) (1,036)
Provision for losses (100) (25) (75)
Interest expense, net (3,176) (2,207) (969)
------- ------- -------
Net income before income taxes $ 178 $ 108 $ 70
======= ======= =======
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<PAGE>
I. Results of Operations, continued
---------------------
INTERIM FINANCIAL RESULTS, continued
Three Months Ended
August 31,
------------------
CATG 1999 1998 Change
---- ------- ------- ------
Equipment sales margin $ 1,030 $ 775 $ 255
Operating and other expenses (944) (636) (308)
Interest expense, net (102) (90) (12)
------- ------ -------
Net income before income taxes $ (16) $ 49 $ (65)
======= ====== =======
LEASE ORIGINATIONS
For the three months ended August 31, 1999 and 1998, the Company originated
leases having an aggregate equipment acquisition cost of $59 million and
$52 million, respectively.
Generally, originated leases are initially financed utilizing the Company's
Warehouse Credit Facility and then sold to private investors, private
programs or to the PIF's. Profits from the sale of leases are reported in
the table above as "equipment sales margin". In addition, the Company
realizes rental or finance profits from leases held prior to sale (reported
as "leasing margin" in the table above) and incurs interest expense on the
Warehouse Credit Facility during the period the leases are held.
EQUIPMENT SALES
Equipment sales revenue and the related equipment sales margin consists of
the following (in thousands):
<TABLE>
<CAPTION>
Three Months Ended
----------------------------------------- Increase
August 31, 1999 August 31,1998 (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 $ 10,773 $ 246 $ 8,029 $ 164 $ 2,744 $ 82
Equipment under lease sold to private investors 26,191 158 39,663 449 (13,472) (291)
-------- ------- -------- ------- --------- ------
36,964 404 47,692 613 (10,728) (209)
-------- ------- -------- ------- --------- ------
Transactions subsequent to initial lease term
(remarketing revenue):
Sales of off-lease equipment 2,279 835 1,863 125 416 710
Sales-type leases 215 215 - - 215 215
Excess collections (cash collections in excess of
the associated residual value from equipment
under lease sold to private investors) 15 15 97 97 (82) (82)
-------- ------- -------- ------- --------- ------
2,509 1,065 1,960 222 549 843
Deduct related provision for losses - (100) - (25) - (75)
-------- ------- -------- ------- --------- ------
Realization of value in excess of provision for
losses 2,509 965 1,960 197 549 768
Add back related provision for losses - 100 - 25 - 75
-------- ------- -------- ------- --------- ------
2,509 1,065 1,960 222 549 843
-------- ------- -------- ------- --------- ------
Equipment brokerage sales 450 67 34 4 416 63
CATG sales 9,523 1,030 6,957 775 2,566 255
-------- ------- -------- ------- --------- ------
Total equipment sales $ 49,446 $ 2,566 $ 56,643 $ 1,614 $ (7,197) $ 952
======== ======= ======== ======= ========= ======
</TABLE>
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<PAGE>
I. Results of Operations, continued
---------------------
Equipment Sales to PIF's
------------------------
In February 1998, the Company sold the remaining publicly offered units in
Capital Preferred Yield Fund-IV, L.P. The Company has elected not to
organize additional PIFs and only two PIFs are in their reinvestment stage
and are actively acquiring leases. As such, equipment sales to the PIFs
reflects the funds available for reinvestment by the PIFs.
Equipment Sales to Private Investors
------------------------------------
Equipment sales to private investors decreased for the three months ended
August 31, 1999 compared to the three months ended August 31,1998 by $13.4
million. Equipment sales during the three months ended August 31, 1998
include a one-time portfolio sale of approximately $20 million to a private
investor.
The margin from sales of equipment under lease to private investors
reflects the impact of the period of time leases are held by the Company
prior to sale (referred to as the "hold period"). During the hold period,
the Company records leasing margin. For equipment sold to PIFs or to
private investment programs, the sales price of the equipment is adjusted
in accordance with the relevant partnership or program agreement to reflect
leasing margin during the hold period as if the PIF or private investor had
owned the equipment since lease inception. Consequently, the sales price
paid to the Company is reduced by any leasing margin the Company retains.
As a result, the Company's economic profit attributed to leases it sells is
reflected, in part, as leasing margin and, in part, as margin from
equipment sale. The longer the hold period is for a particular lease, the
greater the amount of the economic profit reflected as leasing margin.
Because the Company has been increasing the period of time it holds leases
prior to sale, equipment sales margin for transactions during the initial
lease term for the three months ended August 31, 1999 has declined and
leasing margin has increased.
The Company defers income related to its servicing obligation on leases it
sells. This income is amortized over the life of the lease and is included
in "Other Income".
During the three months ended August 31, 1999, other equipment sales
revenue related to equipment leased to two lessees accounted for 68% of
total other equipment sales revenue. During the three months ended August
31,1998, other equipment sales revenue related to one lessee accounted for
29% of total other equipment sales revenue.
Equipment Brokerage Sales
-------------------------
NBCO acquires used personal computers, monitors and printers from a variety
of sources, including end-users and other lessors. The equipment is sold in
quantity to third parties through NBCO's telemarketing and brokerage
operations or to consumers through NBCO's retail facilities.
Revenue from equipment brokerage sales increased during the three months
ended August 31, 1999 compared to the same period in 1998 as a result of
sales to consumers through NBCO's retail facilities. The Company
significantly expanded its retail sales to consumers when NBCO was
established in December 1998. Prior to establishing NBCO, equipment
brokerage sales generally consisted of quantity sales to third parties.
11 of 21
<PAGE>
I. Results of Operations, continued
---------------------
Remarketing of the Portfolio and Related Provision for Losses
-------------------------------------------------------------
The Company has successfully realized gains on the remarketing of its
portfolio of equipment after the initial lease term for the past seven
years. The remarketing of equipment for an amount greater than its book
value is reported as part of equipment sales margin (if the equipment is
sold) or leasing margin (if the equipment is re-leased). The realization of
less than the carrying value of equipment is recorded as provision for
losses (which is typically not known until remarketing after the expiration
of the initial lease term). As shown in the table above, the realizations
from sales exceeded the provision for losses during the three months ended
August 31, 1999 even without considering realizations from remarketing
activities recorded as leasing margin.
Remarketing revenue and the related margin (i.e., sales occurring after the
initial lease term) are affected by the (i) number and dollar amount of
equipment leases that mature in a particular quarter (the average lease
term is 3 to 5 years) and (ii) the composition of equipment available for
remarketing.
The Company retained very few lease originations for its own portfolio
during the mid-1990's resulting in lower amounts of equipment available for
remarketing after lease maturity. Lease originations have increased since
that time and the Company has retained more leases for its own portfolio.
Consequently, leases maturing subsequent to 1999 are increasing and the
Company expects remarketing revenue and margin to increase during fiscal
year 2000.
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 such that it has credit and residual value
exposure and in the ordinary course of business, will incur losses arising
from these exposures. The Company performs quarterly assessments of its
assets to identify other than temporary losses in value. The Company's
policy is to record allowances for losses as soon as any
other-than-temporary declines in asset values are known. However,
chargeoffs are recorded upon the termination or remarketing of the
underlying assets. As such, chargeoffs will primarily occur subsequent to
the recording of the allowances for losses. The provision for losses
recorded during the three months ended August 31, 1999 reflects the
Company's best estimate of the amount necessary to maintain the allowance
for losses at a level which adequately provides for other-than-temporary
declines in the value of equipment.
CATG
CATG activities consist primarily of the sale of new information technology
hardware. In conjunction with the sale of hardware, CATG also sells
software and services. Revenue from such sources is not material to total
CATG sales.
Since its acquisition, the Company has invested significant time and
capital resources in CATG in order to extend CATG's capabilities beyond its
regional market to CAI's national market. The costs associated with this
effort primarily include salaries and wages, training, and travel expenses.
CATG has not yet realized a material amount of revenue from this effort.
Sales revenue and associated sales margin from CATG's traditional local
market have increased significantly for the three months ended August 31,
1999. However, costs in excess of revenues from the national effort have
increased to a greater extent resulting in a loss of $16,000 for the three
months ended August 31, 1999.
12 of 21
<PAGE>
I. Results of Operations, continued
---------------------
CATG, continued
The increase in revenue for the three months ended August 31, 1999 has
resulted in an increase in trade receivables of approximately $2.1 million.
LEASING MARGIN
Leasing margin consists of the following (in thousands):
Three Months Ended
August 31,
----------------------
1999 1998
-------- --------
Leasing revenue $ 16,504 $ 9,115
Leasing costs and expenses (11,204) (5,905)
-------- --------
Leasing margin $ 5,300 $ 3,210
======== ========
The increase in leasing revenue, leasing costs and expenses and leasing
margin is due to the increase in the volume of lease originations
warehoused pending sale to private investors and growth in the Company's
lease portfolio. Subject to the Company's ability to obtain additional
funding, these revenue and expense amounts are expected to increase further
as the Company continues to grow its lease portfolio, and increase the
amount of leases warehoused pending sale.
Leasing margin may fluctuate based upon (i) the mix of direct finance
leases and operating leases, (ii) remarketing activities and (iii) the
relative age and types of leases in the portfolio (operating leases have a
lower leasing margin early in the lease term, increasing as the term passes
and the majority of leases added to CAI's portfolio have been operating
leases).
OTHER INCOME
Other income consists of the following (in thousands):
Three Months Ended
August 31,
---------------------
1999 1998
----- -------
Fees and distributions from the PIFs $ 228 $ 541
Fees from private leasing programs 311 318
Other 147 464
----- -------
$ 686 $ 1,323
===== =======
During fiscal 1998, the Company completed the offering of units in its most
recent PIF, Capital Preferred Yield Fund-IV, L.P. ("CPYF-IV"). The Company
has elected not to organize additional PIFs. As a result, fees and
distributions from the PIFs (reported as "Other income") have declined and
will continue to decline.
13 of 21
<PAGE>
I. Results of Operations, continued
Operating and Other Expenses
The aggregate amount of operating and other expenses for CAI without its
CATG subsidiary increased approximately $1 million for the three months
ended August 31, 1999, compared to the three months ended August 31,1998.
The increase reflects costs associated with the start-up of the Company's
Name Brand Computer Outlet ("NBCO") subsidiary and expenses associated with
making the Company's computer systems Year 2000 compliant.
Interest Expense, Net
Interest expense, net consists of the following (in thousands):
Three Months Ended
August 31,
----------------------
1999 1998
-------- --------
Interest income $ (496) $ (879)
Non-recourse interest expense 2,757 2,148
------- --------
Net non-recourse interest expense 2,261 1,269
Recourse interest expense 1,017 1,028
------- --------
Interest expense, net $ 3,278 $ 2,297
======= ========
The Company finances leases for its own portfolio primarily with
non-recourse debt. Interest income arises when equipment financed with
non-recourse debt is sold to investors. As a result, interest income
reported in the accompanying Consolidated Statements of Income reflects an
amount equal to non-recourse interest expense recognized for leases sold to
private investors. Therefore, net non-recourse interest expense on related
discounted lease rentals pertains to the Company's owned lease portfolio.
Such amount increased due to an increase in the average outstanding balance
of related discounted lease rentals related to growth in the Company's
owned portfolio. It is anticipated that net non-recourse interest expense
on related discounted lease rentals will continue to increase in the future
as the Company adds additional leases financed with non-recourse debt to
its portfolio through its securitization facility.
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 the three months ended August 31, 1998, for
a reduction in the valuation allowance for deferred income tax assets to
reflect a reduction in uncertainty about the utilization of the AMT credit
carryforward in future years as a result of the Company's recurring
profitable results of operations. The Company believes that it is more
likely than not that the results of future operations will generate
sufficient taxable income to realize the remaining net deferred tax assets.
14 of 21
<PAGE>
II. Liquidity and Capital Resources
-------------------------------
The Company's activities are principally funded by proceeds from sales of
on-lease equipment (to PIFs or Private Investors), non-recourse debt and
securitization proceeds, recourse bank debt, rents, fees and distributions
from PIFs and private investors, and sales or re-leases of equipment after
the expiration of the initial lease terms. In addition, the Company
finances receivables of its CATG subsidiary primarily under an agreement
with a specialized finance company. Management believes the Company's
ability to generate cash from operations is sufficient to fund operations,
as shown in the accompanying Consolidated Statements of Cash Flows.
As of August 31, 1999, there were no amounts drawn on the Company's $15
million committed non-recourse facility.
Historically, the Company sold a significant portion of its lease
originations to the PIFs. During fiscal 1998, the Company completed the
offering of units in the most recent PIF, Capital Preferred Yield Fund-IV.
The Company has elected not to organize additional PIFs. Consequently,
future equipment sales to PIFs will reflect only the reinvestment needs of
the existing PIFs, and therefore are expected to represent smaller amounts
of equipment sales margin and cash flow.
Leases that, in the past, would have been originated for sale to the PIF's
are now being retained by the Company. This strategy is expected to
increase the Company-owned leased portfolio. Increases in the size of the
Company's lease portfolio are expected to result in an increase in (a) the
Company's revenue and ultimate profitability and (b) the amount of capital
needed to fund leasing activities. The Company finances leases for its own
portfolio on a long-term basis utilizing the Securitization facility
described in Note 2 to Notes to Consolidated Financial Statements.
Securitization generally provides financing for 90-95% of the cost of
leased equipment. The remaining cost of the equipment (also referred to as
"equity capital") is financed utilizing availability under the Company's
recourse debt facility and/or cash from operations.
In addition, the Company has significantly increased the amount of leases
it is holding in its warehouse portfolio. The Company generally finances
leases it holds pending sale utilizing borrowings under the Warehouse
Credit Facility portion of its Senior Facility equal to 95% of the cost of
the leased equipment, and equity capital for the remainder of the cost. In
addition, the Company has originated certain leases intended for sale to
investors which are not eligible for financing under the Warehouse Credit
Facility. In such cases, equity capital is utilized to finance 100% of the
cost of the leased equipment.
To enable the Company to continue to significantly add leases to its
portfolio, it must increase the availability of equity capital. Its present
strategy is to sell existing leases in its warehouse portfolio to private
investors in order to "free-up" previously invested equity capital. In
addition, the Company is evaluating additional sources of capital which
will provide the liquidity necessary to continue to add leases to its
portfolio, including the sale of Company-owned leases, the sale of retained
residuals, a public debt offering and the sale of non-leasing related
assets. There can be no assurance that the Company will be successful in
selling existing leases to private investors, or in raising additional
equity capital.
The Company's Senior Facility was expanded during fiscal 1999 to
approximately $71 million. The terms of the Senior Facility are
substantially unchanged and expire on November 26, 2000. See Note 10 to
Notes to Consolidated Financial Statements in Form 10-K for a description
of the Company's Senior Facility. As of August 31, 1999, the Company was in
compliance with the terms of the facility. As of August 31, 1999, the
Company had drawn $45.8 million under this facility.
15 of 21
<PAGE>
II. Liquidity and Capital Resources, continued
-------------------------------
The Company finances receivables and inventory for its CATG subsidiary
under an agreement with Deutsche Financial Services that provides for a
financing commitment of up to $6 million. At August 31, 1999, accounts
receivable, net included $5.2 million of eligible receivables related to
the Company's CATG subsidiary which were eligible collateral under the
financing agreement. The balance outstanding under the facility was $3.8
million at August 31, 1999. As of August 31, 1999, CATG and the Company
were in compliance with the terms of the facility.
Inflation has not had a significant impact upon the operations of the
Company.
III. Year 2000 Issue
---------------
The Company has conducted a comprehensive review of its internal
information technology ("IT") 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.
The Company is in the process of upgrading or replacing all components of
its IT systems which were identified as being affected by the Year 2000
issue. At the present time, the Company has completed upgrades and testing
of the upgrades for all components of its IT systems except its primary
application software which controls the Company's financial records, asset
management detail, and billing records. The Company has fully identified
all aspects of the application software which have Year 2000 issues and has
commenced the process of upgrading the software. The Company expects that
the new upgrades will be fully operational by December 31, 1999, and
therefore will be fully Year 2000 compliant. The Company does not expect
any other changes required for the Year 2000 to have a material effect on
its financial position or results of operations. As such, the Company has
not developed any specific contingency plans in the event it fails to
complete the upgrades by December 31, 1999. However, should the Company be
unsuccessful in completing the necessary upgrades by December 31, 1999, the
Company does not expect there will be a material adverse effect on the
Company's financial position or results of operations. The Company believes
it could continue to operate utilizing manual procedures until all system
upgrades are completed. However, there could be a negative impact on the
Company's ability to realize expected cash flows from leased equipment on a
timely basis due to billing or collection problems which could arise
related to Year 2000 issues. While it is expected that the Company's
ability to ultimately realize all expected cash flows will not be impacted,
delays in collecting cash flows would have a negative impact on the
liquidity and financial resources.
Operating and other expenses for the three months ended August 31, 1999
include cost of approximately $200,000 associated with Year 2000 readiness.
The Company expects that additional costs of becoming Year 2000 compliant
will be incurred through December 1999 and will amount to an additional
$100,000 to $200,000.
Some risks associated with the Year 2000 problem are beyond the Company's
ability to control, including the extent to which lessees, suppliers and
service providers can address their Year 2000 problems. The Company has
received correspondence from substantially all significant lessees,
suppliers and service providers representing their expected readiness in
regards to the ability to do business after December 31, 1999. The Company
cannot estimate, therefore, the impact on it if third parties are not Year
2000 compliant. The failure by a lessee or supplier to adequately address
the Year 2000 issue could hurt the lessor or supplier and disrupt the
Company's business. The most likely worst case Year 2000 scenario is if one
or more lessee's business is disrupted by Year 2000 problems and is
16 of 21
<PAGE>
III. Year 2000 Issue, continued
---------------
unable to remit lease payments on a timely basis. Such a situation could
negatively impact the Company's cash flow and liquidity for a period of
time. However, because substantially all of the Company's leases are with
lessees of substantial credit-worthiness, it is expected that such a
disruption would be temporary, and therefore not have a material impact on
the Company's financial position or results of operations.
IV. New Accounting Pronouncements
-----------------------------
In June 1998, the Financial Accounting Standards Board issued SFAS No. 133,
Accounting for Derivative Instruments and Hedging Activities ("Statement
133"). Statement 133 establishes accounting and reporting standards for
derivative instruments and for hedging activities. It requires that an
entity recognize all derivatives as either assets or liabilities in the
statement of financial position and measure those instruments at fair
value. In June 1999, the Financial Accounting Standards Board issued SFAS
No. 137, Accounting for Derivative Instruments and Hedging Activities -
Deferral of the Effective Date of FASB Statement 133, an Amendment of FASB
Statement 133. Statement 137 effectively extends the required application
of Statement 133 to fiscal years beginning after June 15, 2000, with
earlier application permitted. The Company adopted Statement 133 in the
first quarter of 2000.
The Company's hedging activities are limited to the floating-to-fixed
interest rate swap acquired in connection with the Securitization Facility.
That hedge is designed to effectively hedge the exposure to interest rate
changes. As such, the impact of adoption of SFAS 133 is not material.
V. "Safe Harbor" Statement Under the Private Securities Litigation Reform Act
---------------------------------------------------------------------------
of 1995
-------
The statements contained in this report which are not historical facts may
be deemed to contain forward- looking statements with respect to events,
the occurrence of which involve risks and uncertainties, and are subject to
factors that could cause actual future results to differ both adversely and
materially from currently anticipated results, including, without
limitation, the level of lease originations, realization of residual
values, the availability and cost of financing sources and the ultimate
outcome of any contract disputes. Certain specific risks associated with
particular aspects of the Company's business are discussed in detail
throughout Item 2 of this report and Parts I and II of the 1999 Form 10-K
when and where applicable.
Item 3. Quantitative and Qualitative Disclosures About Market Risk
Not applicable
17 of 21
<PAGE>
CAPITAL ASSOCIATES, INC. AND SUBSIDIARIES
PART II
OTHER INFORMATION
Item 1. Legal Proceedings
-----------------
The Company is involved in the following legal proceedings:
a. BANK ONE TEXAS, N.A. V. CAPITAL ASSOCIATES INTERNATIONAL, INC. AND CAPITAL
ASSOCIATES, INC., UNITED STATES DISTRICT COURT FOR THE NORTHERN DISTRICT OF
TEXAS, DALLAS DIVISION, CIVIL ACTION NO. 3-99CV0697-G
On March 2, 1999, Bank One Texas, N.A. ("Bank One") filed a complaint
against the Company seeking recovery from the Company of $1,324,715.02
together with interest at the lesser of 18% per annum or the maximum amount
permitted by law from December 30, 1991. To date, Bank One has not served
the complaint on the Company. Bank One is alleging in the lawsuit that the
Company breached the terms of its Purchase Agreement, dated December 30,
1991, with Bank One pursuant to which Bank One agreed to purchase from the
Company, for an initial payment of $1,324,715.02 (the "Bank One Payment"),
certain furniture, fixtures and equipment (the "FF&E") previously leased to
MBank Dallas, N.A. ("MBank"). MBank defaulted on the lease in 1989 and was
eventually placed in receivership. Bank One filed a lawsuit over the
ownership of the FF&E and certain collateral for MBank's lease obligations
(the "MBank Collateral") in January 1992 (the "MBank Litigation"). See the
Company's Annual Reports on Form 10-K for the fiscal years ended May 31,
1994 and 1995, for the history of the MBank Litigation. In August 1995, all
of the parties to the MBank Litigation, except Bank One, settled their
claims with respect to the MBank Collateral. The Company received
approximately $10.8 million as part of the settlement. Later in August
1995, the Company, pursuant to the terms of the settlement agreement,
delivered $2.2 million to Bank One in repayment of the Bank One Payment
together with interest thereon. Bank One 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. In August 1998, the trial court
held that Bank One was the owner of the FF&E. Now, a year after the trial
court's decision and more than four years since it rejected the Company's
tender, Bank One is seeking recovery of the Bank One Payment plus interest
thereon since December 30, 1991.
If Bank One pursues this lawsuit, the Company intends to (1) defend
vigorously the claims asserted against it by Bank One and (2) assert
vigorously all counterclaims it may have against Bank One. The Company
believes that, at very least, it has strong defenses to the running of any
additional interest on the Bank One Payment since Bank One rejected the
Company's tender in August 1995. The Company also believes it may have
credible defenses to the repayment of any portion of the Bank One Payment
or any of the interest thereon based on Bank One's conduct over the past
eight years.
b. The Company is involved in other routine legal proceedings incidental to
the conduct of its business. Management believes that none of these legal
proceedings, or the matter noted above, will have a material adverse effect
on the financial condition or operations of the Company.
18 of 21
<PAGE>
Item 5. Other Information
-----------------
On September 1, 1999, the Nasdaq stock market ("NASDAQ") informed the Company
that it was not in compliance with the minimum requirements for continued
listing of its common stock on the Nasdaq National Market.
By letter dated August 31, 1999, NASDAQ informed the Company that it was not in
compliance with the $5 million market value of public float requirement for
continued listing of its Common Stock on the NASDAQ National Market (the "MVPF
Requirement"). As of September 8, 1999, the total number of shares of Common
Stock held by non-affiliates is 1,270,000 (24% of the outstanding shares),
having a market value of $3,810,000. The letter states that, unless it regains
compliance with the MVPF Requirement by November 30, 1999, the Company's Common
Stock will be de- listed at the opening of business on December 3, 1999. The
letter goes on to state that the Company may apply for listing on the NASDAQ
SmallCap Market if it satisfies the requirements for continued listing thereon.
The Company does not believe that it will be able to regain compliance with the
MVPF Requirement on or before November 30, 1999. The Company is currently
reviewing its alternatives, i.e., submitting an application for listing on the
SmallCap Market, listing its Common Stock on the NASDAQ Over-The-Counter
Bulletin Board, etc. The Company intends to timely file a Current Report on Form
8-K announcing any change in the listing of its Common Stock.
Item 6. Exhibits and Reports on Form 8-K
--------------------------------
(a) Exhibits
(b) Reports on Form 8-K
-------------------
None
19 of 21
<PAGE>
Item No. Exhibit Index
- -------- -------------
27 Financial Data Schedule
20 of 21
<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: October 15, 1999 By: /s/Anthony M. DiPaolo
--------------------------
Anthony M. DiPaolo,
Senior Vice-President and
Chief Financial Officer
21 of 21
<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> 3-MOS
<FISCAL-YEAR-END> MAY-31-2000
<PERIOD-END> AUG-31-1999
<CASH> 11,870
<SECURITIES> 0
<RECEIVABLES> 10,258
<ALLOWANCES> 136
<INVENTORY> 2,531
<CURRENT-ASSETS> 0
<PP&E> 158,661
<DEPRECIATION> 0
<TOTAL-ASSETS> 260,618
<CURRENT-LIABILITIES> 0
<BONDS> 0
0
0
<COMMON> 42
<OTHER-SE> 25,714
<TOTAL-LIABILITY-AND-EQUITY> 260,618
<SALES> 49,446
<TOTAL-REVENUES> 67,132
<CGS> 46,880
<TOTAL-COSTS> 66,970
<OTHER-EXPENSES> 5,012
<LOSS-PROVISION> 100
<INTEREST-EXPENSE> 3,774
<INCOME-PRETAX> 162
<INCOME-TAX> 0
<INCOME-CONTINUING> 162
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 162
<EPS-BASIC> .02
<EPS-DILUTED> .02
</TABLE>
