-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, OAtceNWMmkxSecvspetRUeGBwbXKRj/aEJh6rTowpJnoGSBgVuVXVq20+GKj8I8A g3bmWXwrwptADq88ol3XnQ== 0000804188-99-000027.txt : 19990914 0000804188-99-000027.hdr.sgml : 19990914 ACCESSION NUMBER: 0000804188-99-000027 CONFORMED SUBMISSION TYPE: 10-K PUBLIC DOCUMENT COUNT: 7 CONFORMED PERIOD OF REPORT: 19990531 FILED AS OF DATE: 19990913 FILER: COMPANY DATA: COMPANY CONFORMED NAME: CAPITAL ASSOCIATES INC CENTRAL INDEX KEY: 0000804188 STANDARD INDUSTRIAL CLASSIFICATION: WHOLESALE-COMPUTER & PERIPHERAL EQUIPMENT & SOFTWARE [5045] IRS NUMBER: 841055327 STATE OF INCORPORATION: DE FISCAL YEAR END: 0531 FILING VALUES: FORM TYPE: 10-K SEC ACT: SEC FILE NUMBER: 000-15525 FILM NUMBER: 99710600 BUSINESS ADDRESS: STREET 1: 7175 W JEFFERSON AVE STE 3000 CITY: LAKEWOOD STATE: CO ZIP: 80235 BUSINESS PHONE: 3039801000 10-K 1 4Q99CAI.001 SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-K [x] Annual report pursuant to section 13 or 15(d) of the Securities Exchange Act of 1934 For the fiscal year ended May 31, 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 Securities registered pursuant to Section 12(b) of the Act: None Securities registered pursuant to Section 12(g) of the Act: Common Stock, $.008 par value Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes X No ----- ----- Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. The approximate market value of stock held by non-affiliates was $3,810,000 based upon 1,270,000 shares held by such persons and the closing price on September 8, 1999 of $3.00. The number of shares outstanding of the Registrant's $.008 par value common stock at September 8, 1999 was 5,271,626. Page 1 of 36 Pages Exhibit Index Begins on Page 33 PART I Item 1. Business -------- Capital Associates, Inc. ("the Company") is a commercial finance company engaged in the leasing of a variety of equipment. The Company is principally engaged in (i) the origination of equipment leases with equipment users, including the acquisition of leases initially originated by other lessors (ii) the sale of equipment leases to third parties, (iii) the management and servicing of equipment leases retained by the Company or sold to private investors or other lessors, (iv) the sale and remarketing of equipment as it comes off-lease and (v) the sale and servicing of new information technology equipment. During fiscal years 1999 and 1998, the Company originated approximately $576 million of equipment leases. The principal market for the Company's activities is the United States. Leasing Activities - ------------------ The Company's lease origination strategy is transaction driven. With each lease origination opportunity, the Company evaluates the prospective lessee's creditworthiness and the importance of the equipment to the lessee's business. With respect to the equipment, the Company evaluates the equipment's remarketability, upgrade potential and the probability that the equipment will remain in place at the end of the initial lease term. Typically, equipment which remains in place produces better residual returns than equipment sold or leased to a third party. The Company generally purchases equipment that is subject to relatively short-term leases (generally seven years or less). All of the Company's lease transactions are net leases with a specified noncancelable lease term. These noncancelable leases have a "hell-or-high-water" provision which requires the lessee to make all lease payments under all circumstances. In addition, the lessee is required to insure the equipment against casualty loss, pay all related maintenance expenses and pay property, sales and other taxes. The Company has master leases in place with approximately 538 customers. Master leases are contracts that establish general terms and conditions under which the Company conducts its leasing business and are frequently a prerequisite in competing for new financing. Master leases simplify the approval process for lessees and enable the Company to compete for new business at all levels of an enterprise. The Company attempts to diversify its lease origination and funding sources in order to enhance its competitiveness regardless of changes in technology or regulations. Lease originations are diversified by (i) locating the retail originations sales force in regional branch offices throughout the United States, (ii) targeting a variety of specific industries and equipment types for lease originations and (iii) originating leases on a wholesale basis (i.e., acquiring leases from other lessors). Funding sources are diversified by (x) matching individual equipment originations with the investment needs of private investors, (y) originating leases on a recurring basis on behalf of private lease investment programs it manages on behalf of other lessors (private investment programs) and (z) funding lease transactions for its own portfolio through securitization or permanent non-recourse financing. The Company diversifies lease originations to include a variety of equipment types that meet the Company's underwriting standards with emphasis on (i) material handling equipment, (ii) office furniture and store fixtures, (iii) circuit board and semiconductor manufacturing, production and testing equipment, (iv) machine tool and factory automation equipment and (v) information technology equipment. The Company seeks to maintain a diversified lease portfolio in order to minimize its credit and residual exposure to any single lessee, industry or equipment category. As of May 31, 1999, no single industry or lessee accounted for more than 10% of the Company's portfolio of leases. During fiscal 1998, the Company acquired DBL, Inc. d/b/a Connecting Point (subsequently renamed Capital Associates Technology Group or "CATG"). CATG provides a wide range of information technology ("IT") services, including 2 of 36 Item 1. Business, continued -------- Leasing Activities, continued - ------------------ procurement of new PC's and networking equipment and software, and maintenance of IT equipment. In June 1999, CATG completed the purchase of substantially all the assets of Sento Consulting Corporation ("Sento") for $50,000 cash and $350,000 of contingent consideration based on the level of revenues during the next thirty-six months. The acquisition of Sento expands CATG's product line to include enterprise computing products, including high-end servers and data storage devices. CATG provides the Company with enhanced equipment expertise and evaluation services for our customers and the capability of acquiring new IT equipment at favorable prices. The Company's principal sources of funding for its leasing transactions include (i) a $61.2 million warehouse facility ("Warehouse Facility"), (ii) a $6.9 million working capital facility ("Working Capital Facility"), (iii) permanent non-recourse financing, including securitization of receivables, (iv) sales of equipment leases to third parties or lease investment programs it manages and (v) the Company's internally generated revenues. Historically, the Company sold a significant portion of its lease originations to public limited partnership income funds ("PIF") in which the Company was the general partner or co-general partner. 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, future equipment sales to PIFs will reflect only the reinvestment needs of the existing PIFs, and are expected to represent a smaller amount of equipment sales. In the case of leases held for the Company's account, a typical lease transaction requires a cash investment by the Company of 5% to 30% of the original equipment cost, commonly known in the leasing industry as an "equity investment". The balance of original equipment cost is financed through securitization funding or the discounting of lease rentals, also referred to as discounted lease rentals. Such borrowings are secured by a first lien on the equipment and the related lease rental payments. The Company's equity investment is typically financed with proceeds from its Working Capital Facility, Term Loan, securitization proceeds, or internally generated funds. The Company recovers its equity investment from renewal rents received and/or sales proceeds realized from the equipment after payment in full of the related permanent non-recourse debt or securitization funding. The Company is pursuing additional lease investment programs and is renewing its existing securitization program to finance its leases. Of the equipment leases originated or acquired by the Company in fiscal years 1999 and 1998, the Company retained approximately 41% and 28%, sold 19% and 29% to private leasing investment programs, sold 5% and 15% to the PIFs, and syndicated 35% and 28% to unaffiliated third parties, respectively. Equipment leases retained or serviced by the Company increased 13% to $936 million as of May 31, 1999 from $828 million in June 1998. The Company serviced $176 million and $118 million in assets (based on original equipment cost) for private leasing investment programs in fiscal years 1999 and 1998, respectively. As of May 31, 1999, the Company had awards for future business amounting to approximately $65.1 million, as compared to $24.9 million at May 31, 1998. On average approximately 93% of the Company's awarded business was closed for fiscal year 1999. Underwriting Standards - ---------------------- All leases are subject to review under the Company's underwriting standards. To minimize credit risk, the Company has established credit underwriting standards which specify that the Company's lessees have a credit rating of not less than Baa as determined by Moody's Investor Services, Inc., or comparable credit ratings as determined by other recognized credit rating services (an "investment grade credit"), or although not rated by a recognized credit rating service or rated below Baa, are believed by the Company to be sufficiently creditworthy to satisfy the financial obligations under the lease (a "non investment grade credit"). As of May 31, 1999, approximately 98% of the equipment owned by the 3 of 36 Item 1. Business, continued -------- Underwriting Standards, continued - ---------------------- Company was leased to companies that meet the above criteria. As of May 31, 1999, the dollar-weighted average credit rating of the Company's lessees was the equivalent of Baa. The Company originates leases for the PIFs and for private investment programs in accordance with each program's lease underwriting standards. In the case of the PIFs, the underwriting standards are similar to those of the Company. The Company's historical losses associated with leases originated since 1991, are approximately 1% of the amount originated. Residual values are established at lease inception equal to the estimated value to be received from the equipment at the termination of the lease. In estimating such values, the Company considers relevant factors regarding the equipment and the lessee, including, for example, (i) the equipment's remarketability, (ii) upgrade potential, and (iii) probability that the equipment will continue to be in place at the end of the initial lease term. The nature of the Company's leasing activities is that it has credit exposure and residual value exposure and, accordingly, in the ordinary course of business it will incur losses arising from these exposures. The Company performs quarterly assessments of its assets to identify other-than-temporary losses in value. The Company records allowances for losses as soon as any other-than-temporary declines in asset values are known. Charge-offs are recorded upon the termination or remarketing of the underlying assets. As such, charge-offs will primarily occur subsequent to the recording of the allowances for losses. The Company's Transaction Review Committee ("TRC"), which is comprised of members of senior management, (1) reviews and approves all material aspects of lease transactions, including credit ratings assigned to lessees and certain pricing and residual value assumptions; (2) advises on lease documentation requirements and deal structuring guidelines; (3) monitors asset quality in order to estimate and assess the net realizable values at the end of a lease terms for the Company's equipment; and (4) revises and updates the underwriting standards, when and as necessary. All transactions over $3,000,000 with a less than investment grade credit and over $5,000,000 with an investment grade credit must be approved by the Executive Committee. Private Investment Programs and PIFs - ------------------------------------ The majority of leases originated by the Company are sold to private investors or to lease investment programs, collectively referred to as "Private Investors". The Company records sales revenue equal to the sales price of the equipment and equipment sales cost equal to the carrying value of the equipment. In the event the Company warehouses a transaction prior to sale, the Company records leasing revenue and expenses during the warehouse period. Revenue from the sale of equipment under lease to private investors or to lease investment programs was $158.7 million, $179.4 million and $131.6 million during fiscal years 1999, 1998 and 1997, respectively. The Company currently sponsors or co-sponsors three PIFs. The Company sells certain equipment leases it originates to these PIFs. Revenue from the sale of leased equipment to the PIFs was $19.0 million, $48.6 million and $67.0 million during fiscal years 1999, 1998 and 1997, respectively. As discussed under Leasing Activities, sales to PIF's are expected to decline significantly in the future. Various subsidiaries and affiliates of the Company are the general partners or co-general partners of the PIFs. In addition, the Company contributed cash and/or equipment to each PIF in exchange for a Class B limited partner interest ("Class B interest") in each PIF. Public investors purchased Class A limited partnership units ("Class A Units") for cash, which the PIFs used to purchase leased equipment. The Company receives fees for performing various services for the PIFs (subject to certain dollar limits) including acquisition fees and management fees, and was reimbursed for organizational and offering expenses incurred in selling the Class A Units (subject to certain dollar limits). The Company receives a Class B cash distribution from each PIF (subordinated to the cash returns on the Class A Units). The general partner receives cash distributions and reimbursement of certain operating expenses incurred in connection with each PIFs operations. 4 of 36 Item 1. Business, continued -------- Equipment Remarketing Activities - -------------------------------- Remarketing activities consist of lease portfolio management (i.e., managing equipment under lease) and asset management (i.e., managing off-lease equipment). One of the Company's principal goals is to minimize off-lease equipment by proactively managing such equipment while it is under lease (e.g., renewing or extending the lease, or re-leasing to a third party, or upgrading or adding to the equipment before the end of the initial lease term). In general, remarketing equipment in place produces better residual returns than equipment sold or re-leased to third- parties. However, if the Company is unsuccessful in keeping the equipment in place, it will attempt to sell or release the equipment to a different end-user/lessee, or sell the off-lease equipment to brokers or dealers. Revenue from remarketing activities was approximately $3.0 million, $5.7 million, and $5.7 million during fiscal years 1999, 1998 and 1997, respectively. The Company maximizes the remarketing proceeds from, and minimizes the warehousing costs for, off-lease equipment by (1) remarketing IT equipment through its Name Brand Computer Outlet subsidiary ("NBCO"), (2) employing qualified and experienced remarketing personnel, (3) developing and acquiring equipment remarketing expertise in order to maximize the profit from sales of off-lease equipment, (4) minimizing the amount of off-lease equipment stored at independently operated equipment warehouses, (5) operating its own storage facilities to further reduce warehousing costs for off-lease material handling and information technology equipment, (6) eliminating scrap inventory, and (7) conducting on-site equipment inspections for on-lease equipment. The Company further supports these activities by carefully monitoring the residual values of its equipment portfolio and maintaining adequate reserves on its books, when and as needed, to reflect anticipated future reductions in such values due to obsolescence and other factors. NBCO was established in December of 1998 as a subsidiary of Capital Associates, Inc. for the purpose of remarketing commercial quality used personal computers, monitors and printers. NBCO's operation consists of a distribution facility ("the factory"), three retail stores located in the Denver metropolitan area and one retail store located near Toledo, Ohio. The NBCO factory is a 50,000 square foot facility located in Aurora, Colorado and is a full service personal computer equipment receiving, reconditioning and upgrade center. NBCO also remarkets computers through its website and employs a sales staff who target small businesses, school districts, governmental operations and other large users. NBCO also 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 or to consumers through NBCO's retail facilities. These activities are referred to as Equipment Brokerage Sales. Competition - ----------- The Company competes mainly on the basis of its lease rates, terms offered in its leasing transactions, reliability in meeting its commitments and customer service. Lease rates are determined primarily by the Company's funding costs and equipment residuals resulting from its remarketing capability. The Company's continued ability to compete effectively may be materially affected by the availability of funding options and of financing and the costs of such financing. The Company competes with a large number of equipment lessors, many of which have greater financial resources, greater economies of scale and lower costs of capital than the Company. Employees - --------- The Company had approximately 195 employees as of May 31, 1999 versus approximately 170 employees as of May 31, 1998, none of whom were represented by a labor union. The Company believes that its employee relations are good. 5 of 36 Item 2. Properties ---------- The Company leases office facilities (approximately 25,000 square feet) in Lakewood, Colorado (a suburb of Denver). These facilities house the Company's administrative, financing and marketing operations. The Lakewood, Colorado facility adequately provides for present and future needs, as currently planned. In addition, the Company leases a warehouse facility, four retail stores, and has seven regional or satellite marketing offices. The Company also leases facilities in Ogden and Salt Lake City, Utah where it markets and services information technology equipment. Item 3. 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. Item 4. Submission of Matters to a Vote of Security Holders --------------------------------------------------- There were no matters submitted to a vote of security holders during the three months ended May 31, 1999. 6 of 36 PART II Item 5. Market for the Registrant's Common Stock and Related Stockholder ----------------------------------------------------------------------- Matters ------- The Company's common stock trades on the Nasdaq Stock Market ("NASDAQ") under the symbol: CAII. The following table sets forth the high and low sales prices of the Company's common stock for the periods indicated, according to published sources. High and low sales prices shown reflect inter-dealer quotations without retail markups, markdowns or commissions and do not necessarily represent actual transactions. 2000 HIGH LOW ---- ---- --- First Quarter (through September 8, 1999) 3 1/2 2 1/8 1999 HIGH LOW ---- ---- --- First Quarter 5 3/8 2 1/2 Second Quarter 4 1/2 3 1/8 Third Quarter 5 3/4 2 3/4 Fourth Quarter 4 1/2 2 7/8 1998 HIGH LOW ---- ---- --- First Quarter 4 2 1/4 Second Quarter 4 1/4 2 13/16 Third Quarter 3 1/2 2 1/8 Fourth Quarter 5 3/8 2 15/16 On September 8, 1999, the date on which trading activity last occurred, the closing sales price of the Company's common stock was $3.00. On September 8, 1999, there were approximately 158 shareholders of record and at least 872 beneficial shareholders of the Company's outstanding common stock. No dividends were paid during the periods indicated. The Company does not anticipate that it will pay cash dividends on its common stock in the foreseeable future. See Note 9 of Notes to Consolidated Financial Statements for a discussion of restrictions on CAII's ability to transfer funds to the Company which, in turn, limits the Company's ability to pay dividends on its outstanding common stock. On September 1, 1999, 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 reported herein, 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. 7 of 36 Item 6. Selected Financial Data ----------------------- The table on the following page sets forth selected consolidated financial data for the periods indicated derived from the Company's consolidated financial statements. The data should be read in conjunction with Item 7, Management's Discussion and Analysis of Financial Condition and Results of Operations, and the Company's consolidated financial statements and notes to the financial statements appearing elsewhere. Income Statement Data - --------------------- (in thousands, except per share and number of shares data)
1999 1998 1997 1996 1995 --------- ---------- ---------- ---------- ---------- Revenue: Equipment sales $ 193,914 $ 248,258 $ 204,545 $ 166,242 $ 81,370 Leasing 42,614 25,101 14,420 10,212 7,672 Interest 2,219 3,487 4,828 6,943 11,386 Other 4,623 4,228 3,741 3,284 4,516 --------- ---------- ---------- ---------- ---------- 243,370 281,074 227,534 186,681 104,944 --------- ---------- ---------- ---------- ---------- Costs and expenses: Equipment sales 187,733 240,702 200,018 161,797 70,866 Leasing 27,260 17,337 8,928 5,466 3,893 Operating and other expenses 15,513 11,830 9,568 8,332 11,603 Provision for losses 555 705 365 430 2,940 Interest - non-recourse debt 8,503 6,123 6,012 7,705 12,548 Interest - recourse debt 3,409 2,857 1,900 2,145 1,618 --------- ---------- ---------- ---------- ---------- 242,973 279,554 226,791 185,875 103,468 --------- ---------- ---------- ---------- ---------- Income before income taxes 397 1,520 743 806 1,476 Income tax expense - - 10 202 360 --------- ---------- ---------- ---------- ---------- Net income $ 397 $ 1,520 $ 733 $ 604 $ 1,116 ========= ========== ========== ========== ========== Earnings per common share: Basic $ .08 $ .30 $ .15 $ .12 $ .22 Diluted $ .07 $ .28 $ .14 $ .12 $ .21 Weighted average number of common shares outstanding: Basic 5,173,000 5,117,000 5,004,000 4,987,000 5,052,000 Diluted 5,399,000 5,449,000 5,403,000 5,186,000 5,325,000 Balance Sheet Data (in thousands) May 31, ----------------------------------------------------------------------- 1999 1998 1997 1996 1995 --------- ---------- ---------- ---------- ---------- Total assets $ 246,741 $ 214,093 $ 146,517 $ 127,511 $ 158,956 Recourse debt 50,060 49,088 20,712 17,538 24,520 Discounted lease rentals 125,639 104,311 61,466 63,749 98,216 Stockholders' equity 25,615 25,186 23,501 22,881 22,490
8 of 36 Item 7. Management's Discussion and Analysis of Financial Condition and Results ----------------------------------------------------------------------- of Operations ------------- I. Results of Operations --------------------- During fiscal years 1999, 1998, 1997, 1996, and 1995, the Company reported net income of $397,000, $1,520,000, $733,000, $604,000, and $1,116,000, respectively. Net income for 1999 and 1998 includes the results for its CATG subsidiary subsequent to its acquisition effective November 1, 1997. Excluding the results for CATG, the Company had net income of $1,439,000 and $1,799,000 for 1999 and 1998, respectively. The Company's profits during these five years were achieved primarily as a result of expanding and improving its lease originations, asset management, remarketing and leased equipment sales activities and the sale of other corporate assets and the settlement of litigation. During fiscal year 1999 the Company: * generated profits for the seventh consecutive year * renewed it's senior secured debt facility with an increase in the commitment amount under the Warehouse Credit Facility and the Working Capital Facility to $61,250,000 and $6,900,000, respectively * continued to invest in its sales force through an extensive training program and personnel expansion * originated leases exceeding $266 million * closed a new $50 million lease securitization facility * added two new private investment programs * established a new subsidiary to remarket off-lease commercial quality used personal computers, monitors and printers * increased net investment in direct finance leases and leased equipment, net by $56 million. Significant factors which may impact the Company's profitability in the future include the amount of capital available to the Company, it's success in developing and retaining the field sales force, the cost of capital 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. 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 to fall with interest rates, although lease rate movements generally lag interest rate movements. 9 of 36 Item 7. Management's Discussion and Analysis of Financial Condition and Results ----------------------------------------------------------------------- of Operations, continued ------------- I. Results of Operations, continued --------------------- 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 because (i) 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 to a private investor 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. 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 by fiscal year (in thousands).
Years Ended May 31, ---------------------------------------- 1999 1998 1997 --------- --------- --------- Placement: Equipment under lease sold to PIFs $ 14,000 $ 47,000 $ 63,000 Equipment under lease sold to private investors 144,000 176,000 101,000 Leases added to the Company's lease portfolio (a significant portion of which will be/were sold during the subsequent fiscal years) 108,000 87,000 67,000 --------- --------- --------- Total lease origination volume $ 266,000 $ 310,000 $ 231,000 ========= ========= =========
The Company continues to evaluate additional sources of capital which will provide the liquidity necessary to add leases to its own portfolio. The goal of such financing is to 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. 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. 10 of 36 Item 7. Management's Discussion and Analysis of Financial Condition and Results ----------------------------------------------------------------------- of Operations, continued ------------- I. Results of Operations, continued --------------------- Presented below are schedules showing condensed income statement categories and analyses of changes in those condensed categories derived from the Consolidated Statements of Income appearing on page F-4 of this report on Form 10-K, prepared solely to facilitate the discussion of results of operations that follows (in thousands):
YEARS ENDED MAY 31, YEARS ENDED MAY 31, ------------------------- ----------------------- CAI CONSOLIDATED 1999 1998 CHANGE 1998 1997 CHANGE ---------------- ---------- ---------- --------- --------- --------- --------- Equipment sales margin $ 6,181 $ 7,556 $ (1,375) $ 7,556 $ 4,527 $ 3,029 Leasing margin 15,354 7,764 7,590 7,764 5,492 2,272 Other income 4,623 4,228 395 4,228 3,741 487 Operating and other expenses (15,513) (11,830) (3,683) (11,830) (9,568) (2,262) Provision for losses (555) (705) 150 (705) (365) (340) Interest expense, net (9,693) (5,493) (4,200) (5,493) (3,084) (2,409) Income taxes - - - - (10) 10 --------- --------- -------- -------- -------- -------- Net income $ 397 $ 1,520 $ (1,123) $ 1,520 $ 733 $ 787 ========= ========= ======== ======== ======== ======== YEARS ENDED MAY 31, YEARS ENDED MAY 31, ------------------------- ----------------------- CAI WITHOUT CATG 1999 1998 CHANGE 1998 1997 CHANGE ---------------- ---------- ---------- --------- --------- --------- --------- Equipment sales margin $ 3,731 $ 6,152 $ (2,421) $ 6,152 $ 4,527 $ 1,625 Leasing margin 15,354 7,764 7,590 7,764 5,492 2,272 Other income 4,623 4,228 395 4,228 3,741 487 Operating and other expenses (12,465) (10,348) (2,117) (10,348) (9,568) (780) Provision for losses (479) (635) 156 (635) (365) (270) Interest expense, net (9,325) (5,361) (3,964) (5,361) (3,084) (2,277) Income taxes - - - - (10) 10 -------- -------- -------- -------- -------- -------- Net income $ 1,439 $ 1,800 $ (361) $ 1,800 $ 733 $ 1,067 ======== ======== ======== ======== ======== ======== YEARS ENDED MAY 31, YEAR ENDED SEVEN MONTHS ------------------------- MAY 31, ENDED MAY 31, CATG 1999 1998 CHANGE 1998 1997 CHANGE ---- ---------- ---------- --------- ---------- ------------- --------- Equipment sales margin $ 2,450 $ 1,404 $ 1,046 $ 1,404 $ - $ 1,404 Operating and other expenses (3,048) (1,482) (1,566) (1,482) - (1,482) Provision for losses (76) (70) (6) (70) - (70) Interest expense, net (368) (132) (236) (132) - (132) -------- -------- -------- -------- -------- -------- Net loss $ (1,042) $ (280) $ (762) $ (280) $ - $ (280) ======== ======== ======== ======== ======== ========
EQUIPMENT SALES Equipment sales revenue and the related margin (including retail sales of new information technology equipment by the Company's CATG subsidiary) consist of the following (in thousands): 11 of 36 Item 7. Management's Discussion and Analysis of Financial Condition and Results ----------------------------------------------------------------------- of Operations, continued ------------- I. Results of Operations, continued --------------------- EQUIPMENT SALES, continued
Years Ended May 31, -------------------------------------------- Increase 1999 1998 (Decrease) --------------------- -------------------- --------------------- Revenue Margin Revenue Margin Revenue Margin --------- -------- --------- -------- --------- -------- Transactions during initial lease term: Equipment under lease sold to PIFs $ 18,996 $ 437 $ 48,648 $ 1,090 $ (29,652) $ (653) Equipment under lease sold to private investors 143,910 2,013 179,408 2,204 (35,498) (191) --------- -------- --------- -------- --------- -------- 162,906 2,450 228,056 3,294 (65,150) (844) --------- -------- --------- -------- --------- -------- Transactions subsequent to initial lease term (remarketing revenue): Sales of off-lease equipment 2,360 363 3,723 885 (1,363) (522) Sales-type leases 56 56 322 156 (266) (100) Excess collections (cash collections in excess of the associated residual value from equipment under lease sold to private investors) 570 570 1,622 1,622 (1,052) (1,052) --------- -------- --------- -------- --------- -------- 2,986 989 5,667 2,663 (2,681) (1,674) Deduct related provision for losses - (555) - (705) - 150 --------- -------- --------- -------- --------- -------- Realizations of value in excess of provision for losses 2,986 434 5,667 1,958 (2,681) (1,524) Add back related provision for losses - 555 - 705 - (150) --------- -------- --------- -------- --------- -------- 2,986 989 5,667 2,663 (2,681) (1,674) Equipment brokerage sales 874 292 650 196 224 96 CATG sales 27,148 2,450 13,885 1,403 13,263 1,047 --------- -------- --------- -------- --------- -------- Total equipment sales $ 193,914 $ 6,181 $ 248,258 $ 7,556 $ (54,344) $ (1,375) ========= ======== ========= ======== ========= ======== Years Ended May 31, -------------------------------------------- Increase 1999 1998 (Decrease) --------------------- -------------------- --------------------- Revenue Margin Revenue Margin Revenue Margin --------- -------- --------- -------- --------- -------- Transactions during initial lease term: Equipment under lease sold to PIFs $ 48,648 $ 1,090 $ 66,987 $ 1,442 $ (18,339) $ (352) Equipment under lease sold to private investors 179,408 2,204 131,600 1,768 47,808 436 --------- -------- --------- -------- --------- -------- 228,056 3,294 198,587 3,210 29,469 84 --------- -------- --------- -------- --------- -------- Transactions subsequent to initial lease term (remarketing revenue): Sales of off-lease equipment 3,723 885 5,142 679 (1,419) 206 Sales-type leases 322 156 71 69 251 87 Excess collections (cash collections in excess of the associated residual value from equipment under lease sold to private investors) 1,622 1,622 528 528 1,094 1,094 --------- -------- --------- --------- --------- -------- 5,667 2,663 5,741 1,276 (74) 1,387 Deduct related provision for losses - (705) - (365) - (340) --------- -------- --------- -------- --------- -------- Realizations of value in excess of provision for losses 5,667 1,958 5,741 911 (74) 1,047 Add back related provision for losses - 705 - 365 - 340 --------- -------- --------- -------- --------- -------- 5,667 2,663 5,741 1,276 (74) 1,387 Equipment brokerage sales 650 196 217 41 433 155 CATG sales 13,885 1,403 - - 13,885 1,403 --------- -------- --------- -------- --------- -------- Total equipment sales $ 248,258 $ 7,556 $ 204,545 $ 4,527 $ 43,713 $ 3,029 ========= ========= ========= ======== ========= ========
12 of 36 Item 7. Management's Discussion and Analysis of Financial Condition and Results ----------------------------------------------------------------------- of Operations, continued ------------- I. Results of Operations, continued --------------------- Equipment Sales to PIFs ----------------------- 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. Consequently, equipment sales margin arising from equipment under lease sold to PIF's has declined and will continue to decline. In addition, fees and distributions from the PIF's (reported as "Other Income") has also declined. Equipment sales to the PIFs decreased during fiscal year 1998 as compared to fiscal year 1997 because three of the PIFs were in their planned liquidation stage and two of the PIFs had been liquidated in 1998. Once a PIF enters the liquidation stage, it no longer acquires equipment under lease. Two PIFs were actively acquiring leases in 1998 as compared to four PIFs which were actively acquiring leases in 1997. Equipment Sales to Private Investors ------------------------------------ Equipment sales to private investors decreased in fiscal year 1999 compared to fiscal year 1998 principally because 1998 results reflect a large, one-time portfolio acquisition the majority of which was sold to private investors. Equipment sales to private investors increased in fiscal year 1998 compared to fiscal year 1997 principally because of the increased volume of lease originations. The Company has, in recent years, invested in its lease origination sales force through extensive training and personnel expansion, adopted a strategy of vertical integration (i.e., the development of specialized equipment and remarketing expertise) and established strategic alliances with investors having a lower cost of capital enabling the Company to originate and to sell leases at competitive prices. 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. 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 or to consumers through NBCO's retail facilities. Revenue from equipment brokerage sales increased during fiscal year 1999 as a result of sales to consumers through NBCO's retail facilities. Prior to 1999, equipment brokerage sales generally consisted of quantity sales to third parties. Equipment brokerage sales increased in fiscal year 1998 compared to fiscal year 1997 because in 1998 the Company dedicated personnel to pursuing such sales. Prior to 1998, Company personnel were devoted only part-time to this activity. 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-eight consecutive quarters. The remarketing of equipment for an amount greater than its book value is reported as equipment sales margin (if the equipment is sold) or as leasing margin (if the equipment is re-leased). The realization of less than the carrying value of equipment is recorded as provision for losses (which is typically not known until 13 of 36 Item 7. 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 ------------------------------------------------------------- until remarketing after the expiration of the initial lease term). As shown in the tables above, the realizations from sales exceeded the provision for losses for fiscal years 1999, 1998 and 1997, even without considering realizations from remarketing activities recorded as leasing margin. Remarketing revenue and the related margins from sales (i.e., sales occurring after the initial lease term) are affected by the number and the dollar amount of equipment leases that mature in a particular year (the average lease term is 3 to 5 years). Remarketing revenue and margin declined in 1999 as a result of a low-level of leases maturing during the period. That low level of leases reflects the Company's low level of leases originated during the mid-1990's. Because lease originations have been increasing since that time, leases maturing subsequent to 1999 are also increasing, therefore the Company expects remarketing revenue and margin to increase during fiscal year 2000. The provision for losses of $555,000 recorded during fiscal year 1999 consisted of: * $479,000 attributable to leases having a net book value of $671,000 with a lessee who filed for bankruptcy protection under Chapter 11 of the Bankruptcy Code during the third quarter fiscal 1999 and has begun the process of liquidating its business. The carrying value of the leased equipment was reduced to reflect the Company's best estimate of its recoverable value upon liquidation. * $76,000 arising from the write-off of bad debts for CATG. The provision for losses recorded during fiscal year 1998 included the following significant items: * 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. * Approximately $185,000 for two off-lease commuter aircraft. The Company engaged MCC Financial Corporation ("MCC"), the Company's majority stockholder and a 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 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 losses recorded during fiscal year 1997 included the following significant items: * Approximately $275,000 for other-than-temporary declines in the value of equipment which occurred primarily because lessees returned equipment to the Company at the end of the lease. The Company had previously expected to realize the carrying value of that equipment through lease renewals and proceeds from sale of the equipment to the original lessee. The fair market value of the equipment re-leased or sold to a third party was considerably less than was anticipated. 14 of 36 Item 7. 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 ------------------------------------------------------------- * Approximately $90,000 as a result of a lease having a net book value of $245,000 at February 28, 1997 with a lessee that filed for bankruptcy protection under Chapter 11 of the Bankruptcy code during the third quarter fiscal 1997. 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. CATG's revenue and margin have been included in the accompanying financial statements since November 1, 1997, the date of acquisition. Since its acquisition, the Company has invested significant time and capital resources into CATG in order to extend its capabilities beyond CATG's traditional regional market to CAI's customers throughout the United States. The costs associated with this effort primarily include additional salaries and wages, training, and travel and expenses. CATG has not yet realized a material amount of revenue from this effort. Consequently, costs in excess of revenues from the national effort have resulted in an increase in net loss from operations of approximately $600,000 for fiscal year 1999 compared to fiscal year 1998. In addition, in the fourth quarter 1999, a charge of $500,000 was recorded to reflect adjustments to equipment purchases payable. CATG interest expense increased approximately $200,000 because (i) the prior year results reflected less than twelve months results and (ii) the acquisition term loan utilized to finance the acquisition of CATG closed on May 31, 1999. Prior to that time, CAI had temporarily financed the acquisition of CATG utilizing internally generated funds and did not allocate any internal interest expense to CATG. CAI is presently evaluating its strategic options for improving CATG's operating results. LEASING MARGIN Leasing margin consists of the following (in thousands): Years Ended May 31, ------------------------------------ 1999 1998 1997 -------- -------- -------- Leasing revenue $ 42,614 $ 25,101 $ 14,420 Leasing costs and expenses (27,260) (17,337) (8,928) -------- -------- -------- Leasing margin $ 15,354 $ 7,764 $ 5,492 ======== ======== ======== 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, (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). 15 of 36 Item 7. Management's Discussion and Analysis of Financial Condition and Results ----------------------------------------------------------------------- of Operations, continued ------------- I. Results of Operations, continued --------------------- OTHER INCOME Other income consists of the following (in thousands): Years Ended May 31, ------------------------------ 1999 1998 1997 ------- ------- ------- Fees and distributions from PIFs $ 2,757 $ 3,114 $ 2,453 Fees from private leasing programs 1,068 451 38 Interest on installment sale of equipment 198 443 769 Gain on sale of installment sale note 423 - - Other 177 220 481 ------- ------- ------- $ 4,623 $ 4,228 $ 3,741 ======= ======= ======= For the reasons discussed under EQUIPMENT SALES TO PIFs, the amount of fees and distributions from PIF's declined in 1999 and is expected to decline in future years. The Company recorded an installment sale contract in connection with the settlement agreement reached with respect to the Hemmeter Litigation (which is discussed in Note 12 of Notes to Consolidated Financial Statements to the 1996 Form 10-K). During fiscal years 1999 and 1998, the Company received $483,000 and $650,000, respectively, of cash payments related to the installment sale note. In the third quarter of fiscal 1999, the Company sold the installment sale contract, which had a carrying value of $246,000, to the parent company of the debtor for $669,000. OPERATING AND OTHER EXPENSES Operating and other expenses increased approximately $3.7 million (31%) for fiscal year 1999 compared to fiscal year 1998. Approximately $1.6 million of the increase was due to an increase in CATG expenses. Approximately $1,000,000 of the increase in CATG expenses reflects a full year of operations in 1999 compared to seven months of operations reflected in 1998 and $600,000 of the increase reflects costs associated with building CATG's national sales capabilities. The remaining increase was due primarily to costs associated with the Company's investment in its retail marketing infrastructure (i.e., personnel training costs associated with new sales representatives) and NBCO subsidiary. Operating and other expenses also includes a charge of $130,000 to reflect the write-off of costs associated with an unsuccessful subordinated debt offering. Operating and other expenses increased $2.3 million (24%) for fiscal year 1998 as compared to fiscal year 1997. Approximately $1.5 million of the increase in fiscal 1998 was due to CATG expenses which have been included in the consolidating financial statements since the acquisition date of November 1, 1997. The remaining increase was due primarily to costs associated with the Company's investment in its retail marketing infrastructure. 16 of 36 Item 7. Management's Discussion and Analysis of Financial Condition and Results ----------------------------------------------------------------------- of Operations, continued ------------- I. Results of Operations, continued --------------------- INTEREST EXPENSE, NET Interest expense, net consists of the following (in thousands): 1999 1998 1997 ---- ---- ---- Interest income $ (2,219) $ (3,487) $ (4,828) Non-recourse interest expense 8,503 6,123 6,012 -------- -------- -------- Net non-recourse interest expense 6,284 2,636 1,184 Recourse interest expense 3,409 2,857 1,900 -------- -------- -------- Interest expense, net $ 9,693 $ 5,493 $ 3,084 ======== ======== ======== 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 includes an amount equal to the non-recourse interest expense on financed equipment sold to 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 growth in the Company's owned portfolio. It is anticipated that net non-recourse interest expense will continue to increase in the future as the Company adds additional leases financed with non-recourse debt to its portfolio. Recourse interest expense increased during fiscal year 1999 compared to fiscal year 1998 primarily due to (i) increased borrowings under the Company's Senior Facility used to fund the growth in the number of leases the Company holds for sale to private investors, and (ii) leases held in the Company's own portfolio financed through its Securitization facility (which has a recourse component). Recourse interest expense increased during fiscal year 1998 compared to fiscal year 1997 primarily due to increased borrowings under the Company's Warehouse Facility used to fund the growth in the number of leases the Company holds for sale to private investors. INCOME TAXES As shown in the table in Note 12 of Notes to the Consolidated Financial Statements, the Company's significant deferred tax assets consist of ITC carryforwards of approximately $600,000 (which expire in fiscal years 2000 and 2001), NOL carryforwards of approximately $700,000 (which expire from 2013 through 2014) and alternative minimum tax ("AMT") credits of $4.6 million (which are not subject to expiration). These tax assets are available to offset federal income tax liability. However, the amount of ITC and AMT credit carryforward that may be utilized to reduce tax liability is significantly limited due to the computation of AMT liability (see discussion below). As a result of the future expiration of the ITC carryforward, the Company has established a valuation allowance for deferred tax assets to reflect the uncertainty that the ITC carryforward will be fully utilized prior to expiration. Income tax expense is provided on income at the appropriate statutory rates applicable to such earnings. The appropriate statutory federal and state income tax rate for fiscal years 1999, 1998 and 1997 was approximately 40%. Adjustments to the valuation allowance are recognized as a separate component of the provision for income tax expense. Consequently, the actual income tax rate for fiscal years 1999, 1998 and 1997 was less than the effective rate of 40% primarily due to the reduction in the valuation allowance. The decrease in the valuation allowance recorded in fiscal 17 of 36 Item 7. Management's Discussion and Analysis of Financial Condition and Results ----------------------------------------------------------------------- of Operations, continued ------------- I. Results of Operations, continued --------------------- INCOME TAXES 1999 and 1998 represented the utilization of an ITC carryforward for which a valuation allowance had been provided, and reduction in the uncertainty about future utilization of ITC carryforwards prior to expiration as the Company continued to report net income from operations. The reductions in the valuation allowance recorded during the years ended May 31, 1999 and May 31, 1998 resulted in income tax benefits of $100,000 and $464,000, respectively. The reduction of the valuation allowance recorded in fiscal 1997 represented the utilization of an ITC carryforward and the receipt of a state income tax refund for which a valuation allowance had been provided. During fiscal year 1996, a transaction was completed in which the Company's largest shareholder obtained more than fifty percent of the ownership and voting rights of the Company within a three year period ("a change in control"). Upon a change in control, provisions of the Internal Revenue Code limit the amount of ITC carryforwards and AMT carryforwards that could be utilized to reduce income tax liability in any year. However, the Company had previously established a valuation allowance for deferred taxes due to uncertainty that the full amount of the ITC carryforward would be utilized prior to expiration and therefore, the change in control and resulting limitation on the ITC and AMT carryforward is not expected to reduce the recoverability of the amount of the net deferred income tax assets, net of the valuation allowance. II. Liquidity and Capital Resources ------------------------------- The Company's activities are principally funded by proceeds from sales of on-lease equipment (to its PIFs or Private Investors), non-recourse debt and Securitization proceeds, recourse bank debt (see Note 10 of Notes to Consolidated Financial Statements), rents, fees and distributions from its 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. On December 20, 1998, Capital Associates International Inc. ("CAII") obtained $15 million in committed non-recourse financing from NationsBanc Leasing Corporation. CAII may use the committed financing at its discretion to finance leases under a warehousing arrangement. The loan is secured by lease transactions financed under the facility only. The loan was primarily underwritten utilizing the underlying credit quality of the leases pledged as collateral under the facility. The interest rate option associated with the facility is Prime rate minus 0.25% or LIBOR plus 2.5% (7.75% & 4.90% at May 31, 1999, respectively). The Company is required to pay a fee of 0.2% of the unused commitment quarterly. The outstanding balance under the facility at May 31, 1999 was $1.3 million. The loan is included with "Discounted lease rentals" in the accompanying consolidated Balance Sheets. The facility contains general operating and reporting requirements, however, no formal financial covenants are required of CAII. As of May 31, 1999, CAII was in compliance with the terms of the 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. 18 of 36 Item 7. Management's Discussion and Analysis of Financial Condition and Results ----------------------------------------------------------------------- of Operations, continued ------------- II. Liquidity and Capital Resources, continued ------------------------------- 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 9 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. The Company has significantly increased its investment in its portfolio (comprising both the Company-owned and warehouse portfolios) during the most recent two fiscal years, as reflected in the following balances, as of May 31 of its most recent three fiscal year ends: Years Ended May 31, -------------------------------- 1999 1998 1997 --------- --------- -------- Net investment in direct finance leases $ 42,116 $ 31,181 $ 7,700 Leased equipment, net 150,338 104,825 71,443 --------- --------- -------- $ 192,454 $ 136,006 $ 79,143 ========= ========= ======== The increasing investment in the portfolio has also caused an increase in accounts receivable at May 31, 1999 compared to May 31, 1998. The trend of increasing investment in leases has continued through August 31, 1999. The increases in leases and related accounts receivable have required significant investment of equity capital. During 1999, the Company significantly increased its Equipment Brokerage Sales. Such sales entail the acquisition of inventory for sale to third parties and for sale to consumers through the NBCO retail stores. At May 31, 1999, inventory held for equipment brokerage sale amounted to approximately $1 million. The Company finances the inventory utilizing availability under its Working Capital Facility. Utilization of the Working Capital Facility directly reduces the amount of "equity capital" available to invest in leases. To enable the Company to continue to add leases to its portfolio, it must increase the availability of equity capital. Its primary 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. 19 of 36 Item 7. Management's Discussion and Analysis of Financial Condition and Results ----------------------------------------------------------------------- of Operations, continued ------------- II. Liquidity and Capital Resources, continued ------------------------------- 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 for a description of the Company's Senior Facility. As of May 31, 1999, the Company was not in compliance with the Interest Coverage Covenant, as defined, for which it received a waiver from its Lenders in August 1999. The waiver included a temporary reduction in the minimum interest coverage ratio for the fiscal quarters ended May 31, 1999, August 31, 1999 and November 30, 1999 and amended (in a manner favorable to the Company) certain definitions used in calculating certain of the Company's financial covenants. After that time, the minimum interest coverage ratio will return to its prior level. In connection with the execution of the waiver, Messrs. Buckland and Walker loaned the Company $350,000 on a subordinated basis. See Part III, Item 13, below for discussion of the terms of this loan. No assurance can be given that the Company will be able to achieve the level of profitability necessary to remain in compliance with the Interest Coverage Covenant in the future. Should the Company not remain in compliance, it would constitute an Event of Default, as defined in the bank agreement, and there is no assurance that the Lenders would again grant a waiver. In the event of a default there is no assurance that the Lenders would continue to provide advances to the Company. Should the Lenders no longer provide advances to the Company, its ability to continue to operate its business would be significantly impaired. The Company finances receivables and inventory for its CATG subsidiary under an agreement with Deutsche Financial Services. At May 31, 1999, accounts receivable, net included $4,502,000 of receivables related to the Company's CATG subsidiary which were eligible collateral under the financing agreement. 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 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. 20 of 36 Item 7. Management's Discussion and Analysis of Financial Condition and Results ----------------------------------------------------------------------- of Operations, continued ------------- II. Liquidity and Capital Resources, continued ------------------------------- YEAR 2000 ISSUES, continued To date, costs associated with Year 2000 readiness have been immaterial. The Company expects that any additional costs of being Year 2000 compliant will be immaterial. 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 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. III. New Accounting Pronouncements ----------------------------- In June 1997, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 131, Disclosures about Segments of an Enterprise and Related Information ("Statement 131"). Statement 131 provides guidance for reporting information about operating segments in annual financial statements and requires reporting of selected information about operating segments in interim financial reports of public companies. An operating segment is defined as a component of a business that engages in business activities from which it may earn revenue and incur expenses, a component whose operating results are regularly reviewed by the company's chief operating decision maker, and a component for which discrete financial information is available. Statement 131 establishes quantitative thresholds for determining operating segments of a company. Statement 131 is effective for fiscal years beginning after December 15, 1997, with earlier application permitted. The Company adopted Statement 131 in the first quarter of 1999 by reporting operating segment information on Form 10-Q for its leasing and equipment retailing segments. 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 expects to adopt Statement 133 in the first quarter of 2000. The Company does not expect the adoption of Statement 133 or Statement 137 to have an impact on its financial reporting. 21 of 36 Item 7. Management's Discussion and Analysis of Financial Condition and Results ----------------------------------------------------------------------- of Operations, continued ------------- IV. "Safe Harbor" Statement Under the Private Securities Litigation Reform Act --------------------------------------------------------------------------- of 1995 ------- The statements contained in this report which are not historical facts may be deemed to contain forward-looking statements with respect to events, the occurrence of which involve risks and uncertainties, and are subject to factors that could cause actual future results to differ both adversely and materially from currently anticipated results, including, without limitation, the level of lease originations, realization of residual values, customer credit risk, competition from other lessors, specialty finance lenders or banks and the availability and cost of financing sources. Certain specific risks associated with particular aspects of the Company's business are discussed in detail throughout Parts I and II of this report when and where applicable. Item 8. Financial Statements and Supplementary Data ------------------------------------------- See the Index to Financial Statements and Schedule appearing at Page F-1 of this Report. Item 9. Disagreements on Accounting and Financial Disclosure ---------------------------------------------------- None. PART III Item 10. Directors and Executive Officers -------------------------------- The following table sets forth (i) the names of the directors of the Company, (ii) their ages at the Record Date and (iii) their tenure on the Board of Directors: DIRECTORS Name Age Position(s) with Company Director Since ---- --- ------------------------ -------------- William H. Buckland 54 Director 1995 James D. Edwards 59 Director 1987 Gary M. Jacobs 52 Director 1978-1990 and 1994 Robert A. Sharpe II 41 Director 1996 James D. Walker 54 Chairman of the Board, 1994 President, Chief Executive Officer and Director Mr. Buckland has been Chairman of the Board, President and Chief Executive Officer of MCC Financial Corporation, an aircraft and equipment lessor ("MCC"), since May 1998. From May 1988 to May 1998, Mr. Buckland was Chairman of the Board, Secretary and Treasurer of MCC. From May 1988 to present, Mr. Buckland has been and continues to be a director and 50% stockholder of MCC. Immediately prior to the purchase of MCC in 1988, Mr. Buckland held, from 1978 to 1988, a number of executive positions at Fairchild Industries, Inc. Mr. Buckland is also a director of MCC Aircraft Leasing I, Inc., MCC World Aviation Associates, Inc., and Capital Associates International, Inc., a wholly-owned subsidiary of the Company ("CAII"). 22 of 36 Item 10. Directors and Executive Officers, continued -------------------------------- DIRECTORS, continued Mr. Edwards has been retired since 1995. From May 1989 to May 1995, Mr. Edwards was President, Chief Executive Officer and a director of Tricord Systems, Inc., a computer hardware and software development firm. From 1987 to 1989, Mr. Edwards was President and Chief Executive Officer of Telwatch, Inc., a telecommunications firm. From 1983 to 1987, Mr. Edwards held various executive positions with AT&T, including President of AT&T Computer Systems. Prior to 1983, Mr. Edwards held executive positions with IBM Corporation, Xerox Corporation and Bausch & Lomb. Mr. Edwards is also a director of Chatcom, Inc., Lexicor, Red Hill, Dezignz and CAII. Mr. Jacobs has been Executive Vice President and Secretary of Corporate Express, Inc., an office products supply company ("CEI"), since July 1995. From 1992 to July 1995, Mr. Jacobs was also Chief Financial Officer of CEI. From 1990 through November 1992, Mr. Jacobs served as the President and Chief Executive Officer of Boulder Retail Finance Corporation, an investment firm controlled by Mr. Jacobs. From 1978 through mid-1990, Mr. Jacobs served as Executive Vice President and in various other senior executive positions with the Company and CAII. Prior to joining the Company, Mr. Jacobs served as a director of finance for Storage Technology Corporation, a company which manufactures computer peripheral devices. Mr. Jacobs served as a director of the Company and CAII from 1978 through mid-1990 and is currently a director of Boulder Retail Finance Corporation and CAII. Mr. Sharpe has been Executive Vice President of Fairchild Fasteners, a fastener manufacturer, since July 1996. From July 1994 through June 1996, Mr. Sharpe was Vice President, Corporate Development of Smithfield Foods, Inc, a food processor. Prior to joining Smithfield Foods, Inc., Mr. Sharpe had a ten year career in corporate banking. From 1987 through June 1994, Mr. Sharpe served in a number of capacities at NationsBank Corporation, a bank holding company, including Senior Vice President in charge of Mid-Atlantic Corporate Banking relationships. Mr. Sharpe is also a director of the Fairchild Corporation and CAII. Mr. Walker has been the President and Chief Executive Officer of the Company since April 1998. From May 1988 to May 1998, Mr. Walker was President and Chief Executive Officer of MCC. From May 1988 to present, Mr. Walker has been and continues to be a director and 50% stockholder of MCC. Prior to that time, Mr. Walker was involved in equipment lease management with Equipment Leasing and Financing Corp. (President 1987- 1988),Thomson McKinnon Securities, Regional Vice President - Lease Originations from 1986 to 1987 and Finalco, Inc. starting as Marketing Representative in 1981 and becoming Senior Vice President of Marketing. Prior to that, Mr. Walker held marketing and engineering positions with IBM Corporation and TRW, Inc. Mr. Walker is also a director of MCC Aircraft Leasing I, Inc., MCC World Aviation Associates, Inc. and CAII. DIRECTOR COMPENSATION The Board amended and restated the Company's Board of Directors Compensation Policy in Fiscal 1996 (the "Amended Policy"), effective on and as of October 26, 1995. Pursuant to the Amended Policy, the Company pays each director (1) a $3,750 quarterly retainer ($5,000 for the Chairman of the Board), (2) $1,000 for each Board meeting attended, (3) $1,000 for each committee meeting (other than Executive Committee meetings) attended, (4) consulting fees for consulting services at a rate approved by the Board, and (5) all reasonable out-of-pocket expenses of attending such meetings and performing any consulting services for the Company. Pursuant to a Consulting Agreement with Mr. Buckland, dated as of June 1, 1996, the Company paid Mr. Buckland $112,500 for services rendered during Fiscal 1999. Mr. Walker became an employee of the Company effective April 7, 1998 at which time his Consulting Agreement with the Company, dated June 1, 1996, terminated and he entered into an Employment Agreement with the Company (the terms of which are described in Part III, Item 11, below). Messrs. Buckland and Walker earned no incentive compensation during Fiscal 1999. 23 of 36 Item 10. Directors and Executive Officers, continued -------------------------------- DIRECTOR COMPENSATION, continued For Fiscal 1997, the Board's Special Compensation Committee decided to provide incentive compensation to each of Messrs. Buckland and Walker through the Company's assignment to each of a 2.70735 percent interest in the residual proceeds derived from certain equipment leased to General Motors. Such residual proceeds will be realized and paid over approximately seven (7) years. The assignments of these interests is evidenced by non-recourse residual sharing notes from the Company. In Fiscal 1997, the Company accrued estimated expenses of $50,500, for each of the residual sharing notes, reducing the Company's book value for these residuals to reflect this assigned interest to Messrs. Buckland and Walker. For Fiscal 1998 and 1999, the Consulting Agreements provide incentive compensation of 4% (the "Base Incentive Payment Percentage") of the Company's pre-tax earnings for each such fiscal year. The Base Incentive Payment Percentage is to be adjusted up or down by the percentage change in the average closing price of the Company's stock for the last four months of the applicable fiscal year, as compared to the same period in the prior fiscal year, but in no event will the Base Incentive Payment Percentage be adjusted lower than 3% or higher than 6%. For Fiscal 1998, the total incentive compensation earned by Mr. Buckland was $96,000 and by Mr. Walker was $82,000. Mr. Walker's incentive compensation payment was pro-rated to the date his Consulting Agreement was terminated, April 7, 1998. Of those amounts, payment of one-third has been deferred to June 1, 2001 so that Messrs. Buckland and Walker have received for Fiscal 1998, $64,000 and $54,667, respectively, and will receive the balance of $32,000 and $27,333, respectively, on June 1, 2001, provided each is still a director and/or employee on that date. The following table sets forth the amount of quarterly retainer fees, meeting fees, Executive Committee fees, consulting fees and total fees paid to directors during Fiscal 1999:
Quarterly Prior Year Consulting Directors Retainer Meeting Fees Fees Fees Total (1) - -------------------- -------- ------------ ---------- ---------- --------- William H. Buckland $ 15,000 $ 9,000 (3) -0- $ 112,500 $ 136,500 James D. Edwards $ 15,000 $ 9,000 (3) -0- -0- $ 24,000 Gary M. Jacobs $ 15,000 $ 8,000 (4) -0- -0- $ 23,000 Robert A. Sharpe II $ 15,000 $ 8,000 (4) -0- -0- $ 23,000 James D. Walker $ 20,000 (2) $ 9,000 (3) $ 6,250 -0- $ 32,250
(1) These amounts do not include (a) expense reimbursements paid to the directors during Fiscal 1999 and (b) the value of stock options that were granted to the directors in Fiscal 1999 and prior fiscal years. (2) As Chairman of the Board, Mr. Walker's quarterly retainer is $5,000. At Mr. Walker's instructions, the Company paid $5,000 of accrued Board fees otherwise payable to Mr. Walker to MCC World Aviation Associates, Inc., a corporation owned 50% by Mr. Buckland and 50% by Mr. Walker. (3) Consists of $1,000 per meeting for 4 regular Board meetings and 4 committee meetings. (4) Consists of $1,000 per meeting for 4 regular Board meetings and 4 committee meetings, and (c) 2 special committee meetings. 24 of 36 Item 10. Directors and Executive Officers, continued -------------------------------- DIRECTOR COMPENSATION, continued For Fiscal 1998, the Company granted under the its Non-Employee Director Stock Option Plan (the "Non-Employee Director Plan") to each of Messrs. Edwards, Jacobs and Sharpe an option to acquire 5,000 shares of Common Stock at an exercise price of $3.25 per share and to each of Messrs. Buckland and Walker an option to acquire 10,000 shares at an exercise price of $ 3.25 per share (the "1998 Director Options"). All of the 1998 Director Options vested in full on May 31, 1998, and will expire in June 2008. The Board determined that it was beneficial to the Company that Mr. Walker became an employee of the Company on April 7, 1998, and waived the forfeiture of his 1998 Director Options. For Fiscal 1999, the Company granted under the Non-Employee Director Plan to each of Messrs. Edwards, Jacobs and Sharpe an option to acquire 5,000 shares of Common Stock at an exercise price of $4.125 per share and to Mr. Buckland an option to acquire 45,000 shares at an exercise price of $4.125 per share (the "1999 Director Options"). All of the 1999 Director Options vested in full on May 31, 1999, provided each recipient remains as a director and will expire in June 2009. Per Mr. Walker's Employment Agreement, the Company granted Mr. Walker an option to acquire 10,000 shares of Common Stock under the Employee Stock Option Plan, at an exercise price of $4.125 per share, which vested in full on May 31, 1999 and will expire in June 2009. In November 1998, Mr. Edwards exercised stock options for 86,250 shares of common stock with an average exercise price of $1.53 by paying the par value in cash of $690.00 and issuing a note payable to the Company equal to approximately $131,000, the remainder of the exercise price. The note bears interest at the rate of 4.5% compounded semi-annually and is due November 3, 2002. The Company believes that the transactions, described above, were on terms no less favorable to the Company than could have been obtained in arm's length transactions. All transactions or loans between the Company and its directors, officers, principal stockholders and their affiliates have been, and similar future transactions or loans will be, approved in advance by disinterested directors and have been or will be on terms believed by the Company to be no less favorable to the Company than those which could be obtained in arm's length transactions. COMPENSATION AND OPERATIONS COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION Messrs. Edwards and Walker are directors of the Company. In April 1998, Mr. Walker became an employee of the Company. Mr. Edwards has never been an employee of the Company. Messrs. Edwards and Walker also are directors of CAII. Messrs. Buckland and Walker are directors and 50% stockholders of MCC and MCC World Aviation Associates, Inc. ("MCC World"), which own of record 2,833,369 and 23,706 shares, respectively, of Common Stock. Mr. Buckland is also an officer of MCC and MCC World. See "Certain Transactions" below. The Company leased from MCC office space for its Southeast Region Office and paid MCC rent in the amount of $23,000 for Fiscal 1999. Mr. Walker is now President and Chief Executive Officer and a director of CAII. EXECUTIVE OFFICERS The following table sets forth (i) the names of the executive officers of the Company (ii) their ages as of the Record Date and (iii) their positions with the Company: Name of Individual Age Capacities in Which Served - -------------------- --- ------------------------------------------------- James D. Walker 54 Chairman of the Board, President, Chief Executive Officer and Director Anthony M. DiPaolo 40 Senior Vice President - Chief Financial Officer and Treasurer John F. Olmstead 56 Senior Vice President - Capital Markets Group and Assistant Secretary Richard H. Abernethy 45 Vice President - Portfolio Management 25 of 36 Item 10. Directors and Executive Officers, continued -------------------------------- EXECUTIVE OFFICERS, continued See "DIRECTORS" above for a description of Mr. Walker's background and the positions held by Mr. Walker with the Company. Mr. DiPaolo has been Senior Vice President - Chief Financial Officer and Treasurer of the Company since March 1997. Mr. DiPaolo joined the Company in July 1990 and has held various positions in the accounting and finance areas of the Company. Prior to July 1990, he held the offices of Chief Financial Officer for the Mile High Kennel Club, Inc. and Vice President - Controller for VICORP Restaurants, Inc. and was an audit manager for Coopers & Lybrand. Mr. DiPaolo is an officer, but not a director, of CAII. Mr. Olmstead has been Vice President - Capital Markets Group and Assistant Secretary of the Company since September 1991. Mr. Olmstead joined the Company as a Vice President in December 1988. From 1969 through 1983, Mr. Olmstead was a co-owner of Finalco, Inc., an independent leasing company, and served as a senior officer of Finalco Corporation. From 1983 through the present, Mr. Olmstead has served as Chairman of the Board of Neo-Kam Industries, Inc., Matchless Metal Polish Company, Inc., and ACL, Inc. Mr. Olmstead is an officer, but not a director, of CAII. Mr. Abernethy has been Vice President - Portfolio Management of the Company since October 1997. Mr Abernethy joined CAII in April 1992, as the Equipment Valuation Manager. From September 1994 to October 1997, Mr. Abernethy was Vice President - Asset Management of the Company. Prior to joining CAII, Mr. Abernethy was employed by Barclays Leasing for six years where he served as Equipment Manager with similar duties. Mr. Abernethy is not an officer or director of the Company but does serve as an officer of CAII. Section 16(a) of the Securities Exchange Act of 1934, as amended, (the "Exchange Act") requires the Company's directors, officers and persons who own more than ten percent of a registered class of the Company's equity securities ("10% Holders") to file with the SEC initial reports of ownership and reports of changes in ownership of Common Stock and other equity securities of the Company. Directors, officers and 10% Holders are required by SEC regulations to furnish the Company with copies of all of the Section 16(a) reports they file. To the Company's knowledge, during Fiscal 1999 all Section 16(a) filing requirements applicable to its directors, officers and 10% Holders were timely made by such persons. Item 11. Executive Compensation ---------------------- THE WALKER EMPLOYMENT AGREEMENT. The Company entered into an Employment Agreement with Mr. Walker, dated as of April 7, 1998 (the "Walker Employment Agreement"), whereby: (1) Mr. Walker's employment with the Company as President and Chief Executive Officer (in addition to his existing office as Chairman of the Board) commenced on April 7, 1998, and continues until May 31, 2001 and, thereafter, the term will be automatically renewed for successive one year terms unless either provides the other notice to terminate 60 days prior to the end of the then current term; (2) Mr. Walker's annual base salary is $325,000; (3) Mr. Walker is to receive incentive compensation equal to 4% of the Company's pre-tax earnings (subject to the Company achieving certain minimum profitability targets), which percentage can be increased or decreased by the percentage change in the average closing price of the Company's common stock for the last four months of the current fiscal year as compared to the same period in the prior fiscal year, but in no event will it be adjusted lower than 3% or higher than 6% (he earned no incentive compensation for fiscal 1999); (4) Mr. Walker will be granted stock options annually, equal to those granted to the non-employee Directors (see Part III, Item 10, above); (5) Mr. Walker's Director's fees will continue, including the additional fee for Mr. Walker's service as Chairman of the Board (see Part III, Item 10, above); (6) payments are to be made to MCC to reimburse it for certain group benefit plans and MCC's SEP/IRA plans provided to Mr. Walker; (7) reimbursement is made to Mr. Walker of his reasonable expenses incurred in carrying out his duties; and (8) payment is to be made to Mr. Walker of severance benefits in the event of his involuntary 26 of 36 Item 11. Executive Compensation, continued ---------------------- termination without cause or due to a change of control of the Company, equal to the greater of (i) three times his annual base salary or (ii) his base salary to the end of the term of the Walker Employment Agreement, plus the pro rated amount of the incentive compensation Mr. Walker would have received for the fiscal year in which such termination occurs. The Walker's Employment Agreement also acknowledges Mr. Walker's duties as an officer and director of MCC and his duties in the event of a conflict of interest between the Company and MCC, and requires Mr. Walker to abide by certain non-disclosure and non-use of the Company's confidential information and his agreement not to solicit employees or customers of the Company. SUMMARY COMPENSATION TABLE. The following table provides certain summary information for Fiscal 1999, Fiscal 1998 and Fiscal 1997, concerning compensation awarded or paid to, or earned by, the Company's current Chief Executive Officer, each of the three other highest paid executive officers of the Company and one executive officer who resigned his offices in April 1999 (collectively referred to herein as the "Named Executive Officers"):
| Long-Term Compensation |-------------------------------------- Annual Compensation | Awards (15) | Payouts ------------------------------------------- |-----------------------|-------------- Fiscal | | Year Other |Restricted Securities| Ended Annual | Stock Underlying| LTIP Name and Position 5/31 Salary Bonus (2) Compensation | Awards Options | Payouts - --------------------- ------ ------------- ------------ ------------- |---------- ----------|-------------- | James D. Walker, | | President, Chief 1999 $ 250,000 $ -0- $ 1,600 (6) | -0- -0- | $ -0- Executive, Chairman 1998 $ 42,500 $ 14,000 (3) $ -0- | -0- 35,000 | $ -0- of the Board 1997 $ -0- $ -0- $ -0- | -0- -0- | $ -0- | | Anthony M. DiPaolo | | Senior Vice President 1999 $ 156,800 (1) $ -0- $ -0- | -0- -0- | $ -0- Chief Financial 1998 $ 138,030 (1) $ 45,000 (4) $ -0- | -0- 25,000 | $ -0- Officer & Treasurer 1997 $ 110,722 (1) $ 20,000 $ -0- | -0- -0- | $ 45,335 (7) | | John F. Olmstead, | | Senior Vice 1999 $ 174,300 (1) $ -0- $ -0- | -0- -0- | $ -0- President, Capital 1998 $ 173,304 (1) $ 45,000 (5) $ 1,600 (6) | -0- 25,000 | $ -0- Markets Group & 1997 $ 164,300 (1) $ 40,000 $ -0- | -0- -0- | $ 81,527 (8) Assistant Secretary | | | | Richard H. Abernethy 1999 $ 105,000 $ -0- $ -0- | -0- -0- | $ -0- Vice President, 1998 N/A N/A N/A | N/A N/A | N/A Portfolio Management 1997 N/A N/A N/A | N/A N/A | N/A | | John A. Reed, Senior 1999 $ 170,715 (10) $ -0- $ -0- | -0- -0- (13)| $ -0- Vice President, 1998 $ 152,045 (11) $ 6,000 $ 1,600 (12) | -0- 15,000 | $ -0- Administration (9) 1997 $ 88,126 $ 17,000 $ -0- | -0- -0- | $ 21,225 (14)
27 of 36 Item 11. Executive Compensation, continued ---------------------- (1) Includes an accrual of $6,800 in each of Fiscal 1999, 1998 and 1997 for premium paid on behalf of the Executive Officer, for a universal life insurance policy pursuant to an insurance benefit plan (the "Insurance Plan"). The amount of the annual premium allowance under the Insurance Plan is determined by a formula based on the value of certain benefits relinquished by the Executive Officers under the Company's 401(k) plan, from which such officers voluntarily withdrew during the fiscal year ended May 31, 1991 in order to prevent the Company's 401(k) plan from being "top heavy" under applicable Treasury regulations. (2) All bonuses were paid in the following fiscal year. (3) $9,333 paid in Fiscal 1999 and payment of the remaining one-third ($4,667) is deferred to June 1, 2001, provided Mr. Walker continues as an employee of the Company through that date. (4) $30,000 paid in Fiscal 1999 and payment of the remaining one-third ($15,000) is deferred to June 1, 2001, provided Mr. DiPaolo continues as an employee of the Company through that date. (5) $30,000 paid in Fiscal 1999 and payment of the remaining one-third ($15,000) is deferred to June 1, 2001, provided Mr. Olmstead continues as an employee of the Company through that date. (6) Travel expense paid with respect to employee's spouse accompanying employee on business travel. (7) In Fiscal 1997, Mr. DiPaolo received $45,335 of proceeds (net of the option exercise prices) from the sale of options to acquire 40,000 shares of Common Stock to the Company pursuant to the Stock Option Repurchase Program. (8) In Fiscal 1997, Mr. Olmstead received $81,527 of proceeds (net of the option exercise prices) from the sale of options to acquire 56,250 shares of Common Stock to the Company pursuant to the Stock Option Repurchase Program. (9) In April 1999, Mr. Reed resigned from his office with the Company. (10) Includes $39,082 in commissions and $21,635 in separation pay. (11) Includes $54,526 in commissions (12) Travel expense paid with respect to employee's companion accompanying employee on business travel. (13) During 1999, Mr. Reed exercised options underlying 5,000 shares of Common Stock and sold all such shares. (14) In Fiscal 1997, Mr. Reed received $21,255 of proceeds (net of the option exercise prices) from the sale of options to acquire 20,000 shares of Common Stock to the Company pursuant to the Stock Option Repurchase Program. (15) There were no stock option grants to Named Executive Officers in Fiscal 1999. OPTION EXERCISES AND HOLDINGS The following table provides information with respect to the Named Executive Officers concerning the exercise of stock options during Fiscal 1999 and unexercised stock options held as of the end of Fiscal 1999: 28 of 36 Item 11. Executive Compensation, continued ----------------------
Aggregated Option Exercises in Last Fiscal Year and Fiscal Year End Option Values Number of Number of Unexercised Value of Unexercised In-the- Shares Value Options at Year End money Options at Year End (2) Acquired on Realized on ---------------------------- ----------------------------- Name Exercise(1) Exercise (1) Exercisable Unexercisable Exercisable Unexercisable ---- ----------- ------------ ----------- ------------- ----------- ------------- James D. Walker -0- $ -0- 81,367 -0- $ 35,100 -0- Anthony M. DiPaolo -0- $ -0- 16,250 18,750 $ 27,000 -0- John F. Olmstead -0- $ -0- 25,000 18,750 $ 39,200 -0- Richard H. Abernethy -0- $ -0- 7,500 11,250 $ 5,200 -0- John A. Reed (3) 5,000 $ 16,600 -0- -0- $ -0- -0-
(1) See "Executive Officers - Summary Compensation Table" above for information concerning sales of stock options by Named Executive Officers to the Company during Fiscal 1999. (2) The value of unexercised in-the-money options at the end of Fiscal 1997 is based on the closing price of the Common Stock as reported on the NASDAQ/NMS at May 31, 1999 ($3.375 per share), less the exercise price per share of the options. (3) In April 1999, Mr. Reed resigned from his offices with the Company. STOCK OPTION REPURCHASE PROGRAM Effective as of May 31, 1996, the Company adopted and implemented its Stock Option Repurchase Program, pursuant to which it repurchased 401,367 stock options granted under its employee stock option plan from 33 employees at a price of $2.45 per option share less the exercise price of the repurchased stock options (a total repurchase price, net of option exercise amounts, of $557,240). See "Executive Compensation - Summary Compensation Table" to determine the Named Executive Officers who participated in this program. LONG-TERM INCENTIVE PLANS See "Summary Compensation Table" above for a discussion of long-term incentive plan awards in Fiscal 1998. See also "Stock Option Repurchase Program" above for information concerning sales of stock options by the Named Executive Officers to the Company during Fiscal 1997. Item 12. Security Ownership of Certain Beneficial Owners and Management -------------------------------------------------------------- The following table sets forth, as of the Record Date, the number of shares and percentage of the outstanding Common Stock beneficially owned by each person known by the Company to own more than 5% of the outstanding Common Stock ("Major Stockholders"): 29 of 36 Item 12. Security Ownership of Certain Beneficial Owners and Management, --------------------------------------------------------------------- continued Beneficial Ownership(4) Number of Shares Percent ---------------- ------- James D. Walker (1) 1,509,905 28.21% 7175 West Jefferson Avenue, Suite 4000 Lakewood, Colorado 80235 William H. Buckland (1) 1,507,205 28.17% 8180 Greensboro Drive, Suite 1000 McLean, Virginia 22102 ROI Capital Management, Inc. (2) 700,550 13.29% 17 East Sir Francis Drake Boulevard - #225 Larkspur, California 94939 Gary M. Jacobs (3) 355,904 6.71% 2995 Baseline Road Boulder, Colorado 80303 (1) Messrs. Buckland and Walker, who otherwise are unrelated to each other, each own 50% of the issued and outstanding capital stock of MCC and MCC World Aviation Associates, Inc. ("MCC World"). MCC and MCC World, each having the address of 8180 Greensboro Drive, Suite 1000, McLean, Virginia 22102, are record owners of 2,833,369 and 23,706 shares, respectively, of Common Stock, which represents 53.74% and 0.4% respectively of the issued and outstanding Common Stock. Messrs. Buckland and Walker also own 78,667 and 81,367 vested stock options, respectively, for the purchase of Common Stock. (2) As disclosed in the Schedule Forms 13G filed with the United States Securities and Exchange Commission on February 19, 1999. (3) Includes (a) 30,971 shares of Common Stock that Mr. Jacobs is entitled to acquire upon the exercise of vested stock options, (b) 3,000 shares held in the name of Mr. Jacobs' minor children for which he disclaims beneficial ownership and (c) 321,933 shares held of record. (4) A person is deemed to be the beneficial owner of securities that can be acquired by such person within sixty (60) days from the Record Date upon the exercise of options. The record ownership of each beneficial owner is determined by assuming that stock options that are held by such person and that are exercisable within sixty (60) days from the Record Date have been exercised. The total outstanding shares used to calculate each beneficial owner's percentage includes such stock options. The following table sets forth, as of the Record Date, the number of shares and percentage of the outstanding Common Stock beneficially owned by directors who are not Major Stockholders, the Named Executive Officers and the directors and executive officers as a group: 30 of 36 Item 12. Security Ownership of Certain Beneficial Owners and Management, --------------------------------------------------------------------- continued Management Ownership(6) --------------------------- Holder Number of Shares Percent ------ ---------------- ------- Richard H. Abernethy (1) 7,550 0.14% Anthony M. DiPaolo (2) 23,250 0.44% James D. Edwards (3) 86,250 1.63% John F. Olmstead (4) 47,500 0.90% Robert A. Sharpe II (5) 17,959 0.34% Directors and Executive Officers 182,459 3.46% (other than Major Stockholders) as a Group (5 persons) (1) Includes 7,500 shares of Common Stock that Mr. Abernethy is entitled to acquire upon the exercise of vested stock options. This does not include 11,250 shares subject to unvested stock options granted to Mr. Abernethy. (2) Includes 16,250 shares of Common Stock that Mr. DiPaolo is entitled to acquire upon the exercise of vested stock options. This does not include 18,750 shares subject to unvested stock options granted to Mr. DiPaolo. (3) In November 1998, Mr. Edwards exercised stock options for 86,250 shares of common stock with an average exercise price of $1.53 by paying the par value in cash of $690.00 and issuing a note payable to the Company equal to approximately $131,000, the remainder of the exercise price. The note bears interest at the rate of 4.5% compounded semi-annually and is due November 3, 2002. (4) Includes 25,000 shares of Common Stock that Mr. Olmstead is entitled to acquire upon the exercise of vested stock options. This does not include 18,750 shares subject to unvested stock options granted to Mr. Olmstead. (5) Includes 17,959 shares of Common Stock that Mr. Sharpe is entitled to acquire upon the exercise of vested stock options. (6) A person is deemed to be the beneficial owner of securities that can be acquired by such person within sixty (60) days from the Record Date upon the exercise of options. The record ownership of each beneficial owner is determined by assuming that options that are held by such person and that are exercisable within sixty (60) days from the Record Date have been exercised. The total outstanding shares used to calculate each beneficial owner's percentage includes such options. Item 13. Certain Relationships and Related Transactions ---------------------------------------------- In November 1995, MCC acquired voting control of the Company through a private stock purchase transaction and the delivery to MCC of proxies for shares of Common Stock subject to purchase in the future pursuant to agreements (the "Stock Purchase Agreements") executed by and among MCC, Messrs. Jack Durliat and Gary M. Jacobs, who, at that time, were two of the Company's largest stockholders. Messrs. Buckland and Walker are each 50% owners of MCC. Pursuant to these Stock Purchase Agreements, MCC acquired 65,120 shares of Common Stock for a purchase price of $3.30 per share, or an aggregate amount of $214,896. In January 1995, MCC purchased 75,000 shares of Common Stock for a purchase price of $2.00 per share, or an aggregate amount of $150,000. In addition, MCC acquired (1) the right to purchase an additional 1,245,000 shares of Common Stock in the future for an aggregate purchase price of approximately $4.5 million and (2) proxies from Messrs. Durliat and Jacobs to vote such shares, pending their purchase. In January 1996, 1997 and 1998, MCC completed the purchase of 550,000, 437,500 and 257,500 shares, respectively, of Common Stock for a purchase price of $3.30, $3.70 and $4.02 per share, respectively, or an aggregate amount of $4,468,900. 31 of 36 Item 13. Certain Relationships and Related Transactions, continued ---------------------------------------------- During Fiscal 1999, 1998 and 1997, the Company paid the following amounts to the Messrs. Buckland and Walker, who are each 50% stockholders of MCC, for Executive Committee fees and under their consulting agreements: Fiscal 1999 Fiscal 1998 Fiscal 1997 ----------- ----------- ----------- Mr. Buckland $ 112,500 $ 187,500 $ 187,500 Mr. Walker * 218,750 250,000** *In April 1998, Mr. Walker became an employee of the Company and was paid for the balance of 1998 and 1999 pursuant to the terms of his employment agreement discussed above. **In Fiscal 1997, the Company paid Mr. Walker $150,000 for relocation expenses. On August 11, 1999, the Company borrowed $350,000 from Messrs. Buckland and Walker and issued a subordinated note to each in the face amount of $175,000. The notes bear interest at 7% per year plus additional contingent interest at 9% per year based on the performance of certain residual interests owned by the Company. Principal and interest (which accrues quarterly) are due on August 11, 2002, subject to certain prepayment obligations. The notes are subordinated to all existing recourse bank debt. PART IV Item 14. Exhibits, Financial Statement Schedule and Reports on Form 8-K -------------------------------------------------------------- (a) and (d) Financial Statements and Schedule --------------------------------- The financial statements and schedule listed on the accompanying Index of Financial Statements and Schedule (page F-1) are filed as part of this Annual Report. (b) Reports on Form 8-K ------------------- None (c) Exhibits -------- Included as exhibits are the items listed in the Exhibit Index. The Company will furnish to its shareholders of record as of the record date for its 1999 Annual Meeting of Stockholders, a copy of any of the exhibits listed below upon payment of $.25 per page to cover the costs to the Company of furnishing the exhibits. 32 of 36 Item No. Exhibit Index 3.1 Certificate of Incorporation of Capital Associates, Inc. (the "Company"), incorporated by reference to Exhibit 3.1 of the Company's registration statement on Form S-1 (No. 33-9503). 3.2 Bylaws of the Company, incorporated by reference to Exhibit 3.2 of the Annual Report on Form 10-K for the fiscal year ended May 31, 1991 (the "1991 10-K"). 4.2(a) Certificate of Incorporation as filed on October 17, 1986, incorporated by reference to 4.2(a) of the December 15, 1995 Form S-3. 4.2(b) Certificate of Amendment to Certificate of Incorporation, as filed on March 3, 1987, incorporated by reference to 4.2(a) of the December 15, 1995 Form S-3. 4.2(c) Certificate of Amendment of Certificate of Incorporation, as filed on November 2, 1995, incorporated by reference to 4.2(a) of the December 15, 1995 Form S-3. 10.8(f) Extension and Amendment of Second Amended and Restated Dennis J. Lacey Executive Employment Agreement executed on July 1, 1997 and effective as of October 1, 1997, by and between Dennis J. Lacey, the Company and Capital Associates International, Inc. ("CAII") (the "Lacey Employment Agreement"), incorporated by reference to exhibit 10.8(f) of the May 31, 1997 Form 10-K. 10.40 Purchase Agreement, dated as of December 30, 1991 by and among CAII, the Company and Bank One, Texas, N.A., incorporated by reference to Exhibit 19.11 of the November 1991 10-Q. 10.55 Consulting Agreement, effective as of June 1, 1996 by and among the Company, CAII and William H. Buckland, incorporated by reference to Exhibit 10.55 of the August 31, 1997 Form 10-Q. 10.57 Residual Sharing Note, dated as of June 1, 1997 by and among the Company, CAII and William H. Buckland, incorporated by reference to Exhibit 10.57 of the August 31, 1997 Form 10-Q. 10.58 Residual Sharing Note, dated as of June 1, 1997 by and among the Company, CAII and James D. Walker, incorporated by reference to Exhibit 10.58 of the August 31, 1997 Form 10-Q. 10.59 Loan and Security Agreement, dated as of November 26, 1997 by and among the Company and CAII as Borrowers and CoreStates Bank, N.A., as Agent and Issuing Bank and each of the Financial Institutions now or hereafter shown on the Signature pages of this Agreement, incorporated by reference to Exhibit 10.59 of the November 30, 1997 Form 10-Q. 10.60 First Amendment to Loan and Security Agreement, dated as of April 7, 1998 by and between Capital Associates, Inc., and Capital Associates International, Inc. as Borrowers and CoreStates Bank, N. A. as Agent and Issuing Bank and the four participating financial institutions, incorporated by reference to Exhibit 10.60 of the May 31, 1998 Form 10-K. 10.61 Employment Agreement, dated as of April 7, 1998, by and among the Company, CAII and James D. Walker, incorporated by reference to Exhibit 10.61 of the May 31, 1998 Form 10-K. 33 of 36 Item No. Exhibit Index 10.62 Business Financing Agreement, Addendum to Business Financing Agreement and Agreement for Wholesale Financing, Corporate Guaranty and Addendum to Guaranty, dated as of April 21, 1998 by and between Capital Associates Technology Group, Inc. and Deutsche Financial Services Corporation, incorporated by reference to Exhibit 10.62 of the May 31, 1998 Form 10-K. 10.63 Second Amendment to Loan and Security Agreement, dated as of May 29, 1998 by and between Capital Associates, Inc., and Capital Associates International, Inc. as Borrowers and CoreStates Bank, N. A. as Agent and Issuing Bank and the four participating financial institutions, incorporated by reference to Exhibit 10.63 of the May 31, 1998 Form 10-K. 10.64 Amendment to the Business Financing Agreement and Agreement for Wholesale Financing dated July 15, 1991 between Capital Associates Technology Group, Inc. and Deutsche Financial Services Corporation, incorporated by reference to Exhibit 10.64 of the August 31, 1998 Form 10-Q. 10.65 Credit Agreement dated as of August 19, 1998 among CAI Lease Securitization-II Corp., as Borrower, Capital Associates International, Inc., as Servicer, Concord Minutemen Capital Company, LLC, as Senior Lender and Key Corporate Capital Inc., as Junior Lender, as Residual Lender and as Agent, incorporated by reference to Exhibit 10.65 of the August 31, 1998 Form 10-Q. 10.66 Lease Receivables Sale and Contribution Agreement dated as of August 19, 1998 between CAI Lease Securitization-II Corp. as the Buyer and Capital Associates International, Inc. as the Originator, incorporated by reference to Exhibit 10.66 of the August 31, 1998 Form 10-Q. 10.67 Custody Agreement between CAI Lease Securitization-II Corp. as Borrower, Capital Associates International, Inc. as the Originator, Key Corporate Capital Inc. as Agent and Bankers Trust Company dated August 19, 1998 requesting Bankers Trust Company to act as Collateral Custodian and hold financial instruments on behalf of all parties, incorporated by reference to Exhibit 10.67 of the August 31, 1998 Form 10-Q. 10.68 International Swap Dealers Association, Inc. (ISDA) Master Agreement dated as of August 24, 1998 between KeyBank National Association and CAI Lease Securitization-II Corp., incorporated by reference to Exhibit 10.68 of the August 31, 1998 Form 10-Q. 10.69 Schedule to the ISDA Master Agreement dated as of August 19, 1998 between KeyBank National Association and CAI Lease Securitization-II Corp., incorporated by reference to Exhibit 10.69 of the August 31, 1998 Form 10-Q. 10.70 Third Amendment to Loan and Security Agreement dated as of November 25, 1998 by and between Capital Associates, Inc. and Capital Associates International, Inc. as borrowers and First Union National Bank, as Agent and Issuing Bank and the four participating financial institutions, incorporated by reference to Exhibit 10.70 of the November 30, 1998 Form 10-Q. 10.71 Promissory Note, dated as of November 4, 1998, in the original amount of $131,069.25 made by James D. Edwards, Director of Capital Associates, Inc. and Capital Associates International, Inc. and payable to the order of Capital Associates, Inc. in payment of a portion of the exercise price for the purchase of CAI common stock, par value $.008 per share, upon the exercise by Mr. Edwards of a portion of his stock options, incorporated by reference to Exhibit 10.71 of the November 30, 1998 Form 10-Q. 34 of 36 Item No. Exhibit Index 10.72 Security Agreement and Stock Pledge Agreement, dated as of November 4, 1998, pledging 86,250 shares of CAI common stock, par value $.008 per share, executed by James D. Walker, Director of Capital Associates, Inc. and Capital Associates International, Inc. and delivered to Capital Associates, Inc. to secure payment and performance of Mr. Edwards promissory note to Capital Associates International, Inc, in the original principal amount of $131,069.25, incorporated by reference to Exhibit 10.72 of the November 30, 1998 Form 10-Q. 10.73 Fourth Amendment to Loan and Security Agreement dated as of December 22, 1998 by and between Capital Associates, Inc. and Capital Associates International, Inc. as borrowers and First Union National Bank, as Agent and Issuing Bank and the four participating financial institutions, incorporated by reference to Exhibit 10.73 of the February 28, 1999 Form 10-Q. 10.74 Warehousing Loan and Security Agreement dated as of December 20, 1998 by and between Capital Associates International, Inc. as borrowers and NationsBanc Leasing Corporation as Lender with respect to a $15 million Lease-Collateralized Loan Facility, incorporated by reference to Exhibit 10.74 of the February 28, 1999 Form 10-Q. 10.75 Fifth Amendment to Loan and Security Agreement dated as of August 11, 1999 by and between Capital Associates, Inc. and Capital Associates International, Inc. as borrowers and First Union National Bank, as Agent and Issuing Bank and the four participating financial institutions. 10.76 Subordination Agreement dated as of August 13, 1999 by and between Capital Associates, Inc. and Capital Associates International, Inc. as borrowers and James D. Walker and First Union National Bank, as Agent and Issuing Bank and the four participating financial institutions. 10.77 Subordination Agreement dated as of August 13, 1999 by and between Capital Associates, Inc. and Capital Associates International, Inc. as borrowers and William H. Buckland and First Union National Bank, as Agent and Issuing Bank and the four participating financial institutions. 21 List of Subsidiaries 23 Consent of KPMG LLP 27 Financial Data Schedule 35 of 36 SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. CAPITAL ASSOCIATES, INC. Dated: September 13, 1999 By: /s/Anthony M. DiPaolo -------------------------------- Anthony M. DiPaolo Senior Vice President and Chief Financial Officer Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons in the capacities indicated and on the dates listed. Signature Title --------- ----- /s/James D. Walker President, CEO and Chairman of the Board - ----------------------- James D. Walker /s/William H. Buckland Director - ----------------------- William H. Buckland /s/James D. Edwards Director - ----------------------- James D. Edwards /s/Gary M. Jacobs Director - ----------------------- Gary M. Jacobs /s/Robert A. Sharpe Director - ----------------------- Robert A. Sharpe /s/Dana T. Martin Assistant Vice President and Controller - ----------------------- (Principal Accounting Officer) Dana T. Martin Each of the above signatures is affixed as of September 13, 1999 36 of 36 INDEX OF FINANCIAL STATEMENTS AND SCHEDULE Page ---- Financial Statements - -------------------- Independent Auditors' Report F-2 Consolidated Balance Sheets as of May 31, 1999 and 1998 F-3 Consolidated Statements of Income for the Years Ended May 31, 1999, 1998 and 1997 F-4 Consolidated Statements of Changes in Stockholders' Equity for the Years Ended May 31, 1999, 1998 and 1997 F-5 Consolidated Statements of Cash Flows for the Years Ended May 31, 1999, 1998 and 1997 F-6 Notes to Consolidated Financial Statements F-7 to F-24 Schedule - -------- Independent Auditors' Report F-25 Schedule II - Valuation and Qualifying Accounts and Reserves for the Years Ended May 31, 1999, 1998 and 1997 F-26 F-1 INDEPENDENT AUDITORS' REPORT The Board of Directors and Stockholders Capital Associates, Inc.: We have audited the accompanying consolidated balance sheets of Capital Associates, Inc. and subsidiaries as of May 31, 1999 and 1998, and the related consolidated statements of income, changes in stockholders' equity, and cash flows for each of the years in the three-year period ended May 31, 1999. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Capital Associates, Inc. and subsidiaries as of May 31, 1999 and 1998 and the results of their operations and their cash flows for each of the years in the three-year period ended May 31, 1999, in conformity with generally accepted accounting principles. /s/ KPMG LLP ----------------------- KPMG LLP Denver, Colorado September 10, 1999 F-2 CAPITAL ASSOCIATES, INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS (Dollars in thousands, except shares and par value) ASSETS May 31, ---------------------- 1999 1998 --------- --------- Cash and cash equivalents $ 7,926 $ 17,684 Receivable from affiliated limited partnerships 744 352 Accounts receivable, net 7,992 5,835 Inventory 2,578 1,141 Residual values, net, arising from equipment under lease sold to private investors 4,469 4,277 Net investment in direct finance leases 42,116 31,181 Leased equipment, net 150,338 104,825 Investment in affiliated limited partnerships 1,957 3,589 Other 5,448 4,883 Deferred income taxes 3,400 2,500 Discounted lease rentals assigned to lenders arising from equipment sale transactions 19,773 37,626 --------- --------- $ 246,741 $ 213,893 ========= ========= LIABILITIES AND STOCKHOLDERS' EQUITY Recourse debt $ 50,060 $ 49,088 Accounts payable - equipment purchases 29,806 25,029 Accounts payable and other liabilities 15,621 10,279 Discounted lease rentals 125,639 104,311 --------- --------- 221,126 188,707 --------- --------- Commitments and contingencies (Notes 9, 11, 16 and 17) Stockholders' equity: Common stock, $.008 par value, 15,000,000 shares authorized, 5,254,000 and 5,165,000 shares issued 42 41 Additional paid-in capital 16,829 16,854 Retained earnings 8,771 8,374 Treasury stock, at cost (27) (83) --------- --------- Total stockholders' equity 25,615 25,186 --------- --------- $ 246,741 $ 213,893 ========= ========= See accompanying notes to consolidated financial statements. F-3 CAPITAL ASSOCIATES, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF INCOME (Dollars in thousands, except shares and per share data) Years Ended May 31, ------------------------------------ 1999 1998 1997 ---------- ---------- ---------- Revenue: Equipment sales to PIFs $ 18,996 $ 48,648 $ 66,987 Other equipment sales 174,918 199,610 137,558 Leasing 42,614 25,101 14,420 Interest 2,219 3,487 4,828 Other 4,623 4,228 3,741 ---------- ---------- ---------- Total revenue 243,370 281,074 227,534 ---------- ---------- ---------- Costs and expenses: Equipment sales to PIFs 18,559 47,558 65,545 Other equipment sales 169,174 193,144 134,473 Leasing 27,260 17,337 8,928 Operating and other expenses 15,513 11,830 9,568 Provision for losses 555 705 365 Interest: Non-recourse debt 8,503 6,123 6,012 Recourse debt 3,409 2,857 1,900 ---------- ---------- ---------- Total costs and expenses 242,973 279,554 226,791 ---------- ---------- ---------- Income before income taxes 397 1,520 743 Income tax expense - - 10 ---------- ---------- ---------- Net income $ 397 $ 1,520 $ 733 ========== ========== ========== Earnings per common share: Basic $ .08 $ .30 $ .15 ========== ========== ========== Diluted $ .07 $ .28 $ .14 ========== ========== ========== Weighted average number of common shares outstanding: Basic 5,173,000 5,117,000 5,004,000 ========== ========== ========== Diluted 5,399,000 5,449,000 5,403,000 ========== ========== ========== See accompanying notes to consolidated financial statements. F-4 CAPITAL ASSOCIATES, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY (Dollars in thousands)
Common Stock Additional Treasury Stock ------------ Paid-in Retained -------------- Shares Amount Capital Earnings Shares Cost Total ------ ------ ------- -------- ------ ---- ----- Balance at June 1, 1996 5,139,000 $ 41 $ 17,017 $ 6,121 145,000 $ (298) $ 22,881 Issuance of common stock under: - incentive stock option plan 6,000 - 4 - - - 4 - non-qualified stock option plan 12,000 - 10 - - - 10 Issuance of treasury shares upon exercise of incentive stock options - - (16) - (5,000) 16 - Income tax benefit from stock compensation - - 11 - - - 11 Non-employee stock option buyout - - (138) - - - (138) Net income - - - 733 - - 733 ---------- ------ -------- ------- -------- ------ -------- Balance at May 31, 1997 5,157,000 41 16,888 6,854 140,000 (282) 23,501 Issuance of common stock under incentive stock option plan 8,000 - 14 - - - 14 Issuance of treasury shares upon exercise of incentive stock options - - (82) - (98,000) 199 117 Income tax benefit from stock compensation - - 34 - - - 34 Net income - - - 1,520 - - 1,520 ---------- ------ -------- ------- -------- ------ -------- Balance at May 31, 1998 5,165,000 41 16,854 8,374 42,000 (83) 25,186 Issuance of common stock under: incentive stock option plan 3,000 - 31 - - - 31 non-qualified stock option plan 86,000 1 131 - - - 132 Issuance of treasury shares upon exercise of incentive stock options - - (56) - (24,000) 56 - Note receivable from sale of stock - - (131) - - - (131) Net income - - - 397 - - 397 ---------- ------ -------- ------- -------- ------ -------- Balance at May 31, 1999 5,254,000 $ 42 $ 16,829 $ 8,771 18,000 $ (27) $ 25,615 ========== ====== ======== ======= ======== ====== ========
See accompanying notes to consolidated financial statements. F-5 CAPITAL ASSOCIATES, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS (Dollars in thousands)
Years Ended May 31, ----------------------------------- 1999 1998 1997 --------- --------- --------- Cash flows from operating activities: Net income $ 397 $ 1,520 $ 733 --------- --------- --------- Adjustments to reconcile net income to net cash provided by operating activities: Depreciation and amortization 29,088 18,172 9,634 Recovery of investment in direct financing leases 13,404 5,200 3,786 Proceeds from the sales of leases, net 48,433 23,536 15,693 Provision for losses 555 705 365 Deferred income tax benefit (900) (200) (400) Deferred financing costs (245) (262) (100) Sales-type lease margin (56) (157) (69) Decrease (increase) in accounts receivable (2,549) (3,450) 1,651 Other (2,060) 1,836 1,879 --------- --------- --------- Total adjustments 85,670 45,380 32,439 --------- --------- --------- Net cash provided by operating activities 86,067 46,900 33,172 --------- --------- --------- Cash flows from investing activities: Equipment purchased for leasing (101,191) (71,495) (35,798) Investment in leased office facility and in capital expenditures (562) (1,236) (452) Net receipts from affiliated public income funds 1,632 3,427 1,810 Acquisition, net of cash acquired - (767) - --------- --------- --------- Net cash used for investing activities (100,121) (70,071) (34,440) --------- --------- --------- Cash flows from financing activities: Proceeds from securitization 24,708 - - Principal payments on securitization (3,930) - - Proceeds from discounting of lease rentals 34,404 23,127 13,686 Principal payments on discounted lease rentals (48,515) (14,716) (12,125) Proceeds from sales of common stock 32 14 14 Purchase of non-employee stock options - - (138) Net borrowings (payments) on revolving credit facilities (1,975) 25,953 7,507 Net borrowings (payments) on Term Loan (428) 283 (4,333) --------- --------- --------- Net cash provided by financing activities 4,296 34,661 4,611 --------- --------- --------- Net (decrease) increase in cash and cash equivalents (9,758) 11,490 3,343 Cash and cash equivalents at beginning of year 17,684 6,194 2,851 --------- --------- --------- Cash and cash equivalents at end of year $ 7,926 $ 17,684 $ 6,194 ========= ========= ========= Supplemental schedule of cash flow information: Recourse interest paid $ 3,409 $ 2,857 $ 1,900 Non-recourse interest paid 6,291 2,892 1,514 Income taxes paid 175 928 183 Income tax refunds received 308 91 602 Supplemental schedule of non-cash investing and financing activities: Discounted lease rentals assigned to lenders arising from equipment sales transactions 8,018 7,583 24,266 Assumption of discounted lease rentals in lease acquisitions 43,905 46,236 22,499 Fair value of assets acquired, including cash - 5,284 - Liabilities assumed and incurred in acquisition - 4,017 -
See accompanying notes to consolidated financial statements. F-6 CAPITAL ASSOCIATES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 1. Summary of Significant Accounting Policies ------------------------------------------ NATURE OF OPERATIONS Capital Associates, Inc. ("the Company") is a commercial finance company engaged in the leasing of a variety of equipment. The Company is principally engaged in (i) the origination of equipment leases with equipment users, including the acquisition of leases initially originated by other lessors (ii) the sale of equipment leases to third parties, (iii) the management and servicing of equipment leases retained by the Company or sold to private investors or other lessors, (iv) the sale and remarketing of equipment as it comes off-lease and (v) the sale and servicing of new information technology equipment. During fiscal years 1999 and 1998, the Company originated $266 million and $310 million, respectively, of equipment leases. The principal market for the Company's activities is the United States. USE OF ESTIMATES The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenue and expenses during the reporting period. For the Company, these are principally the estimates of residual values, collectibility of accounts receivable and valuation of inventory. Actual results could differ from those estimates. PRINCIPLES OF CONSOLIDATION The consolidated financial statements include the accounts of CAI and its subsidiaries. Intercompany accounts and transactions are eliminated in consolidation. The Company has investments in public income funds (the "PIFs", consisting of both general partnership and subordinated limited partnership interests) and other 50%-or-less owned entities. Such investments are primarily accounted for using the equity method. The parent company's assets consist solely of its investments in subsidiaries, and it has no liabilities separate from its subsidiaries. CASH AND CASH EQUIVALENTS Cash and cash equivalents include highly liquid investments with an original maturity of three months or less. INCOME TAXES The Company recognizes deferred tax assets and liabilities for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. Under Statement of Financial Accounting Standard ("SFAS") No. 109, the effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date. F-7 CAPITAL ASSOCIATES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 1. Summary of Significant Accounting Policies, continued ------------------------------------------ INVENTORY Inventory consists of the following (in thousands): 1999 1998 ------ ------- Retail inventory $ 1,195 $ 666 Equipment brokerage inventory 1,032 319 Equipment held for sale or re-lease 351 156 ------- ------- $ 2,578 $ 1,141 ======= ======= Retail inventory consists primarily of new information technology hardware and is stated at the lower of cost (first-in, first-out method) or market. Equipment brokerage inventory consists primarily of used equipment that has been acquired for resale and is recorded at the lower of cost or market value less cost to sell. Equipment held for sale or re-lease consists of equipment recorded at the lower of cost or market value less cost to sell returned to the Company following lease expiration. 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. STOCK OPTION PLAN The Company accounts for its stock option plan in accordance with the provisions of Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to Employees ("APB Opinion No. 25"), and related interpretations. As such, compensation expense is recorded on the date of grant only if the current market price of the underlying stock exceeded the exercise price. SFAS No. 123, Accounting for Stock-Based Compensation ("SFAS No. 123"), permits entities to recognize as expense over the vesting period the fair value of all stock-based awards on the date of grant. Alternatively, SFAS No. 123 allows entities to apply the provisions of APB Opinion No. 25, as the Company has elected to do, and provide pro forma net income and pro forma earnings per share disclosures for employee stock option grants made in fiscal year 1996 and future fiscal years as if the fair-value-based method defined in SFAS No. 123 had been applied. EQUIPMENT LEASING AND SALES LEASE ACCOUNTING - Statement of Financial Accounting Standards No. 13, Accounting for Leases, requires that a lessor account for each lease by either the direct financing, sales-type or operating lease method. Direct financing and sales-type leases are defined as those leases which transfer substantially all of the benefits and risks of ownership of the equipment to the lessee. The Company currently utilizes (i) the direct financing or the operating lease method for substantially all of the Company's lease originations and (ii) the sales-type or the operating lease method for substantially all lease activity for an item of equipment subsequent to the F-8 CAPITAL ASSOCIATES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 1. Summary of Significant Accounting Policies, continued ------------------------------------------ EQUIPMENT LEASING AND SALES, continued expiration of the initial lease term. For all types of leases, the determination of profit considers the estimated value of the equipment at lease termination, referred to as the residual value. After the origination of a lease, the Company may engage in financing of lease receivables on a non-recourse basis (i.e., "non-recourse debt" or "discounted lease rentals") and/or equipment sale transactions to reduce or recover its investment in the equipment. The Company's accounting methods and their financial reporting effects are described below: LEASE INCEPTION DIRECT FINANCING LEASES ("DFLs") - The cost of equipment is recorded as net investment in DFLs. Leasing revenue, which is recognized over the term of the lease, consists of the excess of lease payments plus the estimated residual value over the equipment's cost. Earned income is recognized monthly to provide a constant yield and is recorded in leasing revenue in the accompanying consolidated statements of income. Initial direct costs ("IDC") are capitalized and amortized over the lease term in proportion to the recognition of earned income. Amortization of IDC is recorded as leasing costs in the accompanying consolidated statements of income. Residual values are established at lease inception equal to the estimated value to be received from the equipment following termination of the initial lease (which in certain circumstances includes anticipated re-lease proceeds) as determined by the Company. In estimating such values, the Company considers all relevant information and circumstances regarding the equipment and the lessee. OPERATING LEASES ("OLs") - The cost of equipment is recorded as leased equipment and is depreciated on a straight-line basis over the lease term to an amount equal to the estimated residual value at the lease termination date. Leasing revenue consists principally of monthly rentals. IDC are capitalized and amortized over the lease term in proportion to the recognition of rental income. Depreciation expense and amortization of IDC are recorded as leasing costs in the accompanying consolidated statements of income. Residual values are established at lease inception equal to the estimated value to be received from the equipment following termination of the initial lease (which in certain circumstances includes anticipated re-lease proceeds) as determined by the Company. In estimating such values, the Company considers all relevant information and circumstances regarding the equipment and the lessee. Because revenue, depreciation expense and the resultant profit margin before interest expense are recorded on a straight-line basis, and interest expense on discounted lease rentals is incurred on the interest method, profit is skewed toward lower returns in the early years of the term of an OL and higher returns in later years. TRANSACTIONS SUBSEQUENT TO LEASE INCEPTION NON-RECOURSE DISCOUNTING OF RENTALS - The Company may assign the future rentals from leases to financial institutions at fixed interest rates on a non-recourse basis. In return for such assigned future rentals, the Company receives the discounted value of the rentals in cash. In the event of default by a lessee, the financial institution has a first lien on the underlying leased equipment, with no further recourse against the Company. Cash proceeds from such financings are recorded on the balance sheet as discounted lease rentals. As lessees make payments to financial institutions, leasing revenue and interest expense are recorded. F-9 CAPITAL ASSOCIATES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 1. Summary of Significant Accounting Policies, continued ------------------------------------------ EQUIPMENT LEASING AND SALES, continued SECURITIZATION OF LEASES - Cash proceeds from securitization financing are recorded on the balance sheet as discounted lease rentals. See Note 9 to Notes to Consolidated Financial Statements for a description of the Company's Securitization Facility. SALES TO PRIVATE INVESTORS OF EQUIPMENT UNDER LEASE - The Company may sell title to leased equipment that in some cases is subject to existing discounted lease rentals in equipment sale transactions with third-party investors. In such transactions, the investors obtain ownership of the equipment as well as rights to equipment rentals. Upon sale, the Company records equipment sales revenue equal to the sales price of the equipment which may include a residual interest retained by the Company (recorded as an asset at present value using an appropriate interest rate) and records equipment sales cost equal to the carrying value of the related assets (including remaining unamortized IDC). Income is recorded on residual interests retained by the Company after cumulative cash collections on such residuals exceed the recorded asset amount. Fees for remarketing equipment associated with such transactions are reflected in operations as realized. Other accounts arising from private equity sales include: DISCOUNTED LEASE RENTALS, ETC. - Pursuant to FASB Technical Bulletin No. 86-2, although private investors and PIFs may acquire the equipment sold to them by the Company subject to the associated non-recourse debt (i.e., discounted lease rentals), the debt is not removed from the balance sheet unless such debt has been legally assumed by the third-party investors. If not legally assumed, a corresponding asset ("discounted lease rentals assigned to lenders arising from equipment sale transactions") is recorded representing the present value of the end user rentals receivable relating to such transactions. Interest income is recorded on the discounted lease rentals and an equal amount of interest expense on the related liability is recorded in the accompanying statements of income. SALES TO PIFs - Upon the sale of equipment to its PIFs, the Company records equipment sales revenue equal to the sales price of the equipment (including any acquisition fees earned) and costs of sales equal to the carrying value of the related assets (including remaining unamortized IDC). Fees for services the Company performs for the PIFs are recognized at the time the services are performed. SERVICING FEES - The Company defers income related to its servicing obligation on certain leases it sells. This income is amortized over the life of the lease and is included in other income. TRANSACTIONS SUBSEQUENT TO INITIAL LEASE TERMINATION After the initial term of equipment under lease expires, the equipment is either sold or re-leased. When the equipment is sold, the remaining net book value of equipment sold is removed and gain or loss recorded. When the equipment is re-leased, the Company utilizes the sales-type method (described below) or the OL method (described above). Sales-type Leases ----------------- The excess of the present value of (i) future rentals and (ii) the estimated residual value (collectively, "the net investment") over the carrying value of the equipment subject to the sales-type lease is reflected in operations at the inception of the lease. Thereafter, the net investment is accounted for as a DFL, as described above. F-10 CAPITAL ASSOCIATES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 1. Summary of Significant Accounting Policies, continued ------------------------------------------ EQUIPMENT LEASING AND SALES, continued EQUIPMENT BROKERAGE SALES The Company's NBCO subsidiary purchases various types of used equipment for resale. The cost of the equipment is recorded as inventory. When the equipment is sold, the inventory value is removed and a gain or loss is recorded. Revenue is recognized upon receipt of cash from the customer, if the Company has no significant obligations to the customer after delivery. REVENUE RECOGNITION FOR SALES OF INFORMATION TECHNOLOGY HARDWARE AND SOFTWARE Revenue is recognized upon shipment to the customer, if the Company has no significant obligations to the customer after delivery. ALLOWANCE FOR LOSSES An allowance for losses is maintained at levels determined by management to adequately provide for any other-than-temporary declines in asset values. In determining losses, economic conditions, the activity in used equipment markets, the effect of actions by equipment manufacturers, the financial condition of customers, the expected courses of action by lessees with regard to leased equipment at termination of the initial lease term, changes in technology and other factors which management believes are relevant, are considered. Recoverability of an asset value is measured by a comparison of the carrying amount of the asset to future net cash flows expected to be generated by the asset. If a loss is indicated, the loss to be recognized is measured by the amount by which the carrying amount of the asset exceeds the fair value of the asset. Asset chargeoffs are recorded upon the termination or remarketing of the underlying assets. Assets are reviewed quarterly to determine the adequacy of the allowance for losses. The Company evaluates the realizability of the carrying value of its investment in its PIFs based upon all estimated future cash flows from the PIFs. As a result of such analyses, certain distributions have been accounted for as a recovery of cost instead of income. RECLASSIFICATIONS Certain prior year amounts have been reclassified to conform with the current year presentation. 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"). CATG provides a wide range of information technology ("IT") services, including procurement of software and PC's and networking equipment, and IT equipment maintenance. 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. F-11 CAPITAL ASSOCIATES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 2. Acquisition, continued ----------- The $2,140,000 note payable to the sellers 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 $42,057 beginning December 12, 2000 and continuing through November 12, 2001. The outstanding balance at May 31, 1999 was $1,375,000. Interest expense for fiscal 1999 was approximately $169,000. 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 $1.7 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. Goodwill amortized during the fiscal 1999 was approximately $117,000. Accumulated amortization of goodwill was approximately $188,000 at May 31, 1999. 3. Residual Values and Other Receivables Arising from Equipment Under Lease --------------------------------------------------------------------------- Sold to Private Investors ------------------------- As of May 31, 1999 and 1998, the equipment types for which the Company recorded the present value of the estimated residual values and other receivables arising from sales of equipment under lease to private investors were (in thousands): Description 1999 1998 ----------- ------- ------- Material handling $ 2,388 $ 2,134 Computer equipment 782 500 Mining and manufacturing 771 10 Furniture and fixtures 43 105 Other miscellaneous equipment 285 431 ------- ------- Total equipment residuals 4,269 3,180 Notes receivable due directly from investors 200 1,097 ------- ------- $ 4,469 $ 4,277 ======= ======= Residual values arising from equipment under lease sold to private investors were net of an allowance for losses of $3,000 and $64,000 as of May 31, 1999 and 1998, respectively. 4. Net Investment in DFLs ---------------------- The components of the Company's net investment in DFLs as of May 31, 1999 and 1998 were (in thousands): 1999 1998 -------- -------- Minimum lease payments receivable $ 38,812 $ 32,264 Estimated residual values 9,601 4,217 IDC 452 336 Less unearned income (6,749) (5,636) -------- -------- $ 42,116 $ 31,181 ======== ======== F-12 CAPITAL ASSOCIATES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 5. Leased Equipment, net --------------------- The Company's investment in equipment under OLs, by major classes, as of May 31, 1999 and 1998 were (in thousands): 1999 1998 --------- --------- Information technology $ 86,793 $ 45,861 Material handling 40,067 36,312 Other technology and communication 19,541 19,349 Manufacturing 13,532 - Furniture and fixtures 10,113 11,213 Other 11,060 8,017 Aircraft 339 343 IDC 1,567 1,128 --------- --------- 183,012 122,223 Less accumulated depreciation (31,647) (16,811) Less allowance for losses (1,027) (587) --------- --------- $ 150,338 $ 104,825 ========= ========= Depreciation expense related to leased equipment was $26,630,000, $16,907,000, and $8,662,000 for fiscal years 1999, 1998 and 1997, respectively. 6. Future Minimum Lease Payments ----------------------------- Future minimum lease payments receivable from noncancelable leases on equipment owned by the Company as of May 31, 1999, are as follows (in thousands): Years Ending May 31, DFLs OLs -------------------- -------- -------- 2000 $ 17,078 $ 48,129 2001 10,894 37,491 2002 5,855 21,368 2003 3,216 10,240 2004 1,607 7,657 Thereafter 162 1,175 -------- --------- $ 38,812 $ 126,060 ======== ========= 7. Significant Customer and Concentration of Credit Risk ----------------------------------------------------- During 1999 and 1998, no lessee accounted for more than 10% of leasing revenue. During fiscal year 1997, leasing revenue from one lessee accounted for 13% of total leasing revenue. In addition, other equipment sales revenue related to equipment leased to that lessee accounted for 34%, 30% and 77% of total other equipment sales revenue during fiscal year 1999, 1998 and 1997, respectively. F-13 CAPITAL ASSOCIATES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 7. Significant Customer and Concentration of Credit Risk, continued ----------------------------------------------------- The Company leases various types of equipment to companies in diverse industries throughout the United States. To minimize credit risk, the Company generally leases equipment to (i) companies that have a credit rating of not less than Baa as determined by Moody's Investor Services, Inc., or comparable credit ratings as determined by other recognized credit rating services, or (ii) companies, which although not rated by a recognized credit rating service or rated below Baa, are believed by the Company to be sufficiently creditworthy to satisfy the financial obligations under the lease. At May 31, 1999, approximately 98% of equipment under OLs and DFLs owned by the Company was leased to companies meeting the above credit criteria. 8. Discounted Lease Rentals ------------------------ Discounted lease rentals outstanding at May 31, 1999 bear interest at rates between 6% and 16% with a weighted average rate of 8.6%. Aggregate maturities of such non-recourse obligations are (in thousands): Years Ending May 31: 2000 $ 59,619 2001 40,037 2002 15,408 2003 6,504 Thereafter 4,071 --------- $ 125,639 ========= On December 20, 1998, Capital Associates International Inc. ("CAII") obtained $15 million in committed non-recourse financing from NationsBanc Leasing Corporation. CAII may use the committed credit at its discretion to finance leases under a warehousing arrangement. The loan is secured by lease transactions financed under the facility only. The loan was primarily underwritten utilizing the underlying credit quality of the leases pledged as collateral under the facility. The interest rate option associated with the facility is Prime rate minus 0.25% or LIBOR plus 2.5% (7.75% & 4.90% at May 31, 1999, respectively). The Company is required to pay a non-usage fee of 0.2% of the unused commitment quarterly. The outstanding balance under the facility at May 31, 1999 was $1.3 million. The loan is included with "Discounted lease rentals" in the accompanying consolidated Balance Sheets. The facility contains general operating and reporting requirements, however, no formal financial covenants are required of CAII. As of May 31, 1999, CAII was in compliance with the terms of the facility. 9. Securitization Facility ----------------------- The Company established a securitization facility (the "Securitization Facility") in August 1998 through a wholly-owned special purpose subsidiary ("SPS") which purchases from the Company equipment subject to lease and related lease rental payments. The SPS in turn borrows from Concord Minuteman Capital Company, LLC, a commercial paper conduit entity, as Senior Lender, and Key Corporate Capital, Inc., as Junior Lender, based on the present value of the lease rental payments after being discounted by various factors. The Securitization Facility includes a firm commitment allowing the Company to add leases during its initial term of 364 days. The Securitization Facility is comprised of a senior loan with a maximum principal amount of $50,000,000 ("Senior Loan"), a junior loan with a maximum principal amount of $5,000,000 ("Junior Loan") and a residual loan with a maximum principal amount of $10,000,000 ("Residual Loan"). F-14 CAPITAL ASSOCIATES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 9. Securitization Facility, continued ----------------------- The Senior Loan and the Junior Loan are each a revolving securitization supported by a security interest in the SPS's ownership of leases and the related lease rental payments. The SPS is required to enter into interest rate hedges to provide protection against increasing interest rates attributable to the outstanding Senior and Junior Loans. The Senior Loan and the Junior Loan are each repaid out of the collections from the rental payments attributable to the leases and are recourse only to the extent of the underlying leases. The Senior and Junior Loans are included with "Discounted lease rentals" in the accompanying Consolidated Balance Sheets. The Residual Loan by Key Corporate Capital, Inc. is secured by the residual value of the equipment acquired by the SPS and is expected to be repaid from the proceeds related to any remarketing of the equipment. As the SPS borrows money under the Residual Loan, the SPS lends those funds to the Company. The loan to the Company is evidenced by a demand promissory note which can be called only in the event of certain bankruptcy or insolvency events relating to the Company, or if the remarketing proceeds from the equipment, together with any other funds that the SPS has available to it after payment of amounts owed to the Senior and Junior Lenders are inadequate to pay the amounts then due on the Residual Loan. The Residual Loan is included with "Recourse debt" in the accompanying Consolidated Balance Sheets. The Company services the leases subject to the Securitization Facility and has been appointed the remarketer of the equipment that secures the Residual Loan. The Securitization Facility terminates, and the right of the Company to continue as servicer and remarketer terminates, upon the occurrence of various events, including the Company's failure to maintain certain financial ratios and defaults under other indebtedness of the Company. The Company had approximately $20 million outstanding under the Senior and Junior Loans and approximately $3.4 million under the Residual Loan on May 31, 1999. Interest on the Senior Loan is equal to the LIBO rate (4.90% at May 31, 1999) per annum. Interest on the Junior Loan is equal to the LIBO rate plus 2.8% per annum. Interest on the Residual Loan is equal to the LIBO rate plus 3.25% per annum. 10. Recourse Bank Debt ------------------ The Company's senior, secured debt facility (the "Senior Facility") consists of a term loan, a working capital revolving credit loan ("Working Capital Facility") and a warehouse revolving credit loan ("Warehouse Credit Facility"). The lender group consists of the agent bank, First Union National Bank, and participating lenders, BankBoston, N.A., US Bank, Norwest Bank Colorado, N.A., and European America Bank (the "Lender Group"). The Senior Facility was renewed on December 23, 1998, expires November 30, 2000, and may be renewed annually at the Lender's sole discretion. Interest on the Senior Facility is tied to the Lender Group's prime rate or the LIBO rate (8.5% and 5.7%, respectively at May 31, 1999) 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 $ 61,250,000 $ 6,900,000 Borrowings at May 31, 1999 33,942,024 6,900,000 Potential availability at May 31, 1999 27,307,976 - Applicable Prime Rate Margin - .25% Applicable LIBO Rate Margin 2.5% 2.75% F-15 CAPITAL ASSOCIATES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 10. Recourse Bank Debt, continued ------------------ The Term Loan commitment amount is $4 million with a four-year amortization schedule to a balloon payment of $2 million due on November 30, 1999. As of May 31, 1999, the Term Loan balance was $2,550,000 as a result of scheduled quarterly principal repayments. The Term Loan bears interest at Prime plus .75%, and principal and interest are payable quarterly in arrears. 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 is collateralized by all assets of the Company, except for the assets which collateralize the loan from Deutsche Financial Services ("Deutsche") described below. 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. As of May 31, 1999, the Company was in compliance with the terms of the Senior Facility, except for one financial ratio covenant, for which it received a waiver from the Lenders on August 11, 1999. On May 29, 1998, the Company obtained $6 million in committed revolving credit financing from Deutsche for its CATG subsidiary. The loan is collateralized by specific accounts receivable and inventory generated or purchased by CATG. The facility is renewable annually at Deutsche's discretion. The outstanding balance related to this portion of the facility at May 31, 1999 was approximately $1,919,110, which is due on demand. The interest rate associated with this facility is Deutsche's Prime rate (8.5% at May 31, 1998) plus 0.5%. The Company is required to pay an annual facility fee of 0.125% of the total commitment. Balances outstanding under the facility are guaranteed by Capital Associates International, Inc. This guaranty obligation is subordinate to the Company's obligations under the Senior Facility. The Deutsche facility contains provisions which require CATG to maintain certain minimum levels of capitalization and liquidity. In addition, the agreement contains a minimum capitalization requirement for the Company. As of May 31, 1999, both the Company and its CATG subsidiary were in compliance with the terms of the Deutsche facility, except for one financial ratio covenant. The Company believes it will be able to obtain a waiver from Deutsche. However, should it not be able to obtain a waiver, it does not believe that there would be a material adverse effect on the financial contition or operations of the Company. 11. Related Parties --------------- PIFs The Company sponsors or co-sponsors three PIFs (two of which purchased equipment under lease from the Company during fiscal year 1999). The Company, through its PIF general partner subsidiaries, acts as either a general partner or co-general partner of each PIF for which it receives general partner distributions and management fees. The Company, through CAII, also acts as the Class B limited partner of each PIF for which it receives Class B limited partner distributions. The Class B limited partner is required to make subordinated limited partnership investments in the PIFs. The Class B limited partner has no obligation to make further cash contributions. Amounts related to the PIFs for the years ended May 31, 1999, 1998 and 1997 were as follows (in thousands): 1999 1998 1997 ------- ------- ------- Equipment sales margin $ 437 $ 1,090 $ 1,442 Fees and distributions (included in other income) 2,757 3,114 2,453 Investment contributions in subordinated limited partnership interests - 220 280 F-16 CAPITAL ASSOCIATES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 11. Related Parties, continued --------------- OTHER RELATED PARTIES MCC Financial Corporation ("MCC") acquired voting control of the Company during fiscal year 1996. Two executive officers of that company, Mr. Walker and Mr. Buckland, are directors of the Company. In addition, Mr. Walker became President and CEO of the Company in April 1998. The Company has entered into a consulting agreement with Mr. Buckland and an employment agreement with Mr. Walker. During fiscal years 1999, 1998 and 1997, the Company paid approximately $555,000, $650,000 and $810,000, respectively, under these agreements including $150,000 for expenses of Mr. Walker in connection with his relocation to the Company's headquarters in 1997. On August 11, 1999, the Company borrowed $350,000 from Messrs. Buckland and Walker and issued a subordinated note to each in the face amount of $175,000. The notes bear interest at 7% per year plus additional contingent interest at 9% per year based on the performance of certain residual interests owned by the Company. Principal and interest (which accrues quarterly) are due on August 11, 2002, subject to certain prepayment obligations. The notes are subordinated to all existing recourse bank debt. 12. Income Taxes ------------ The components of income tax expense (benefit) charged to continuing operations were (in thousands): 1999 1998 1997 ------ ------ ------ Current: Federal $ 765 $ -0- $ 240 State and local 135 200 170 ------ ------ ------ 900 200 410 ------ ------ ------ Deferred: Federal (765) -0- (100) State and local (135) (200) (300) ------ ------ ------ (900) (200) (400) ------ ------ ------ Total tax provision $ 0 $ 0 $ 10 ====== ====== ====== Income tax expense differs from the amounts computed by applying the U.S. federal income tax rate of 34% to pre-tax income from continuing operations as a result of the following: 1999 1998 1997 ------ ------ ------ Computed "expected" tax expense $ 135 $ 515 $ 250 State tax provisions, net of federal benefits 65 85 40 Reduction in valuation allowance for deferred income tax assets (200) (600) (280) ------ ------ ------ $ 0 $ 0 $ 10 ====== ====== ====== Income taxes are provided on income from continuing operations at the appropriate federal and state statutory rates applicable to such earnings. F-17 CAPITAL ASSOCIATES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 12. Income Taxes, continued ------------ Components of income tax expense (benefit) attributable to net income before income taxes is as follows (in thousands):
1999 1998 1997 -------- -------- -------- Current: Taxes on net income before carryforwards $ 1,200 $ 200 $ 710 Benefit of investment tax credit ("ITC") carryforward utilized (300) - (300) ------- ------- ------- 900 200 410 ------- ------- ------- Deferred: Tax effect of net change in temporary differences 100 1,300 (420) Net operating loss ("NOL") carryforwards (200) (500) - ITC carryforward utilized 300 - 300 ITC carryforward expired 100 300 - Alternative Minimum Tax ("AMT") (900) (400) - Decrease in valuation allowance for deferred income tax assets (300) (900) (280) ------- ------- ------- (900) (200) (400) ------- ------- ------- Provision for income taxes $ 0 $ 0 $ 10 ======= ======= ======= Significant components of the Company's deferred tax liabilities and assets as of May 31, 1999 and 1998, were as follows (in thousands): 1999 1998 ------- ------- Deferred income tax liabilities: Direct finance leases accounted for as operating leases for income tax purposes, and equipment depreciation for tax purposes in excess of financial reporting depreciation $ 2,000 $ 200 Residual values and other receivables arising from equipment under lease sold to private investors recognized for financial reporting purposes, but not for tax reporting purposes 1,600 1,300 Other assets and liabilities, net - 900 ------- ------- Total deferred income tax liabilities 3,600 2,400 ------- ------- Deferred income tax assets: Other assets and liabilities, net 1,100 - NOL carryforwards 700 500 ITC carryforwards 600 1,000 AMT credit carryforwards 4,600 3,700 ------- ------- Total deferred income tax assets 7,000 5,200 Valuation allowance for deferred income tax assets - (300) ------- ------- Net deferred income tax assets 7,000 4,900 ------- ------- Net deferred income tax asset $ 3,400 $ 2,500 ======= =======
At May 31, 1999, the Company has ITC carryforwards of approximately $600,000, which expire from 2000 through 2001, NOL carryforwards of approximately $700,000, which expire from 2013 through 2014, and AMT credits of approximately $4.6 million. Under present federal tax law, AMT credits may be carried forward indefinitely and may be utilized to reduce regular tax liability to an amount equal to AMT liability. Due to a change in control, provisions of the Internal Revenue Code limit the annual future ITC carryforward and AMT credit carryforward utilization to approximately $300,000 per year. F-18 CAPITAL ASSOCIATES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 12. Income Taxes, continued ------------ The Company had established a valuation allowance for deferred taxes due to the uncertainty that the full amount of the ITC carryforwards will be utilized prior to expiration. The valuation allowance was reduced in fiscal 1999 and 1998 to reflect the utilization and expiration of ITC carryforwards for which the valuation allowance had previously been provided (approximately $400,000 and $300,000, respectively). In addition, the valuation allowance was reduced by an additional $600,000 and $300,000 in fiscal 1998 and 1997, respectively, to reflect a reduction in uncertainty about the utilization of ITC carryforwards in future years. The reductions in the valuation allowance for fiscal years 1999, 1998 and 1997 were recorded in the respective fiscal fourth quarter and resulted in income tax benefits of $100,000, $464,000 and $227,000. 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. 13. Preferred Stock and Earnings Per Common Share --------------------------------------------- PREFERRED STOCK The Company has authority to issue 2,500,000 shares of preferred stock at $0.008 par value. At May 31, 1999, no shares of preferred stock had been issued. EARNINGS PER COMMON SHARE The following is a reconciliation of the weighted average number of common shares used in the calculation of basic and diluted earnings per share for the years ended May 31: 1999 1998 1997 --------- --------- --------- Weighted average number of common shares - basic 5,173,000 5,117,000 5,004,000 Common stock options (utilizing treasury stock method) 226,000 332,000 399,000 --------- --------- --------- Weighted average number of common shares-assuming dilution 5,399,000 5,449,000 5,403,000 ========= ========= ========= Common stock options totaling 296,000 were not included in the diluted earnings per share calculation for the year ended May 31, 1999 because their effect would have been anti-dilutive. 14. Stock Options ------------- The Company has a qualified incentive stock option plan whereby stock options may be granted to employees to purchase shares of the Company's common stock at prices equal to the market price of the Company's stock on date of grant. The Company has a non-qualified plan covering all directors except the CEO. Common stock received through the exercise of qualified incentive stock options which are sold by the optionee within eighteen months of grant or one year of exercise result in a tax deduction for the Company equivalent to the taxable gain recognized by the optionee. In November 1998, a director of the Company exercised stock options for 86,250 shares of common stock with an average exercise price of $1.53 by paying the par value in cash of $690.00 and issuing a note payable to the Company equal to approximately $131,000, the remainder of the exercise price. The outstanding balance at May 31, 1999 was approximately $131,000 and was included in the equity section of the balance sheet. The note bears interest at the rate of 4.5% compounded semi-annually and is due November 3, 2002. F-19 CAPITAL ASSOCIATES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 14. Stock Options, continued ------------- During July 1996, the Company purchased 104,000 outstanding options issued to non-employees at a cost to the Company of $138,000, which was equal to the difference of $2.45 and the exercise price of each option purchased. The cost was reflected as a charge to additional paid-in capital in the accompanying May 31, 1997 consolidated balance sheets. Options generally become exercisable over a four-year period and have a term of ten years. The Company applies APB Opinion No. 25 in accounting for its stock option plans. Accordingly, and since the Company awards stock options at fair market value, no compensation cost has been recognized for its stock options in the financial statements. Had the Company determined compensation cost based on the fair value of options at the grant date under SFAS No. 123, the Company's net income and earnings per common and dilutive common equivalent share would have been reduced to the pro forma amounts indicated below:
1999 1998 1997 --------- ----------- --------- Net income As Reported $ 397,000 $ 1,520,000 $ 733,000 Pro forma $ 288,000 $ 1,349,000 $ 585,000 Basic earnings per share As Reported $ .08 $ 0.30 $ 0.15 Pro forma $ .06 $ 0.25 $ 0.13 Earnings per share assuming dilution As Reported $ .07 $ 0.28 $ 0.14 Pro forma $ .05 $ 0.25 $ 0.11
For purposes of calculating the compensation cost in accordance with SFAS No. 123, the fair value of each option grant is estimated on the date of grant using the Black-Scholes option-pricing model with the following weighted-average assumptions used for grants in fiscal 1999, 1998 and 1997, respectively: no dividend yield; expected volatility of 110%, 104% and 110%; risk free interest rates of 5.61%, 5.62% and 6.58%; and expected lives of five years. Additional information on shares subject to options is as follows:
1999 1998 1997 ----------------------- ------------------------- ------------------------ Weighted- Weighted- Weighted- Number average Number average Number average of Exercise of Exercise of Exercise Options Price Options Price Options Price --------- --------- ---------- --------- ---------- --------- Outstanding at beginning of year 881,000 $ 2.50 649,000 $ 1.47 693,000 $ 1.23 Granted 56,000 3.69 349,000 3.99 90,000 2.88 Exercised (113,000) 1.41 (112,000) 1.18 (19,000) .81 Purchased - - - (104,000) 1.13 Forfeited (57,000) 3.74 (5,000) 2.97 (11,000) 2.10 --------- ------- ---------- ---------- Outstanding at the end of the year 767,000 2.65 881,000 2.50 649,000 1.47 ========= ======= ========== ========== Options exercisable at year-end 582,000 542,000 606,000 Weighted-average fair value of options granted during the year $ 2.98 $ 3.60 $ 2.35
F-20 CAPITAL ASSOCIATES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 14. Stock Options, continued ------------- The following table summarizes information about stock options outstanding at May 31, 1999: Options Outstanding Options Exercisable ---------------------------------- ------------------- Weighted- average Weighted Weighted Number Remaining average Number average Range of of Contractual Exercise of Exercise Exercise Prices Options Life Price Options Price --------------- ------- ----------- -------- ------- -------- $ 0.01 - $ 1.00 63,000 2.45 years $ 0.73 63,000 $ 0.73 $ 1.01 - $ 2.00 250,000 8.75 years 1.29 250,000 1.29 $ 2.01 - $ 3.00 122,000 9.05 years 2.72 85,000 2.60 $ 3.01 - $ 4.00 40,000 9.57 years 3.25 32,000 3.25 $ 4.01 - $ 5.00 292,000 9.32 years 4.13 152,000 - ------- ------- 767,000 8.54 years 2.65 582,000 2.27 ======= ======= 15. Employee Benefit Plan --------------------- The Company has a defined contribution retirement plan whereby employees who have completed six months of service may contribute up to 15% of their annual salaries. The Company will match 50% of non-highly compensated employees contributions subject to a maximum of the lesser of (i) 4% of the employee's eligible compensation or (ii) $1,000. The Company contributed an aggregate of $162,000 for the years ended May 31, 1999, 1998 and 1997. 16. Quarterly Financial Data (unaudited) ------------------------------------ Summarized quarterly financial data for the years ended May 31, 1999 and 1998 are (in thousands, except per share data): Fiscal Year 1999: Total Revenue Net Income Basic Income Per Share ----------------- ------------- ---------- ---------------------- First quarter $ 67,960 $ 143 $ .03 Second quarter 52,558 146 .03 Third quarter 58,645 375 .07 Fourth quarter 64,259 (267) (.05) Fiscal Year 1998: Total Revenue Net Income Basic Income Per Share ----------------- ------------- ---------- ---------------------- First quarter $ 42,038 $ 141 $ .03 Second quarter 73,239 735 .15 Third quarter 82,309 515 .10 Fourth quarter 83,488 129 .03 In the fourth quarter fiscal 1999, the Company recorded a $500,000 charge to reflect adjustments to equipment purchases payable at its CATG subsidiary. F-21 CAPITAL ASSOCIATES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 17. 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. Commitments ----------- The Company leases office space under long-term and short-term non-cancelable operating leases. The leases contain renewal options and provide for annual escalation for utilities, taxes and service costs. Rent expense was $821,000, $650,000, and $502,000 for fiscal years 1999, 1998 and 1997, respectively. F-22 CAPITAL ASSOCIATES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 18. Commitments, continued ----------- Minimum future rental payments required by such leases are as follows (in thousands): Years Ending May 31, 2000 $ 805 2001 333 2002 284 ------- $ 1,422 ======= 19. 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. Direct costs of $150,000 in 1999 associated with these services have been allocated from Leasing to Technology Group. During 1998, services performed by Leasing on behalf of Technology Group were immaterial. In evaluating the financial performance of each business unit, management focuses on revenue and net income before taxes, on total assets and recourse debt. In 1999, 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 amounts borrowed from Deutsche only. Financial performance measurements for Leasing and Technology Group are set forth below for each of the Company's business units for fiscal years ending May 31, 1999 and 1998. The results for 1998 reflect information for Technology after its acquisition effective November 1, 1997. 1999 1998 --------- --------- Revenue: Leasing $ 216,222 $ 267,188 Technology Group 27,148 13,886 --------- --------- $ 243,370 $ 281,074 ========= ========= Interest expense, net: Leasing $ 9,325 $ 5,361 Technology Group 368 132 --------- --------- $ 9,693 $ 5,493 ========= ========= Net income before taxes: Leasing $ 1,439 $ 1,799 Technology Group (1,042) (279) --------- --------- $ 397 $ 1,520 ========= ========= Total assets: Leasing $ 240,536 $ 209,253 Technology Group 6,205 4,840 --------- --------- $ 246,741 $ 214,093 ========= ========= Recourse debt: Leasing $ 48,141 $ 47,379 Technology Group 1,919 1,709 --------- --------- $ 50,060 $ 49,088 ========= ========= F-23 CAPITAL ASSOCIATES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 20. Disclosures about Fair Value of Financial Instruments ----------------------------------------------------- The following disclosure of the estimated fair value of financial instruments was made in accordance with Statements of Financial Standards No. 107 ("SFAS No. 107"), Disclosures about Fair Value of Financial Instruments. SFAS No. 107 specifically excludes certain items from its disclosure requirements such as the Company's investment in leased assets. Accordingly, the aggregate fair value amounts presented are not intended to represent the underlying value of the net assets of the Company. The carrying amounts at May 31, 1999 for cash and cash equivalents, accounts receivable, recourse bank debt, accounts payable-equipment purchases and accounts payable and other liabilities approximate their fair values due to the short maturity of these instruments, or because the related interest rates approximate current market rates. As of May 31, 1999, discounted lease rentals and discounted lease rentals assigned to lenders arising from equipment sale transactions of $125,639,000 and $19,773,000, respectively, have fair values of $120,107,000 and $18,627,000, respectively. The fair values were estimated utilizing market rates of comparable debt having similar maturities and credit quality as of May 31, 1999. F-24 CAPITAL ASSOCIATES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS INDEPENDENT AUDITORS' REPORT The Board of Directors and Stockholders Capital Associates, Inc.: Under date of September 10, 1999, we reported on the consolidated balance sheets of Capital Associates, Inc. and subsidiaries as of May 31, 1999 and 1998, and the related consolidated statements of income, changes in stockholders' equity, and cash flows for each of the years in the three-year period ended May 31, 1999, as contained in the Company's annual report on Form 10-K for the year 1999. In connection with our audits of the aforementioned consolidated financial statements, we also have audited the related financial statement schedule as listed in the accompanying index. This financial statement schedule is the responsibility of the Company's management. Our responsibility is to express an opinion on this financial statement schedule based on our audits. In our opinion, the related financial statement schedule, when considered in relation to the basic consolidated financial statements taken as a whole, presents fairly, in all material respects, the information set forth therein. /s/KPMG LLP -------------------------- KPMG LLP Denver, Colorado September 10, 1999 F-25 CAPITAL ASSOCIATES, INC. AND SUBSIDIARIES SCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS AND RESERVES for the Years Ended May 31, 1999, 1998 and 1997 (in thousands)
COLUMN A COLUMN B COLUMN C COLUMN D COLUMN E -------- ---------- ---------- ------------- --------- Balance at Charged to Balance Beginning Costs and at End of Description of Period Expenses Deductions(1) Period ----------- ---------- ---------- ------------- --------- Year ended May 31, 1999: - ----------------------- Allowance for doubtful accounts: - - accounts receivable $ 90 $ 76 $ (30) $ 136 Allowance for losses: - - residual values arising from equipment under lease sold to private investors 64 - (61) 3 - - leased equipment 587 479 (39) 1,027 ------- ------ ------ ------- $ 741 $ 555 $ (130) $ 1,166 ======= ====== ====== ======= Year ended May 31, 1998: - ----------------------- Allowance for doubtful accounts: - - accounts receivable $ 30 $ 60 $ - $ 90 Allowance for losses: - - residual values arising from equipment under lease sold to private investors 157 - (93) 64 - - leased equipment 707 645 (765) 587 ------- ----- ------ ------- $ 894 $ 705 $ (858) $ 741 ======= ===== ====== ======= Year ended May 31, 1997: - ----------------------- Allowance for doubtful accounts: - - accounts receivable $ 44 $ - $ (14) $ 30 Allowance for losses: - - residual values arising from equipment under lease sold to private investors 258 - (101) 157 - - leased equipment 1,120 365 (778) 707 ------- ----- ------ ------- $ 1,422 $ 365 $ (893) $ 894 ======= ===== ====== =======
(1) Principally charge-offs of assets against the established allowances. See accompanying independent auditors' report. F-26 EX-10.75 2 4Q99CAI.001 EXHIBIT 10.75 FIFTH AMENDMENT TO LOAN AND SECURITY AGREEMENT ---------------------------------------------- This Fifth Amendment to Loan and Security Agreement ("Amendment") entered into as of August 13, 1999, by and among CAPITAL ASSOCIATES, INC. and CAPITAL ASSOCIATES INTERNATIONAL, INC. (each a "Borrower" and collectively "Borrowers"), FIRST UNION NATIONAL BANK, SUCCESSOR BY MERGER TO CORESTATES BANK, N.A., a national banking corporation, in its capacity as agent ("Agent") and as lender and Issuing Bank and each of the lenders listed on the signature pages hereof, in their capacity as lenders (singly, each is a "Lender" and collectively, all are "Lenders"). BACKGROUND A. On or about November 26, 1997, Borrowers, Agent and Lenders entered into a certain Loan and Security Agreement, as amended by that certain First Amendment to Loan and Security Agreement dated as of April 7, 1998, that certain Second Amendment to Loan and Security Agreement dated as of May 29, 1998, that certain Third Amendment to Loan and Security Agreement dated as of November 25, 1998 and that certain Fourth Amendment to Loan and Security Agreement dated as of December 22, 1998 (collectively, the "Loan Agreement"), pursuant to which Lenders agreed to make advances to Borrowers up to a maximum aggregate amount of $71,250,000, evidenced by Borrowers' delivery of certain Notes to Lenders. B. The Borrowers have requested the Loan Documents be modified in certain respects. Agent, Lenders and Issuing Bank have consented to these modifications subject to the terms and conditions set forth below. C. All capitalized terms not otherwise defined herein shall have the meanings ascribed to them in the Loan Agreement. NOW, THEREFORE, with the foregoing background incorporated by reference, the parties hereto, intending to be legally bound, hereby agree as follows: 1. ACKNOWLEDGMENT AND WAIVER. Borrowers hereby acknowledge that they have not met the Interest Coverage Ratio covenant contained in Section 6.9(d) of the Loan Agreement for the Borrowers' third fiscal quarter of 1999. Upon the effectiveness of this Amendment, Lender shall be deemed to have waived such non-compliance, provided that Lender's waiver shall not be deemed to be a waiver of any subsequent non-compliance of the Interest Coverage Ratio covenant, nor a waiver of any Events of Default (other than such non-compliance) which may have occurred. 2. AMENDMENTS TO LOAN AGREEMENT: a. The Loan Agreement is hereby amended by adding the following to Section 1.1: DOCUMENTATION AGENT - European American Bank, or any successor thereto. -1- b. The Loan Agreement is hereby amended by adding the following to Section 1.1: FIFTH AMENDMENT WAIVER FEE - That certain fee in the amount of $89,062.50 paid by Borrowers to Agent for the ratable benefit of the Lenders in connection with the execution of the Fifth Amendment to the Loan and Security Agreement dated August 13, 1999. c. The Loan Agreement is hereby amended by deleting the definition of "Interest Coverage Ratio" in its entirety and replacing it with the following to Section 1.1: INTEREST COVERAGE RATIO - The ratio of EBIT to interest expense (excluding any interest expense which is otherwise characterized as Nonrecourse Debt), determined in accordance with GAAP on a consolidated, rolling four quarter basis; provided however that for purposes of calculating and determining the Interest Coverage Ratio for the fourth fiscal quarter of 1999, the first fiscal quarter of 2000 and the second fiscal quarter of 2000 only, the Interest Coverage Ratio shall be the ratio of the sum of EBIT (calculated, in the fourth fiscal quarter of 1999 only, to exclude any reduction for the payment of the Fifth Amendment Waiver Fee (as defined in the Fifth Amendment to Loan and Security Agreement dated August 13, 1999) plus the amount by which the total principal amount of the Officer Subordinated Debt (as defined in the Fifth Amendment to the Loan and Security Agreement dated August 13, 1999) exceeds $350,000, to interest expense (excluding any interest expense which is attributable to the Officer Subordinated Debt and any interest expense which is otherwise characterized as Nonrecourse Debt), determined in accordance with GAAP on a consolidated, rolling four quarter basis. d. The Loan Agreement is hereby amended by adding the following to Section 1.1: OFFICER SUBORDINATED DEBT - Any indebtedness of Borrowers, or either of them, made by MCC Financial Corporation Executive Deferred Compensation Plan, the James D. Walker account or MCC Financial Corporation Executive Deferred Compensation Plan, the William Buckland account, which is expressly subordinated to the Obligations of the Borrowers to the Agent and/or Lenders, on terms and conditions are satisfactory to Agent and Lenders in their sole discretion. Officer Subordinated Debt shall be deemed not to constitute a transaction with an Affiliate within the meaning of Section 7.4. -2- e. The Loan Agreement is hereby amended by adding the following to Section 1.1: SUBORDINATED DEBT - any indebtedness of the Borrowers, or either of them, including without limitation the Officer Subordinated Debt (as defined in the Fifth Amendment to Loan and Security Agreement dated August 13, 1999), which is subordinated to the Obligations of the Borrowers to Agent and/or Lenders on terms and conditions satisfactory to Agent and Lender in their sole discretion. f. The Loan Agreement is hereby amended by deleting Section 6.9(d) in its entirety and replacing it with the following: (d) Interest Coverage Ratio: ----------------------- (i) For the Borrower's fourth fiscal quarter of 1999, first fiscal quarter of 2000 and second fiscal quarter of 2000, the Borrowers shall have and maintain an Interest Coverage Ratio on a consolidated basis, measured as of the last day of each fiscal quarter, of not less than 1.10:1; provided that the Interest Coverage Ratio on a stand alone basis calculated for, and based on the financial results of, the second fiscal quarter of 2000, shall be at least 1.20:1; (ii) Beginning with the third fiscal quarter of 2000, and at all times thereafter, Borrowers shall have and maintain at all times an Interest Coverage Ratio on a consolidated basis, measured as of the last day of each fiscal quarter, of not less than 1.20:1. g. The Loan Agreement is hereby amended by deleting Section 6.9(b) in its entirety and replacing it with the following: (b) NET INCOME/LOSS: Borrowers shall not suffer an operating loss and/or incur negative net income on a consolidated basis in excess of $250,000 during any two consecutive fiscal quarters. For the fourth fiscal quarter of 1999 only, Borrower's net income, for the purposes of this covenant, shall be determined by adding the principal amount of the Officer Subordinated Debt to Borrowers' net income and excluding any reduction for the payment of the Fifth Amendment Waiver Fee. -3- h. The Loan Agreement is hereby amended by deleting Section 7.6(b) in its entirety and replacing it with the following: (b) Neither Borrower shall borrow money from, or incur indebtedness to, any Person other than (i) in the form of Nonrecourse Debt; (ii) pursuant to a Securitization Residual Financing, or (iii) in the form of any Subordinated Debt (as defined in the Fifth Amendment to Loan and Security Agreement dated August13, 1999). i. The Loan Agreement is hereby amended by deleting Section 9.15(c) in its entirety and replacing it with the following: (c) Notwithstanding anything to the contrary contained in subparagraph (a) above, Agent shall not, without the prior written consent of the SuperMajority Lenders: (i) enter into any written amendment to any of the Loan Documents; (ii) except as set forth in the last sentence of this subsection (c), waive Borrower's compliance with the terms and conditions of the Loan Document or any Event of Default hereunder or thereunder; or (iii) consent to Borrower taking any action which, if taken, would constitute an Event of Default under this Agreement or under any of the Loan Documents. Notwithstanding anything to the contrary contained in clause (ii) above, Agent shall not, without the prior written consent of the SuperMajority Lenders and the Documentation Agent, waive Borrower's compliance with the financial covenants set forth in Section 6.9 above. 3. WAIVER FEE: In consideration for Lenders agreeing to the waiver of the Existing Default and the other modifications to the Loan Agreement contained in this Amendment, Borrowers shall pay to Agent, for the ratable benefit of the Lenders, contemporaneously with the execution hereof, a Fifth Amendment Waiver Fee in the amount of $89,062.50. This Fifth Amendment Waiver Fee is fully earned and non-refundable. 4. BORROWER'S RATIFICATION AND RECONFIRMATION: Borrowers agree that they have no defense or set-offs against the Agent or Lenders, their respective officers, directors, employees, agents or attorneys with respect to the Revolving Credit Notes, the Working Capital Notes, the Term Loan Notes, the Loan Agreement or related instruments, agreements or documents, all of which, except as expressly modified herein, remain in full force and effect. Borrowers hereby -4- ratify and confirm their Obligations under the Revolving Credit Notes, the Working Capital Notes, the Term Loan Notes, the Loan Agreement and related instruments, agreements and documents (each as amended hereby or in accordance herewith) and agree that the execution and delivery of this Amendment does not in any way diminish or invalidate any of their Obligations thereunder. As security for their Obligations thereunder, Borrowers reconfirm the prior security interest and lien in and to all of their right, title and interest in and to the Collateral. Borrowers confirm that all of the Collateral and security interests continue to secure the Obligations and nothing contained herein shall in any way limit, alter or impair the validity, priority, enforceability or perfection of Agent's liens and security interests. 5. REAFFIRMATION OF SURETIES: Each Surety party to that certain Amended and Restated Surety Agreement dated as of December 22, 1998 in favor of Agent for the benefit of the Lenders, by execution hereof in their capacity as Sureties, hereby consents to the amendments set forth in this Amendment, and acknowledges that the Amended and Restated Surety Agreement is in full force and effect and that each remains, jointly and severally liable for Obligations of Borrowers to Agent and Lenders under the Loan Documents, as amended hereby. 6. REPRESENTATIONS AND WARRANTIES: a. Borrowers represent and warrant that, except as explicitly described in Section 1 above, as of the date hereof no Event of Default or Unmatured Event of Default has occurred or is existing under the Loan Documents. b. The execution and delivery by each Borrower of this Amendment and performance by it of the transactions herein contemplated (i) are and will be within its powers, (ii) have been authorized by all necessary corporate action, and (iii) are not and will not be in contravention of any order of any court or other agency of government, of law or any other indenture, agreement or undertaking to which such Borrower is a party or by which the Property of such Borrower is bound, or be in conflict with, result in a breach of or constitute (with due notice and/or lapse of time) a default under any such indenture, agreement or undertaking or result in the imposition of any lien, charge or encumbrance of any nature on any of the properties of such Borrower. c. This Amendment and each other agreement, instrument or document executed and/or delivered in connection herewith, shall be valid, binding and enforceable in accordance with its respective terms. d. All warranties and representations made to Lender under the Loan Agreement and any related documents are true and correct as of the date hereof. 7. CONDITIONS TO EFFECTIVENESS: This Amendment shall be effective upon satisfaction of each of the following conditions (all documents to be in form and substance satisfactory to Agent and Agent's counsel): -5- a. Execution and delivery by the Borrowers and the Sureties of this Amendment to the Agent; b. Execution and Delivery of the Subordination Agreements from MCC Financial Corporation Executive Deferred Compensation Plan, the James D. Walker account and MCC Financial Corporation Executive Deferred Compensation Plan, the William Buckland account, subordinating the Officer Subordinated Debt to the Obligations owed to the Lenders under the Loan Agreement. c. Delivery of an updated Exhibit 5.10 (relating to guarantees, investments and borrowing). d. True and correct copies of the promissory notes evidencing the Officer Subordinated Debt. e. Such other agreements, documents and instruments as Agent may reasonably request; and f. Payment of the Fifth Amendment Waiver Fee. 8. MISCELLANEOUS: a. This Amendment shall be governed by, construed and enforced in accordance with the laws of the Commonwealth of Pennsylvania. b. Except as expressly provided herein, all terms and conditions of the Loan Documents remain in full force and effect, unless such terms or conditions are no longer applicable by their terms. To the extent the provisions of this Amendment are expressly inconsistent with the provisions of the Loan Documents, the provisions of this Amendment shall control. c. This Amendment may be executed in any number of counterparts, each of which when so executed shall be deemed to be an original, and such counterparts together shall constitute one and the same respective agreement. d. Signatures by facsimiles shall bind the parties hereto. -6- IN WITNESS WHEREOF, the parties hereto have caused this Amendment to be executed and delivered as of the day and year first above written. BORROWERS: CAPITAL ASSOCIATES, INC. By: /s/David Sislowski -------------------------------- David Sislowski Title: Vice President CAPITAL ASSOCIATES INTERNATIONAL, INC. By: /s/David Sislowski -------------------------------- David Sislowski Title: Vice President AGENT: FIRST UNION NATIONAL BANK, Successor by Merger to CoreStates Bank, N.A. By: /s/Hugh Connelly -------------------------------- Hugh Connelly Title: Vice President -7- LENDERS: FIRST UNION NATIONAL BANK, Successor by Merger to CoreStates Bank, N.A., as Lender and Issuing Bank By: /s/Hugh Connelly -------------------------------- Hugh Connelly Title: Vice President BANKBOSTON, N.A. By: /s/Dierdre Holland -------------------------------- Dierdre Holland Title: Vice President EUROPEAN AMERICAN BANK By: /s/Chris Czaja -------------------------------- Chris Czaja Title: Vice President NORWEST BANK COLORADO, N.A. By: /s/Carol A. Ward -------------------------------- Carol A. Ward Title: Vice President U.S. BANK NATIONAL ASSOCIATION By: /s/Ralph P. Atkinson -------------------------------- Ralph P. Atkinson Title: Vice President SURETIES: CAI EQUIPMENT LEASING III CORP. By: /s/David Sislowski -------------------------------- David Sislowski Title: Vice President -8- CAI EQUIPMENT LEASING IV CORP. By: /s/David Sislowski -------------------------------- David Sislowski Title: Vice President CAI EQUIPMENT LEASING V CORP. By: /s/David Sislowski -------------------------------- David Sislowski Title: Vice President CAI EQUIPMENT LEASING VI CORP. By: /s/Anthony M. DiPaolo -------------------------------- Anthony M. DiPaolo Title: CAI LEASE SECURITIZATION I CORP. By: /s/David Sislowski -------------------------------- David Sislowski Title: Vice President CAI LEASING CANADA, LTD. By: /s/David Sislowski -------------------------------- David Sislowski Title: Vice President CAI SECURITIES CORPORATION By: /s/Anthony M. DiPaolo -------------------------------- Anthony M. DiPaolo Title: -9- CAPITAL ASSOCIATES INTERNATIONAL DE MEXICO S. DE R.L. DE C.V. By: /s/David Sislowski -------------------------------- David Sislowski Title: Vice President CAPITAL ASSOCIATES TECHNOLOGY GROUP, INC. By: /s/David Sislowski -------------------------------- David Sislowski Title: Vice President CAPITAL EQUIPMENT CORPORATION By: /s/David Sislowski -------------------------------- David Sislowski Title: Vice President NAME BRAND COMPUTER OUTLET, INC. By: /s/David Sislowski -------------------------------- David Sislowski Title: Vice President WHITEWOOD EQUIPMENT CORPORATION, f/k/a WHITEWOOD CREDIT CORPORATION By: /s/David Sislowski -------------------------------- David Sislowski Title: Vice President -10- EX-10.76 3 4Q99CAI.001 EXHIBIT 10.76 SUBORDINATION AGREEMENT ----------------------- Dated: August 13, 1999 To: First Union National Bank, as Agent ("Agent") for the Lenders and Issuing Bank named in the Loan Agreement defined below (collectively "Lenders") To induce the Lenders to establish and continue a credit facility for making loans and extending credit from time to time for the joint and several benefit of Capital Associates, Inc. and Capital Associates International, Inc. (collectively, "Borrowers" and each a "Borrower") from time to time pursuant to the terms of that certain Loan and Security Agreement among Borrowers, Lenders, Sureties (as defined in the Loan Agreement) and Agent, dated as of November 26, 1997 (as has been and may hereafter be amended, supplemented or replaced from time to time, the "Loan Agreement"), the undersigned intending to be legally bound, hereby agrees as follows: 1. The payment of any and all Officer Subordinated Debt is expressly subordinated to the Senior Debt to the extent and in the manner set forth in this Subordination Agreement. The term "Officer Subordinated Debt" means the principal of and interest on all indebtedness, liabilities, and obligations of Borrowers, or either of them, now existing or hereafter arising, to the undersigned pursuant to or in connection with the indebtedness of Borrowers, or either of them, evidenced by that certain Senior Subordinated Unsecured Note dated as of August 13, 1999 (as amended, replaced and/or substituted from time to time, "Note"), payable to the order of the undersigned in the original principal amount of $175,000.00. The term "Senior Debt" means any and all Obligations (as defined in the Loan Agreement) of Borrowers to Agent and/or Lenders under the Loan Agreement. 2. Until the Senior Debt is paid in full, Borrowers shall not pay, and undersigned shall not accept, any payments of principal and interest (including prepayments) associated with Officer Subordinated Debt, except that payments may be made on the Officer Subordinated Debt before the Senior Debt is paid in full (i) if the payments are made out of the proceeds of any new Subordinated Debt (as defined in the Loan Agreement) incurred by the Borrowers, or either of them, in accordance with the provisions of the Loan Agreement or (ii) on a scheduled payment date which is a date three years after the date hereof. 3. Any payments on the Officer Subordinated Debt received by the undersigned, other than as permitted in paragraph 2 above, shall be held in trust for Lenders and the undersigned will forthwith turn over any such payments in the form received, properly endorsed, to Agent to be applied to the Senior Debt as determined by Agent. 4. No Borrower shall grant to the undersigned and the undersigned shall not take any lien on or security interest in any of such Borrower's property, now owned or hereafter acquired or created, without Agent's prior written consent. -1- 5. The undersigned agrees that it will not make any assertion or claim in any action, suit or proceeding of any nature whatsoever in any way challenging the priority, validity or effectiveness of the liens and security interests granted to Agent and/or Lenders under and in connection with the Loan Agreement, or any amendment, extension, replacement thereof or related agreement, instrument or document among Lenders and/or Agent and Borrowers or either of them. 6. The undersigned will not commence any action or proceeding against Borrowers, or any of them, to recover all or any part of the Officer Subordinated Debt not paid when due and shall at no time join with any creditor, in bringing any proceeding against any Borrower under any liquidation, conservatorship, bankruptcy, reorganization, rearrangement, or other insolvency law now or hereafter existing, unless and until the Senior Debt shall be paid in full. Subject to the foregoing, the undersigned may accelerate the amount of the Officer Subordinated Debt upon the occurrence of (i) the acceleration of the Senior Debt; and (ii) the filing of a petition under the Bankruptcy Code by any Borrower. 7. In the event of any liquidation, conservatorship, bankruptcy, reorganization, rearrangement, or other insolvency proceeding of Borrowers, or any of them, the undersigned will at Agent's request file any claims, proofs of claim, or other instruments of similar character necessary to enforce the obligations of such Borrower(s) in respect of the Officer Subordinated Debt and will hold in trust for Lenders and pay over to Agent in the same form received, to be applied on the Senior Debt as determined by Agent, any and all money, dividends or other assets received in any such proceedings on account of the Officer Subordinated Debt, unless and until the Senior Debt shall be paid in full, including without limitation interest owing to Lenders after the commencement of a bankruptcy proceeding at the rate specified in the Loan Agreement, whether or not such interest is an allowable claim in any such proceeding. Agent may, as attorney-in-fact for the undersigned, take such action on behalf of the undersigned and the undersigned hereby appoints Agent (for the benefit of Lenders) as attorney-in-fact for the undersigned to demand, sue for, collect, and receive any and all such money, dividends or other assets and give acquittance therefore and to file any claim, proof of claim or other instrument of similar character and to take such other proceedings in Agent's name or in the name of the undersigned, as Agent or Lenders may deem necessary or advisable for the enforcement of this Agreement. The undersigned will execute and deliver to Agent or Lenders such other and further powers of attorney or other instruments as either reasonably may request in order to accomplish the foregoing. 8. Lenders and/or Agent may at any time and from time to time, without the consent of or notice to the undersigned, without incurring responsibility to the undersigned and without impairing or releasing any of Agent's or Lenders' rights, or any of the obligations of the undersigned hereunder: -2- (a) Change the amount, manner, place or terms of payment or change or extend the time of payment of or renew or alter the Senior Debt, or any part thereof, or amend, supplement or replace the Loan Agreement and/or any notes executed in connection therewith in any manner or enter into or amend, supplement or replace in any manner any other agreement relating to the Senior Debt; (b) Sell, exchange, release or otherwise deal with all or any part of any property at any time pledged or mortgaged by any party to secure or securing the Senior Debt or any part thereof; (c) Release anyone liable in any manner for the payment or collection of the Senior Debt; (d) Exercise or refrain from exercising any rights against Borrowers or others (including the undersigned); and (e) Apply sums paid by any party to the Senior Debt in any order or manner as determined by Agent and Lender. 9. The undersigned will advise each future holder of all or any part of the Officer Subordinated Debt that the Officer Subordinated Debt is subordinated to the Senior Debt in the manner and to the extent provided herein. The undersigned represents that no part of the Officer Subordinated Debt or any instrument evidencing the same has been transferred or assigned and the undersigned will not transfer or assign, except to Agent for the benefit of Lenders, any part of the Officer Subordinated Debt while any Senior Debt remains outstanding, unless such transfer or assignment is made expressly subject to this Agreement. Upon Agent's request, the undersigned will in the case of any Officer Subordinated Debt which is not evidenced by any instrument cause the same to be evidenced by an appropriate instrument or instruments, and place thereon and on any and all instruments evidencing the Officer Subordinated Debt a legend in such form as Agent may determine to the effect that the indebtedness evidenced thereby is subordinated and subject to the prior payment in full of all Senior Debt pursuant to this Subordination Agreement, as well as deliver all such instruments to Agent. 10. This Subordination Agreement contains the entire agreement between the parties regarding the subject matter hereof and may be amended, supplemented or modified only by written instrument executed by Agent, on behalf of Lenders, and the undersigned. This Subordination Agreement, and the rights shall terminate upon indefeasible payment in full of all liabilities and obligations owing from Borrowers to Agent and Lenders and termination of the Revolving Credit under the Loan Agreement. -3- 11. The undersigned represents and warrants that neither the execution or delivery of this Subordination Agreement nor fulfillment of nor compliance with the terms and provisions hereof will conflict with, or result in a breach of the terms, conditions, or provisions of or constitute a default under any agreement or instrument to which the undersigned or any of the undersigned's assets is now subject. 12. Any notice of acceptance of this Subordination Agreement is hereby waived. 13. This Subordination Agreement may be assigned by Agent and/or Lenders, or any of them, in whole or in part in connection with any assignment or transfer of any portion of the Senior Debt. 14. This Subordination Agreement shall be binding upon the undersigned, and the undersigned's successors, representatives and assigns. 15. Except as provided in paragraph 2 above, each Borrower agrees that it will not make any payment on any of the Officer Subordinated Debt, or take any other action in contravention of the provisions of this Subordination Agreement. 16. This Subordination Agreement shall in all respects be interpreted, construed and governed by the substantive laws of the Commonwealth of Pennsylvania. The undersigned (i) submits to the jurisdiction of the Courts of the Commonwealth of Pennsylvania or the United States District Court for the Eastern District of Pennsylvania for the purposes of resolving any controversy relating thereto and (ii) waives the right to a jury trial for the purpose of resolving any controversy hereunder or enforcing or defending any rights or claim hereunder or in connection herewith, whether sounding in contract, tort or otherwise. MCC FINANCIAL CORPORATION EXECUTIVE DEFERRED COMPENSATION PLAN, THE WILLIAM BUCKLAND ACCOUNT By: /s/William Buckland ----------------------------- William Buckland -4- Consented and agreed to as of the date first above written: Capital Associates, Inc. By: /s/David Sislowski --------------------------------- David Sislowski Title: Vice President Capital Associates International, Inc. By: /s/David Sislowski --------------------------------- David Sislowski Title: Vice President First Union National Bank, as Agent By: /s/Hugh Connelly --------------------------------- Hugh Connelly, Vice President -5- EX-10.77 4 4Q99CAI.001 EXHIBIT 10.77 SUBORDINATION AGREEMENT Dated: August 13, 1999 To: First Union National Bank, as Agent ("Agent") for the Lenders and Issuing Bank named in the Loan Agreement defined below (collectively "Lenders") To induce the Lenders to establish and continue a credit facility for making loans and extending credit from time to time for the joint and several benefit of Capital Associates, Inc. and Capital Associates International, Inc. (collectively, "Borrowers" and each a "Borrower") from time to time pursuant to the terms of that certain Loan and Security Agreement among Borrowers, Lenders, Sureties (as defined in the Loan Agreement) and Agent, dated as of November 26, 1997 (as has been and may hereafter be amended, supplemented or replaced from time to time, the "Loan Agreement"), the undersigned intending to be legally bound, hereby agrees as follows: 1. The payment of any and all Officer Subordinated Debt is expressly subordinated to the Senior Debt to the extent and in the manner set forth in this Subordination Agreement. The term "Officer Subordinated Debt" means the principal of and interest on all indebtedness, liabilities, and obligations of Borrowers, or either of them, now existing or hereafter arising, to the undersigned pursuant to or in connection with the indebtedness of Borrowers, or either of them, evidenced by that certain Senior Subordinated Unsecured Note dated as of August 13, 1999 (as amended, replaced and/or substituted from time to time, "Note"), payable to the order of the undersigned in the original principal amount of $175,000.00. The term "Senior Debt" means any and all Obligations (as defined in the Loan Agreement) of Borrowers to Agent and/or Lenders under the Loan Agreement. 2. Until the Senior Debt is paid in full, Borrowers shall not pay, and undersigned shall not accept, any payments of principal and interest (including prepayments) associated with Officer Subordinated Debt, except that payments may be made on the Officer Subordinated Debt before the Senior Debt is paid in full (i) if the payments are made out of the proceeds of any new Subordinated Debt (as defined in the Loan Agreement) incurred by the Borrowers, or either of them, in accordance with the provisions of the Loan Agreement or (ii) on a scheduled payment date which is a date three years after the date hereof. 3. Any payments on the Officer Subordinated Debt received by the undersigned, other than as permitted in paragraph 2 above, shall be held in trust for Lenders and the undersigned will forthwith turn over any such payments in the form received, properly endorsed, to Agent to be applied to the Senior Debt as determined by Agent. 4. No Borrower shall grant to the undersigned and the undersigned shall not take any lien on or security interest in any of such Borrower's property, now owned or hereafter acquired or created, without Agent's prior written consent. -1- 5. The undersigned agrees that it will not make any assertion or claim in any action, suit or proceeding of any nature whatsoever in any way challenging the priority, validity or effectiveness of the liens and security interests granted to Agent and/or Lenders under and in connection with the Loan Agreement, or any amendment, extension, replacement thereof or related agreement, instrument or document among Lenders and/or Agent and Borrowers or either of them. 6. The undersigned will not commence any action or proceeding against Borrowers, or any of them, to recover all or any part of the Officer Subordinated Debt not paid when due and shall at no time join with any creditor, in bringing any proceeding against any Borrower under any liquidation, conservatorship, bankruptcy, reorganization, rearrangement, or other insolvency law now or hereafter existing, unless and until the Senior Debt shall be paid in full. Subject to the foregoing, the undersigned may accelerate the amount of the Officer Subordinated Debt upon the occurrence of (i) the acceleration of the Senior Debt; and (ii) the filing of a petition under the Bankruptcy Code by any Borrower. 7. In the event of any liquidation, conservatorship, bankruptcy, reorganization, rearrangement, or other insolvency proceeding of Borrowers, or any of them, the undersigned will at Agent's request file any claims, proofs of claim, or other instruments of similar character necessary to enforce the obligations of such Borrower(s) in respect of the Officer Subordinated Debt and will hold in trust for Lenders and pay over to Agent in the same form received, to be applied on the Senior Debt as determined by Agent, any and all money, dividends or other assets received in any such proceedings on account of the Officer Subordinated Debt, unless and until the Senior Debt shall be paid in full, including without limitation interest owing to Lenders after the commencement of a bankruptcy proceeding at the rate specified in the Loan Agreement, whether or not such interest is an allowable claim in any such proceeding. Agent may, as attorney-in-fact for the undersigned, take such action on behalf of the undersigned and the undersigned hereby appoints Agent (for the benefit of Lenders) as attorney-in-fact for the undersigned to demand, sue for, collect, and receive any and all such money, dividends or other assets and give acquittance therefore and to file any claim, proof of claim or other instrument of similar character and to take such other proceedings in Agent's name or in the name of the undersigned, as Agent or Lenders may deem necessary or advisable for the enforcement of this Agreement. The undersigned will execute and deliver to Agent or Lenders such other and further powers of attorney or other instruments as either reasonably may request in order to accomplish the foregoing. 8. Lenders and/or Agent may at any time and from time to time, without the consent of or notice to the undersigned, without incurring responsibility to the undersigned and without impairing or releasing any of Agent's or Lenders' rights, or any of the obligations of the undersigned hereunder: -2- (a) Change the amount, manner, place or terms of payment or change or extend the time of payment of or renew or alter the Senior Debt, or any part thereof, or amend, supplement or replace the Loan Agreement and/or any notes executed in connection therewith in any manner or enter into or amend, supplement or replace in any manner any other agreement relating to the Senior Debt; (b) Sell, exchange, release or otherwise deal with all or any part of any property at any time pledged or mortgaged by any party to secure or securing the Senior Debt or any part thereof; (c) Release anyone liable in any manner for the payment or collection of the Senior Debt; (d) Exercise or refrain from exercising any rights against Borrowers or others (including the undersigned); and (e) Apply sums paid by any party to the Senior Debt in any order or manner as determined by Agent and Lender. 9. The undersigned will advise each future holder of all or any part of the Officer Subordinated Debt that the Officer Subordinated Debt is subordinated to the Senior Debt in the manner and to the extent provided herein. The undersigned represents that no part of the Officer Subordinated Debt or any instrument evidencing the same has been transferred or assigned and the undersigned will not transfer or assign, except to Agent for the benefit of Lenders, any part of the Officer Subordinated Debt while any Senior Debt remains outstanding, unless such transfer or assignment is made expressly subject to this Agreement. Upon Agent's request, the undersigned will in the case of any Officer Subordinated Debt which is not evidenced by any instrument cause the same to be evidenced by an appropriate instrument or instruments, and place thereon and on any and all instruments evidencing the Officer Subordinated Debt a legend in such form as Agent may determine to the effect that the indebtedness evidenced thereby is subordinated and subject to the prior payment in full of all Senior Debt pursuant to this Subordination Agreement, as well as deliver all such instruments to Agent. 10. This Subordination Agreement contains the entire agreement between the parties regarding the subject matter hereof and may be amended, supplemented or modified only by written instrument executed by Agent, on behalf of Lenders, and the undersigned. This Subordination Agreement, and the rights shall terminate upon indefeasible payment in full of all liabilities and obligations owing from Borrowers to Agent and Lenders and termination of the Revolving Credit under the Loan Agreement. -3- 11. The undersigned represents and warrants that neither the execution or delivery of this Subordination Agreement nor fulfillment of nor compliance with the terms and provisions hereof will conflict with, or result in a breach of the terms, conditions, or provisions of or constitute a default under any agreement or instrument to which the undersigned or any of the undersigned's assets is now subject. 12. Any notice of acceptance of this Subordination Agreement is hereby waived. 13. This Subordination Agreement may be assigned by Agent and/or Lenders, or any of them, in whole or in part in connection with any assignment or transfer of any portion of the Senior Debt. 14. This Subordination Agreement shall be binding upon the undersigned, and the undersigned's successors, representatives and assigns. 15. Except as provided in paragraph 2 above, each Borrower agrees that it will not make any payment on any of the Officer Subordinated Debt, or take any other action in contravention of the provisions of this Subordination Agreement. 16. This Subordination Agreement shall in all respects be interpreted, construed and governed by the substantive laws of the Commonwealth of Pennsylvania. The undersigned (i) submits to the jurisdiction of the Courts of the Commonwealth of Pennsylvania or the United States District Court for the Eastern District of Pennsylvania for the purposes of resolving any controversy relating thereto and (ii) waives the right to a jury trial for the purpose of resolving any controversy hereunder or enforcing or defending any rights or claim hereunder or in connection herewith, whether sounding in contract, tort or otherwise. MCC FINANCIAL CORPORATION EXECUTIVE DEFERRED COMPENSATION PLAN, THE JAMES D. WALKER ACCOUNT By: /s/James D. Walker ----------------------------- James D. Walker -4- Consented and agreed to as of the date first above written: Capital Associates, Inc. By: /s/David Sislowski --------------------------------- David Sislowski Title: Vice President Capital Associates International, Inc. By: /s/David Sislowski --------------------------------- David Sislowski Title: Vice President First Union National Bank, as Agent By: /s/Hugh Connelly --------------------------------- Hugh Connelly, Vice President -5- EX-21 5 4Q99CAI.001 Exhibit 21 LIST OF SUBSIDIARIES OF CAPITAL ASSOCIATES, INC. Place of Name Incorporation - ---- ---------------- Capital Associates International, Inc. Colorado CAI Equipment Leasing I Corporation Colorado CAI Equipment Leasing II Corporation Colorado CAI Equipment Leasing III Corporation Colorado CAI Equipment Leasing IV Corporation Colorado CAI Equipment Leasing V Corporation Colorado CAI Equipment Leasing VI Corporation Colorado CAI Leasing Canada, Limited Alberta, Canada CAI Partners Management Company Colorado CAI Securities Corporation California CAI - UBK Equipment Corporation Colorado Capital Equipment Corporation Colorado Whitewood Credit Corporation Colorado CAI Lease Securitization-I Corporation Delaware Capital Associates International de Mexico s. de R.L. de C.V. Mexico Capital Associates Technology Group, Inc. Utah CAI-RBE Equipment Corp. Colorado Name Brand Computer Outlet Colorado CAI-ALJ Equipment Corp. Colorado EX-23 6 4Q99CAI.001 Exhibit 23 Independent Auditors' Consent The Board of Directors Capital Associates, Inc.: We consent to incorporation by reference in the registration statements on Form S-8 (No. 33-59570 and No. 33- 68514) and Form S-3 (No. 33-65059) of Capital Associates, Inc. of our reports dated September 10, 1999, relating to the consolidated balance sheets of Capital Associates, Inc. and subsidiaries as of May 31, 1999 and 1998, and the related consolidated statements of income, changes in stockholders' equity, and cash flows for each of the years in the three- year period ended May 31, 1999, and the related schedule, which reports appear in the May 31, 1999 Annual Report on Form 10-K of Capital Associates, Inc. /s/KPMG LLP ----------------------- KPMG LLP Denver, Colorado September 10, 1999 EX-27 7 4Q99CAI.001
5 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. 1,000 12-MOS MAY-31-1999 MAY-31-1999 7,926 0 8,600 136 2,578 0 150,338 0 246,741 0 0 0 0 42 25,573 246,741 193,914 243,370 187,733 214,993 15,513 555 11,912 397 0 397 0 0 0 397 .08 .07
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