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Cai International 10-Q 2017
UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549
FORM 10-Q
☒QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended September 30, 2017 or ☐TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from to Commission file number: 001-33388
CAI International, Inc. (Exact name of registrant as specified in its charter)
415-788-0100 (Registrant’s telephone number, including area code) None (Former name, former address and former fiscal year, if changed since last report)
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 ☒ No ☐
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes ☒ No ☐
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Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ☐ No ☒
Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.
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CAI INTERNATIONAL, INC.
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SPECIAL NOTE REGARDING FORWARD LOOKING STATEMENTS
This Quarterly Report on Form 10-Q contains certain forward-looking statements, including, without limitation, statements concerning the conditions in our industry, our operations, our economic performance and financial condition, including, in particular, statements relating to our business, operations, growth strategy and service development efforts. The Private Securities Litigation Reform Act of 1995 provides a “safe harbor” for certain forward-looking statements so long as such information is identified as forward-looking and is accompanied by meaningful cautionary statements identifying important factors that could cause actual results to differ materially from those projected in the information. When used in this Quarterly Report on Form 10-Q, the words “may,” “might,” “should,” “estimate,” “project,” “plan,” “anticipate,” “expect,” “intend,” “outlook,” “believe” and other similar expressions are intended to identify forward-looking statements and information. You are cautioned not to place undue reliance on these forward-looking statements, which speak only as of their dates. These forward-looking statements are based on estimates and assumptions by our management that, although we believe to be reasonable, are inherently uncertain and subject to a number of risks and uncertainties. These risks and uncertainties include, without limitation, those in our Annual Report on Form 10-K for the year ended December 31, 2016 filed with the Securities and Exchange Commission (SEC) on March 13, 2017 and our other reports filed with the SEC. We undertake no obligation to publicly update or revise any forward-looking statement as a result of new information, future events or otherwise, except as otherwise required by law. Reference is also made to such risks and uncertainties detailed from time to time in our other filings with the SEC.
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PART I — FINANCIAL INFORMATION
CONSOLIDATED BALANCE SHEETS (In thousands, except share information) (UNAUDITED)
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See accompanying notes to unaudited consolidated financial statements.
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CONSOLIDATED STATEMENTS OF INCOME (In thousands, except per share data) (UNAUDITED)
See accompanying notes to unaudited consolidated financial statements.
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CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (In thousands) (UNAUDITED)
See accompanying notes to unaudited consolidated financial statements.
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CONSOLIDATED STATEMENTS OF CASH FLOWS (In thousands) (UNAUDITED)
See accompanying notes to unaudited consolidated financial statements.
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CAI INTERNATIONAL, INC. NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (1) The Company and Nature of Operations Organization CAI International, Inc., together with its subsidiaries (collectively, CAI or the Company), is a transportation finance and logistics company. The Company purchases equipment, primarily intermodal shipping containers and railcars, which it leases to its customers. The Company also manages equipment for third-party investors. In operating its fleet, the Company leases, re-leases and disposes of equipment and contracts for the repair, repositioning and storage of equipment. The Company also provides domestic and international logistics services. In February 2016, the Company purchased Challenger Overseas LLC (Challenger), a Non-Vessel Operating Common Carrier, for approximately $10.8 million. Challenger is headquartered in Eatontown, New Jersey. In June 2016, the Company purchased Hybrid Logistics, Inc. and its affiliate, General Transportation Services, Inc. (collectively, Hybrid), asset light truck brokers, for approximately $12.0 million. Hybrid is headquartered in Portland, Oregon. The Company’s common stock is traded on the New York Stock Exchange under the symbol “CAI.” The Company’s corporate headquarters are located in San Francisco, California. Basis of Presentation The accompanying unaudited consolidated financial statements include the financial statements of CAI International, Inc., its wholly-owned subsidiaries, and its previously 80%-owned subsidiary, CAIJ, Inc. (CAIJ), up to its date of disposal in April 2016. All significant intercompany balances and transactions have been eliminated in consolidation. In the opinion of management, the accompanying unaudited consolidated financial statements contain all normal, recurring adjustments necessary to present fairly the Company’s financial position as of September 30, 2017 and December 31, 2016, the Company’s results of operations for the three and nine months ended September 30, 2017 and 2016, and the Company’s cash flows for the nine months ended September 30, 2017 and 2016. The results of operations and cash flows for the periods presented are not necessarily indicative of the results of operations or cash flows which may be reported for the remainder of 2017 or in any future period. Certain information and footnote disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States of America (U.S. GAAP) have been condensed or omitted. The accompanying unaudited interim consolidated financial statements should be read in conjunction with the audited consolidated financial statements and notes thereto for the year ended December 31, 2016, included in the Company’s Annual Report on Form 10-K filed with the Securities and Exchange Commission (SEC) on March 13, 2017.
(2) Accounting Policies and Recent Accounting Pronouncements Accounting Policies Container rental equipment is recorded at original cost and depreciated to an estimated residual value on a straight-line basis over its estimated useful life. The estimated useful lives and residual values of the Company’s container equipment are based on historical disposal experience and the Company’s expectations for future used container sale prices. Depreciation estimates are reviewed on a regular basis to determine whether sustained changes have taken place in the useful lives of equipment or assigned residual values, which would suggest that a change in depreciation estimates is warranted. After the Company conducted its regular depreciation policy review for 2016, it concluded that a change in the estimated residual value for 40-foot high cube dry van containers from $1,650 to $1,400 per container, effective July 1, 2016, was appropriate. The change increased the Company’s depreciation expense by $4.4 million, decreased net income by $4.3 million, and decreased diluted earnings per share by $0.22, for the nine months ended September 30, 2017. The Company continuously monitors disposal prices across its entire portfolio for indications of a sustained market downturn. The Company will adjust its residual value estimates as and when conditions warrant. Except as described below in “Recent Accounting Pronouncements,” there were no changes to the Company’s accounting policies during the nine months ended September 30, 2017. See Note 2 to the consolidated financial statements in the Company’s Annual Report on Form 10-K for the year ended December 31, 2016, filed with the SEC on March 13, 2017, for a description of the Company’s significant accounting policies.
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CAI INTERNATIONAL, INC. NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) Recent Accounting Pronouncements In March 2016, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) No. 2016-09, Improvements to Employee Share-Based Payment Accounting (ASU 2016-09). The new standard simplifies certain aspects of the accounting for share-based payment transactions, including income taxes, classification of awards and classification on the statement of cash flows. The new guidance also allows an entity to make a policy election to account for forfeitures as they occur. The Company adopted ASU 2016-09 effective January 1, 2017. Accordingly, excess tax benefits or deficiencies from stock-based compensation are now reflected in the consolidated statements of income as a component of the provision for income taxes, whereas they were previously recognized in equity. As a result of the adoption of ASU 2016-09, the Company recognized $1.0 million in deferred tax assets associated with excess tax benefits not previously recognized in deferred taxes as a cumulative-effect adjustment to retained earnings as of January 1, 2017. Adoption of the new standard did not have a material impact on our provision for income taxes for the three and nine months ended September 30, 2017. The Company elected to apply the change in presentation to the statements of cash flows prospectively and elected to account for forfeitures as they occur, rather than estimate expected forfeitures, which did not have a material impact on the Company’s consolidated financial statements. (3) Insurance Receivable and Impairment In August 2016, Hanjin Shipping Co., Ltd. (Hanjin) filed for bankruptcy protection from its creditors. Based on the recovery of Hanjin containers to date and prior experience, the Company believes that most of its containers will be recovered. As of September 30, 2017, the Company has recovered approximately 92% of the containers that were on lease to Hanjin. The Company maintains insurance to cover the value of containers that are unlikely to be recovered from its customers, the cost to recover and repair containers, and up to 180 days of lost lease rental income, subject to deductibles of $0.5 million and $2.0 million. During the year ended December 31, 2016, the Company recorded an impairment of $3.2 million representing the book value of containers the Company estimated would not be recovered from Hanjin. As of December 31, 2016, an insurance receivable of $3.8 million was recorded for $1.2 million of estimated unrecoverable containers in excess of the insurance deductible, which was recorded in depreciation expense, and $2.6 million of recovery costs, which was recorded as a reduction to storage, handling and other expenses for the year ended December 31, 2016. During the nine months ended September 30, 2017, the Company recorded an additional insurance receivable of $7.4 million for $2.2 million of lost lease rental income, recognized as container lease income, and $1.5 million of repair costs and $3.7 million of recovery costs, recorded as a reduction to storage, handling and other expenses. The Company also received insurance proceeds of $8.0 million, which was recorded as a reduction to the insurance receivable. As of September 30, 2017, the insurance receivable related to this customer was $3.2 million, of which payment of $1.5 million was received in October 2017. (4) Consolidation of Variable Interest Entities The Company regularly performs a review of its container fund arrangements with investors to determine whether or not it has a variable interest in the fund and if the fund is a variable interest entity (VIE). If it is determined that the Company does not have a variable interest in the fund, further analysis is not required and the Company does not consolidate the fund. If it is determined that the Company does have a variable interest in the fund and the fund is a VIE, a further analysis is performed to determine if the Company is a primary beneficiary of the VIE and meets both of the following criteria under FASB ASC Topic 810:
If in the Company’s judgment both of the above criteria are met, the VIE’s financial statements are included in the Company’s consolidated financial statements as required under FASB ASC Topic 810, Consolidation. The Company currently enters into two types of container fund arrangements with investors which are reviewed under FASB ASC Topic 810, Consolidation. These arrangements include container funds that the Company manages for investors and container funds that have entered into financing arrangements with investors. Several of the funds that the Company manages and funds under financing arrangements are Japanese container funds that were established under separate investment agreements allowed under Japanese commercial laws (see Note 14). Each of the funds is financed by unrelated Japanese third-party investors. Managed Container Funds The fees earned by the Company for arranging, managing and establishing container funds are commensurate with the level of effort required to provide those services, and are at or above the same level of seniority as other operating liabilities of the funds that are incurred in the normal course of business. As such, the Company does not have a variable interest in the managed containers funds, and does not consolidate those funds. The Company recognizes gain on sale of containers to the unconsolidated funds as sales in the ordinary course of business. No container portfolios were sold to the Japanese funds in the three and nine months ended September 30, 2017 and 2016.
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CAI INTERNATIONAL, INC. NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) Collateralized Financing Obligations The Company has transferred containers to Japanese investor funds while concurrently entering into lease agreements for the same containers, under which the Company leases the containers back from the Japanese investors. In accordance with FASB ASC Topic 840, Sale-Leaseback Transactions, the Company concluded these were financing transactions under which sale-leaseback accounting was not applicable. The terms of the transactions with container funds under financing arrangements include options for the Company to purchase the containers from the funds at a fixed price. As a result of the residual interest resulting from the fixed price call option, the Company concluded that it may absorb a significant amount of the variability associated with the funds’ anticipated economic performance and, as a result, the Company has a variable interest in the funds. The funds are considered VIEs under FASB ASC Topic 810, Consolidation, because, as lessee of the funds, the Company has the power to direct the activities that most significantly impact each entity’s economic performance, including the leasing and managing of containers owned by the funds. As the Company has the power to direct the activities that most significantly impact the economic performance of the VIEs and the variable interest provides the Company with the right to receive benefits from the entity that could potentially be significant to the funds, the Company determined that it is the primary beneficiary of these VIEs and included the VIEs’ assets and liabilities as of September 30, 2017, and December 31, 2016, and the results of the VIEs’ operations and cash flows for the three and nine months ended September 30, 2017 and 2016, in the Company’s consolidated financial statements. The containers that were transferred to the Japanese investor funds had a net book value of $66.1 million as of September 30, 2017. The container equipment, together with $22.4 million of cash held by the investor funds that can only be used to settle the liabilities of the VIEs, has been included on the Company’s consolidated balance sheets with the related liability presented in the debt section of the Company’s consolidated balance sheets as collateralized financing obligations of $90.7 million and term loans held by VIE of $3.7 million. No gain or loss was recognized by the Company on the initial consolidation of the VIEs. Containers sold to the Japanese investor funds during the three months ended September 30, 2017 and 2016, had a net book value of $6.0 million and $9.2 million, respectively. Containers sold to the Japanese investor funds during the nine months ended September 30, 2017 and 2016, had a book value of $13.2 million and $26.1 million, respectively. (5) Acquisitions In 2016, the Company completed the acquisitions of Challenger and Hybrid, for total consideration of $22.8 million, $6.0 million of which was contingent and based on their future performance. The aggregate allocation of the combined purchase price included $1.2 million of cash, $9.9 million of identifiable intangible assets, $12.9 million of residual goodwill, and $1.2 million of net liabilities assumed. The contingent consideration liability was $2.2 million as of December 31, 2016. Expected future payments of $2.1 million and $0.1 million were recorded in Other long-term liabilities and Accrued expenses and Other current liabilities, respectively, in the Company’s consolidated balance sheets at December 31, 2016. Based on the forecasted future performance of Challenger and Hybrid, it has been estimated that there will be no future payments made and, as a result, the fair value of the contingent consideration liability has been estimated to be zero at September 30, 2017. The following table provides a reconciliation of the contingent consideration liability measured at estimated fair value based on the balance as of December 31, 2016 and updated quarterly for the nine months ended September 30, 2017 (in thousands):
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CAI INTERNATIONAL, INC. NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (6) Rental Equipment The following table provides a summary of the Company’s rental equipment (in thousands):
(7) Net Investment in Direct Finance Leases The following table represents the components of the Company’s net investment in direct finance leases (in thousands):
In order to estimate the allowance for losses contained in gross finance lease receivables, the Company reviews the credit worthiness of its customers on an ongoing basis. The review includes monitoring credit quality indicators, the aging of customer receivables and general economic conditions. The categories of gross finance lease receivables based on the Company's internal customer credit ratings can be described as follows: Tier 1— These customers are typically large international shipping lines that have been in business for many years and have world-class operating capabilities and significant financial resources. In most cases, the Company has had a long commercial relationship with these customers and currently maintains regular communication with them at several levels of management, which provides the Company with insight into the customer's current operating and financial performance. In the Company's view, these customers have the greatest ability to withstand cyclical down turns and would likely have greater access to needed capital than lower-rated customers. The Company views the risk of default for Tier 1 customers to range from minimal to moderate. Tier 2— These customers are typically either smaller shipping lines or freight forwarders with less operating scale or with a high degree of financial leverage, and accordingly the Company views these customers as subject to higher volatility in financial performance over the business cycle. The Company generally expects these customers to have less access to capital markets or other sources of financing during cyclical down turns. The Company views the risk of default for Tier 2 customers as moderate. Tier 3— Customers in this category exhibit volatility in payments on a regular basis.
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CAI INTERNATIONAL, INC. NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) Based on the above categories, the Company's gross finance lease receivables were as follows (in thousands):
Contractual maturities of the Company's gross finance lease receivables subsequent to and as of September 30, 2017 for the years ending September 30 were as follows (in thousands):
(8) Intangible Assets The Company amortizes intangible assets on a straight line-basis over their estimated useful lives as follows:
The Company’s intangible assets as of September 30, 2017 and December 31, 2016 were as follows (in thousands):
Total amortization expense was $0.4 million for both the three months ended September 30, 2017 and 2016, respectively, and $1.5 million and $0.7 million for the nine months ended September 30, 2017 and 2016, respectively, and was included in administrative expenses in the consolidated statements of income. As of September 30, 2017, estimated future amortization expenses are as follows (in thousands):
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CAI INTERNATIONAL, INC. NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (9) Debt Details of the Company’s debt as of September 30, 2017 and December 31, 2016 were as follows (dollars in thousands):
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