CAI 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 $1 2.0 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 June 30 , 2017 and December 31, 201 6 , the Company’s results of operations   for the three and six months ended June 30 , 2017 and   2016 , and the Company’s cash flows for the six months ended June 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 201 7 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) h ave 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, 201 6 , included in the Company’s Annual Report on Form 10-K filed with the Securities and Exchange Commission (SEC) on March 1 3 , 201 7 .

(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 d epreciation expense by $ 2. 1 million and $ 4.4 million , decreased net income by $ 2 . 1   million and $ 4.3   million , and decreased diluted earnings per share by $ 0.1 1   and $ 0.22 ,   for the three and six months ended June 30 , 2017 , respectively .

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 Pronouncement s , ”  t here were no changes to the Company’s accounting policies during the six months ended June 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. 

CAI INTERNATIONAL, INC.

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Recent Accounting Pronouncements

In March 2016, the F inancial A ccounting S tandards B oard (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 a s 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 six months ended June 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 June 30 , 2017, the Company has recovered approximately 9 1 % 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 containers and up to 180 days of lost lease rental income , subject to a deductible of $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 un recoverable 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 six months ended June 30, 2017, the Company recorded an additional insurance receivable of $ 5.5 million for $2.2 million of lost lease rental income, recognized as container lease income , and $ 3.3 million of recovery costs, recorded as a reduction to storage, handling and other expenses.   The Company also received insurance proceeds of $4.5 million, which was recorded as a reduction to the insurance receivable. As of June 30 , 2017, the insurance receivable related to this customer was $ 4.8 million , of which payment of $3.5 million was received in July 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 Japan ese 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 six months ended June 30 , 2017 and 2016 .  

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, un der 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 June 30 , 2017 , and December 31, 201 6 , and the results of the VIEs’ operations and cash flows for the three and six months ended June 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 $ 65.9 million as of June 30 , 2017 . The container equipment, together with $ 15.5 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 $84 .4 million and term loans held by VIE of $4.7 million. No gain or loss was recognized by the Company on the initial consolidation of th e VIEs. Containers sold to the Japanese investor funds during the three months ended June 30 ,   2017 and 2016 , had a net   book value of $ 7.2 million and $6.2 million, respectively .   Containers sold to the Japanese investor funds during the six months ended June 30, 2017 and 2016 , had a   book value of $ 7.2 million and $16.9 million, respectively.



( 5 )  Acquisition s

In 2016, the Company completed the acquisitions of C hallenger 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 .

T he contingent consideration liability was $1.6 million and $2.2 million as of June 30 , 2017 and December 31, 2016 , respectively .   Expected future payments of $1.2 million and $0.4 million were recorded in Other long-term liabilities and Accrued expenses and Other current liabilities, respectively, in the Company’s consolidated balance sheets at June 30 , 2017 . Expected future payments of $1.7 million and $0.5 million were recorded in Other long-term liabilities and Accrued expenses and Other current liabilities, respectively, in the Company’s consolidated balance sheet s at December 31, 2016.

Management estimated the fair value of the contingent consideration liability as of June 30 , 2017, based on expected future payments , which were   estimated based on forecasted future performance. The fair value of these liabilities would be categorized as Level 3 in the fair value hierarchy.   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 six months ended June 30, 2017 (in thousands):







CAI INTERNATIONAL, INC.

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(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.

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 June 30 , 2017 for the years ending June 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 i ntangible assets as of June 30 , 2017 and December 31, 2016 were as follows (in thousands):









Total amortization expense was $ 0.4 million and $0. 2 million for the three months ended June 30 , 2017 and 2016 , respectively, and $ 1.1 million and $0.3 million for the six months ended June 30, 2017, respectively, and was included in administrative expenses in the consolidated statements of income .

As of June 30 , 2017 ,   estimated future amortization expenses are as follows (in thousands):

















CAI INTERNATIONAL, INC.

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)



( 9 )  Debt

Details of the Company’s debt as of June 30 , 2017 and December 31, 201 6 were as follows (dollars in thousands):





On June 16, 2017 , the Company entered into an amendment to the Third Amended and Restated Revolving Credit Agreement, pursuant to which the revolving credit facility was amended to increase the commitment level from $7 75 .0 million to $ 960 .0 million.  

The Company maintains its revolving credit facilities to finance the acquisition of rental equipment and for general working capital purposes. As of June 30 , 2017 , the Company ha d   $ 688.4 million in total availability und er its revolving credit facilities (net of $0.1 million in letters of credit) .  

The agreements relating to all of the Company’s debt contain various financial and other covenants. As of June 30 , 2017 , the Company was in compliance with all of its debt covenants.

On July 6, 2017, CAL Funding III Limited (CAL Funding III), a wholly-owned indirect subsidiary of CAI, issued $ 240.9 million of 3.6 % Class A fixed rate asset-backed notes and $12.2 million of 4.6% Class B fixed rate asset-backed notes ( collectively, the Notes). Principal and interest on the Notes is payable monthly commencing on July 25, 2017, with the Notes maturing in June 2042. The proceeds from the Notes were used for general corporate purposes, including repayment of debt by the Company. The Notes are secured by all of the assets of CAL Funding III.

For further information on the Company’s debt instruments, see Note 10 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.



( 10 )  Stock–Based Compensation Plan

Stock Options

The Company grants stock options from time to time to certain employees and independent directors pursuant t o its 2007 Equity Incentive Plan , as amended,   (Plan) . Under the Plan, a maximum of 3,421 ,980 share awards may be granted.

Stock options granted to employees have a vesting period of four years from grant date, with 25% vesting after one year, and 1/48th vesting each month thereafter until fully vested. Stock options granted to independent directors vest in one year. All of the stock options have a contractual term of ten years.

CAI INTERNATIONAL, INC.

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)



The following table summarizes the Company’s stock option activities for the six months ended June 30 , 2017 and 2016 :





The aggregate i ntrinsic value of stock options   exercised during the six months ended June 30 , 2017 was   $ 1.8 million. The aggregate intrinsic value of all options outstanding as of June 30 , 2017 was $ 9.7 million based on the closing price of the Company’s common stock of $ 23.60 per share on June 30 , 2017 , the last trading day of the quarter.

The Company recognized stock-based compensation expense relating to stock options of $0. 4 million and $0. 3 million for the three months ended June 30 , 2017 and 2016 ,   respectively , and $0.7 million for both the six months ended June 30, 2017 and 2016 . As of June 30 , 2017 , the remaining unamortized stock-based compensation cost relating to stock options granted to the Company’s employees and independent directors was approximately $ 3 . 3 million , which is to be recognized over the remaining weighted average vesting period of approximately 2 . 6 years.

The fair value of stock options granted to the Company’s employees and independent directors was estimated using the Black-Scholes-Merton pricing model using the following weighted average assumptions :