-----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, P4s9S7/cyif+PV5mM6fe0N1ifklL3XzRIEk/GM3IFdQ2SqEe9quNse6RB6Ptg7W5 1A2XZvrLnnpu9yt2TeqOlA== 0000950150-97-001749.txt : 19971127 0000950150-97-001749.hdr.sgml : 19971127 ACCESSION NUMBER: 0000950150-97-001749 CONFORMED SUBMISSION TYPE: 10-K405 PUBLIC DOCUMENT COUNT: 7 CONFORMED PERIOD OF REPORT: 19970831 FILED AS OF DATE: 19971126 SROS: NONE FILER: COMPANY DATA: COMPANY CONFORMED NAME: MEGO FINANCIAL CORP CENTRAL INDEX KEY: 0000736035 STANDARD INDUSTRIAL CLASSIFICATION: REAL ESTATE DEALERS (FOR THEIR OWN ACCOUNT) [6532] IRS NUMBER: 135629885 STATE OF INCORPORATION: NY FISCAL YEAR END: 0831 FILING VALUES: FORM TYPE: 10-K405 SEC ACT: SEC FILE NUMBER: 001-08645 FILM NUMBER: 97729786 BUSINESS ADDRESS: STREET 1: 4310 PARADISE RD CITY: LAS VEGAS STATE: NV ZIP: 89109 BUSINESS PHONE: 7027373700 MAIL ADDRESS: STREET 1: 4310 PARADISE RD CITY: LAS VEGAS STATE: NV ZIP: 89109 FORMER COMPANY: FORMER CONFORMED NAME: MEGO CORP DATE OF NAME CHANGE: 19920703 10-K405 1 FORM 10-K FOR THE FISCAL YEAR ENDED AUG. 31, 1997 1 ================================================================================ UNITED STATES 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 AUGUST 31, 1997 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 1-8645 MEGO FINANCIAL CORP. (EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER) NEW YORK 13-5629885 (STATE OR OTHER JURISDICTION OF (IRS EMPLOYER INCORPORATION OR ORGANIZATION) IDENTIFICATION NO.) 4310 PARADISE ROAD, LAS VEGAS, NV 89109 (ADDRESS OF PRINCIPAL EXECUTIVE OFFICES) (ZIP CODE)
Registrant's telephone number, including area code 702-737-3700 Securities registered pursuant to Section 12(b) of the Act: None Securities registered pursuant to Section 12(g) of the Act: Common Stock, $.01 Par Value (Title of Class) 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 the 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. Yes [X] No [ ] As of November 7, 1997, 21,009,506 shares of the registrant's common stock were outstanding. The aggregate market value of common stock held by non-affiliates of the registrant as of November 7, 1997 was approximately $56,671,100 based on a closing price of $5.00 for the common stock as reported on the NASDAQ National Market on such date. For purposes of the foregoing computation, all executive officers, directors and 5 percent beneficial owners of the registrant are deemed to be affiliates. Such determination should not be deemed to be an admission that such executive officers, directors or 5 percent beneficial owners are, in fact, affiliates of the registrant. DOCUMENTS INCORPORATED BY REFERENCE None ================================================================================ 2 PART I ITEM 1. BUSINESS GENERAL Mego Financial Corp. (Mego Financial) is a specialty financial services company that, through its wholly-owned subsidiary, Preferred Equities Corporation (PEC), is engaged primarily in originating, selling, servicing and financing consumer receivables generated through timeshare and land sales. Unless the context requires otherwise, the "Company" refers to Mego Financial and its consolidated subsidiaries. PEC markets and finances timeshare interests and land in select resort areas. By providing financing to virtually all of its customers, PEC also originates consumer receivables that it sells and services. The Company formed Mego Mortgage Corporation (MMC) in June 1992 as a wholly-owned subsidiary and operated MMC as such until November 1996. MMC is a specialized consumer finance company that originates, purchases, sells, securitizes and services consumer loans consisting primarily of conventional uninsured home improvement and debt consolidation loans which are generally secured by liens on residential property. In November 1996, MMC consummated an underwritten initial public offering (the IPO) of 2.3 million shares of its common stock, $0.01 par value. As a result of the consummation of the IPO, the Company's ownership of MMC was reduced to approximately 81.3% of the outstanding common stock. On September 2, 1997, the Company distributed all of its 10 million shares of MMC's common stock to the Company's shareholders in a tax-free spin-off (the Spin-off). To fund MMC's past operations and growth and in conjunction with filing consolidated tax returns, MMC incurred debt and other obligations due to the Company and its subsidiary, PEC. The amount of debt due to the Company was $10.1 million at August 31, 1997 and $12.8 million at August 31, 1996, of which $3.4 million was paid in October 1997 together with $500,000 advanced by the Company to MMC in September 1997. It is not anticipated that the Company will provide funds to MMC or guarantee MMC's indebtedness in the future, although it may do so. MMC also has agreements with PEC for the provision of management services and loan servicing. See Notes 3 and 20 of Notes to Consolidated Financial Statements, "Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations (MD&A) -- Discontinued Operations of MMC" and "Item 13. Certain Relationships and Related Transactions." The Company was incorporated under the laws of the state of New York in 1954 under the name Mego Corp. and, in 1992, changed its name to Mego Financial Corp. In January 1988, the Company sold a controlling interest in the Company consisting of approximately 43% of the then outstanding common stock after the sale, to affiliates of the Assignors (as hereinafter defined). See "Item 13. Certain Relationships and Related Transactions" and Note 2 of Notes to Consolidated Financial Statements. In February 1988, the Company acquired PEC, pursuant to an assignment by the Assignors (Comay Corp., GRI, RRE Corp., and H&H Financial Inc.) of their contract right to purchase PEC. The Company's executive offices are located at 4310 Paradise Road, Las Vegas, Nevada, and the telephone number is (702) 737-3700. PREFERRED EQUITIES CORPORATION GENERAL PEC acquires, develops and converts rental and condominium apartment buildings and hotels for sale as timeshare interests and engages in the retail sale of land. PEC's strategy is to acquire properties in desirable destination resort areas that offer a range of recreational activities and amenities. As part of its strategic plan, PEC has shifted its emphasis from sales of land to sales of timeshare interests due both to its diminishing inventory of land available for sale and its increasing inventory of timeshare interests from the opening of new timeshare resorts. The decrease in PEC's inventory of land is due generally to the unavailability of suitable land at acceptable prices. PEC markets and sells timeshare interests in its resorts in Las Vegas and Reno, Nevada; Honolulu, Hawaii; Brigantine, New Jersey; Steamboat Springs, Colorado; Indian Shores and Orlando, Florida; as well as land in Nevada and Colorado. PEC owns additional properties in Steamboat Springs, Colorado and Las Vegas, Nevada which are under construction for sale as timeshare interests and is 2 3 considering the purchase of additional properties for use in its timeshare operations. PEC has contracted to acquire property in Biloxi, Mississippi for the construction of a future timeshare resort. In recent years, several major lodging, hospitality and entertainment companies, including The Walt Disney Company, Hilton Hotels Corporation, Marriott Ownership Resorts, Inc. and Hyatt Corporation, among others, have commenced developing and marketing timeshare interests in various resort properties. The Company believes that the entry into the timeshare industry of certain of these large and well-known lodging, hospitality and entertainment companies has contributed to the growth and acceptance of the industry. To enhance its competitive position, in April 1995, PEC entered into a strategic alliance with Hospitality Franchise Systems, Inc. (HFS) pursuant to which PEC was granted a ten-year (including a renewal option) exclusive license to operate both its existing and future timeshare properties under the name "Ramada Vacation Suites." The American Resort Development Association (ARDA) estimates that approximately 1.8 million families in the United States own timeshare interests in resorts worldwide and that sales of timeshare interests in the United States aggregated approximately $2.2 billion in 1996. Additionally, it is estimated by ARDA that sales volume is increasing at a compounded annual rate of almost 14% due to the entry of brand-name hospitality firms, such as "Ramada," well-financed, publicly held companies with lower costs of capital and strong growth among seasoned timeshare companies. TIMESHARE PROPERTIES AND SALES PEC acquires, develops and converts rental and condominium apartment buildings and hotels for sale as timeshare interests. PEC's strategy is to acquire properties in desirable destination resort areas that offer a range of recreational activities and amenities. The timeshare interests offered by PEC in its resorts other than in Hawaii generally consist of undivided fee interests in the land and facilities comprising the property or an undivided fee interest in a particular unit, pursuant to which the owner acquires the perpetual right to weekly occupancy of a residence unit each year. In its resort in Hawaii, PEC offers "right-to-use" interests, pursuant to which the owner has occupancy rights for one week each year until December 31, 2009, the last full year of the underlying land lease for the resort property. During fiscal 1997, 1996 and 1995, PEC sold 7,860, 6,982 and 5,365 timeshare interests, respectively, at prices ranging from $3,950 to $23,950. The Company believes that PEC's alliance with HFS has enabled it to capitalize on the Ramada reputation, name recognition and customer profile, which closely matches PEC's customer profile. The arrangement required PEC to pay an initial access fee of $1 million, which has been paid, and monthly recurring fees equal to 1% of PEC's Gross Sales (as defined in the agreement) through January 1996 and 1.5% of PEC's Gross Sales each month commencing after January 1996. The initial term of the arrangement is 5 years and PEC has the option to renew the arrangement for an additional term of 5 years if it has met certain conditions, including the addition of at least 20,000 timeshare interests during the initial term, which condition had been satisfied as of August 31, 1997, and the payment of minimum annual fees. In addition to the grant of the license, the arrangement provides for the establishment of joint marketing programs. The Company believes it has benefited from the use of the Ramada name, but is unable to quantify the amount of such benefit. In May 1997, PEC began offering a new sales program whereby a customer pays a fixed fee on an installment basis to use a timeshare interest during an initial one-year period with an option to purchase the timeshare interest. If the customer exercises the option to purchase the interest, the fixed fee is applied toward the down payment of the timeshare interest purchased. PEC currently operates timeshare resorts in Las Vegas and Reno, Nevada; Honolulu, Hawaii; Brigantine, New Jersey; Steamboat Springs, Colorado; Orlando and Indian Shores, Florida; and owns additional properties in Las Vegas, Nevada and Steamboat Springs, Colorado which are under construction. PEC is considering the purchase of additional properties for use in its timeshare operations and has recently contracted to acquire property in Biloxi, Mississippi for future construction of a timeshare resort. PEC's Ramada Vacation Suites at Las Vegas, formerly known as The Grand Flamingo Club, includes 30 buildings with a total of 429 studio units and 1 and 2 bedroom units which have been converted for sale as 21,879 timeshare interests, of which 2,755 remained available for sale as of August 31, 1997. The resort is in 3 4 close proximity to "the Strip" in Las Vegas and features swimming pools and other amenities. Nevada timesharing attracts the upper end of the tourism market and Las Vegas is the most dynamic region of the state for timeshare industry growth according to ARDA statistics. PEC is in the process of converting additional adjacent properties it owns. PEC has completed the expansion of the common areas to include an expanded lobby, convenience store and expanded sales facilities. At August 31, 1997, a total of 5 buildings containing 60 apartment units were under conversion to timeshare interests. The Ramada Vacation Suites at Reno, formerly known as the Reno Spa Resort, consists of a 95-unit hotel that has been converted for sale as 4,845 timeshare interests, of which 729 remained available for sale as of August 31, 1997. The resort features an indoor swimming pool, exercise facilities, sauna, jacuzzi and sun deck. PEC's Ramada Vacation Suites at Honolulu is an 80-unit hotel consisting of 3 buildings that have been converted for sale as 4,160 timeshare interests, of which 444 remained available for sale as of August 31, 1997. The hotel recently changed its name from White Sands Waikiki. The resort is within walking distance of a public beach and features a swimming pool and jacuzzi. PEC holds the buildings, equipment and furnishings under a land lease expiring in March 2010, under which PEC makes annual rental payments of approximately $192,000. The Ramada Vacation Suites on Brigantine Beach consists of a 91-unit hotel and a 17-unit three story building, formerly known as the Brigantine Inn and the Brigantine Villas, respectively, that have been either converted or constructed for sale as 5,508 timeshare interests, of which 658 remained available for sale as of August 31, 1997. The resort is situated on beach front property in close proximity to Atlantic City, New Jersey and features an enclosed swimming pool, cocktail lounge, bar and restaurant. The Ramada Vacation Suites at Steamboat Springs consists of 60 one- and two-bedroom units, which have been converted for sale as 3,060 timeshare interests, of which 1,196 remained available for sale as of August 31, 1997. PEC acquired this condominium resort in 1994 and completed the conversion in 1995. PEC has constructed a 5,500-square foot amenities building at this facility which features a lobby, front desk, spa and sauna. The Ramada Vacation Suites at Indian Shores, formerly known as the Aloha Bay Apartments, consists of a 2-building complex, that has recently been converted into a total of 32 one- and two-bedroom units to be sold as 1,632 timeshare interests. The resort is located on the intercoastal waterway and is in close proximity to Tampa, Florida. Timeshare interests became available for sale in September 1996. At August 31, 1997, 1,272 timeshare interests remained available for sale. The Ramada Vacation Suites at Orlando, formerly known as Ramada Suites at Tango Bay (in Orlando, Florida), consists of a 7 building complex, that is being converted into 102 units to be sold as 5,202 timeshare interests. In June 1997, 42 units became available for sale as 2,142 timeshare interests. At August 31, 1997, 72 timeshare interests had been sold. Florida is one of the country's most significant timeshare markets, representing 23.6% of the total number of resorts in the United States, and, according to ARDA, has experienced unprecedented growth. The Ramada Vacation Suites -- Hilltop, formerly known as The Overlook Lodge, is a 117-room complex complete with indoor swimming pool, restaurant, cocktail lounge and meeting room facilities. Upon completion of conversion, the complex will consist of 56 one- and two-bedroom units to be sold as 2,856 timeshare interests. The resort is located in Steamboat Springs, Colorado, in close proximity to the area's ski slopes and attractions. The timeshare interests will be available for sale upon completion of improvements and registration with the state of Colorado, which is expected to be completed in December 1997. 4 5 The following table sets forth certain information regarding the timeshare interests at the Company's resort properties:
STEAMBOAT INDIAN LAS VEGAS RENO WAIKIKI BRIGANTINE SPRINGS SHORES ORLANDO TOTAL --------- ------ ------- ---------- --------- ------- ------- ------ Maximum number of timeshare interests... 21,879 4,845 4,160 5,508 3,060 1,632 2,142 43,226 Net number of timeshare interests sold through August 31, 1997............... 19,124 4,116 3,716 4,850(1) 1,864 360 72 34,102 Number of timeshare interests available for sale at August 31, 1997........... 2,755 729 444 658 1,196 1,272 2,070 9,124 Percent sold through August 31, 1997.... 87% 85% 89% 88% 61% 22% 3% 79% Number of timeshare interests sold during the year ended August 31, 1997.................................. 4,714 551 608 104 1,340 456 87 7,860 Number of timeshare interests reacquired during the year ended August 31, 1997 through: Contract cancellations................ 780 237 149 136 185 9 -- 1,496 Exchanges(2).......................... 2,342 349 357 61 538 87 15 3,749 Acquired for unpaid maintenance fees................................ 135 68 79 46 -- -- -- 328 ------- ------ ------ ------- ------- ------- ------ ------- Total number of timeshare interests reacquired during the year.......... 3,257 654 585 243 723 96 15 5,573 ------- ------ ------ ------- ------- ------- ------ ------- Net number of timeshare interests sold (reacquired) during the year ended August 31, 1997....................... 1,457 (103) 23 (139) 617 360 72 2,287 Additional timeshare interests under development(3)........................ 3,060 -- -- -- 2,856 -- 3,060 8,976 Sales prices of timeshare interests available at August 31, 1997 range From................................ $ 7,950 $6,150 $3,950 $ 5,150 $ 6,950 $ 7,950 $7,950 N/A To.................................. $14,950 $9,950 $5,950 $ 15,800 $23,950 $14,950 $9,950 N/A
- --------------- (1) 4,823 timeshare interests were sold by the prior developer. (2) These exchanges are primarily related to customers exchanging and/or upgrading their current property to generally higher quality and higher priced units. (3) PEC owns additional units under conversion or to be converted to timeshare interests, and are not included above. In Las Vegas, Nevada, the addition of 60 units will be converted into 3,060 timeshare interests. In Steamboat Springs, Colorado, the addition of 56 units will be converted into 2,856 timeshare interests. In Orlando, Florida, the addition of 60 units will be converted into 3,060 timeshare interests. For the fiscal years ended August 31, 1997, 1996 and 1995, PEC's consolidated revenue from sales of timeshare interests was $32.3 million, $27.8 million and $20.7 million, respectively, representing approximately 47.9%, 45.8% and 36% of total revenues, respectively. RCI EXCHANGE NETWORK The attractiveness of timeshare interest ownership in resorts is enhanced significantly by the availability of exchange networks allowing owners to exchange their occupancy right in the resort in which they own an interest for an occupancy right in another participating network resort. Several companies, including Resorts Condominiums International (RCI), which recently became a wholly-owned subsidiary of HFS, provide broad based timeshare interest exchange networks and PEC has qualified its resort properties for participation in the RCI network. RCI has a total of more than 3,100 participating resort facilities located worldwide. Approximately 46.1% of the participating facilities are located in the United States and Canada. PEC and the Owners' Association (as defined later) of each of PEC's timeshare resorts have entered into an agreement with RCI pursuant to which purchasers of timeshare interests in PEC's resorts may apply for membership in the RCI exchange network. Under the terms of these agreements, RCI agrees to make its exchange program available to PEC's customers who apply for membership. RCI and the Owners' Association agree to promote RCI's program and to honor qualified exchanges by members from other participating resorts. The initial five-year terms of the 5 6 agreements are automatically renewable for additional five-year terms, unless either party gives the other party at least 180 days written notice prior to the expiration of the then current term. Either party may terminate the agreement upon a breach of the agreement by the other party. Membership in RCI entitles PEC's customers, based on availability, trading potential (which is based on their timeshare interval), and the payment of a variable exchange fee to RCI, to exchange their occupancy right in the resort in which they own an interest, for an occupancy right at the same or a different time in another participating resort of similar trading potential. The cost of the subscription fee for RCI, which is at the option and expense of the timeshare interest owner, is approximately $63 for the first year and $74 for each annual renewal. OWNERS' ASSOCIATIONS AND PROPERTY MANAGEMENT PEC's resort properties require ongoing management services. Independent not-for-profit corporations known as Owners' Associations have been established to administer each of PEC's resorts other than the resort in Honolulu. PEC's resort in Honolulu is administered by the White Sands Resort Club, a division of PEC (together with the Owners' Associations, collectively the Associations). Owners of timeshare interests in each of these resorts are responsible for the payment of annual assessment fees to the respective Association, which are intended to fund all of the operating expenses at the resort facilities and accumulate reserves for replacement of furnishings, fixtures and equipment, and building maintenance. Annual assessment fees for 1997 ranged from $247 to $445. PEC has in the past financed budget deficits of the Associations, but is not obligated to do so in the future. During fiscal 1997 and 1996, PEC did not finance any budget deficits for the Associations, since the Associations had an aggregate excess of $1.6 million and $538,000, respectively, of fees received compared to expenses paid. The deficit and/or excess position of the Associations vary primarily due to the timing of major improvement expenditures. Any budget deficits financed by PEC are expected to be recovered in the future by increased assessments to the Associations. The aggregate amount of budget deficits financed by PEC was $1.1 million during fiscal 1995. If the owner of a timeshare interest defaults in the payments of the annual assessment fee, the Association may impose a lien on the related timeshare interest. PEC has agreed to pay to the Associations the annual assessment fees of timeshare interest owners who are delinquent with respect to such fees, but have paid PEC in full for their timeshare interest. In exchange for the payment by PEC of such fees, the Associations assign their liens for non-payment on the respective timeshare interests to PEC. In the event the timeshare interest holder does not satisfy the lien after having an opportunity to do so, PEC typically acquires a quitclaim deed or forecloses on and acquires the timeshare interest for the amount of the lien and any related foreclosure costs. PEC has entered into management arrangements with the Associations pursuant to which PEC receives annual management and administrative fees in exchange for providing or arranging for various property management services such as bookkeeping, staffing, budgeting, maintenance and housekeeping services. During fiscal 1997, 1996 and 1995, PEC received $2,199,000, $2,081,000 and $1,988,000, respectively, of such fees from the Associations. The management arrangements are typically for initial terms ranging from three to five years and automatically renew for successive additional one-year terms unless canceled by the Association. No management arrangement has been canceled to date. The Company believes that proper management is important for maintaining customer satisfaction and protecting PEC's investment in its inventory of unsold timeshare interests. PEC's intent and goal is to manage these properties until all timeshare interests are sold and the receivables generated from such sales have been paid. However, due to cancellations, exchanges and upgrades, none of the Associations are likely to realize a 100% occupancy rate for an extended period of time. The Company believes that continued management of these properties preserves the integrity of the property and the portfolio performance on an ongoing basis beyond the end of the sales period. LAND SALES PEC is engaged in the retail sale of land in Nevada and Colorado for residential, commercial, industrial and recreational use. PEC acquires lots and large tracts of unimproved land and then subdivides the land into 6 7 lots and parcels for retail sale. Residential lots range in size from one-quarter acre to one and one-half acres, while commercial and industrial lots vary in size. PEC's residential lots generally range in price from $16,000 to $91,000 while commercial and industrial lots generally range in price from $19,000 to $79,000. Improvements such as roads and utilities and, in some instances, amenities are typically part of the development program in Nevada. During fiscal 1997, 1996 and 1995, PEC sold 1,459, 1,610 and 1,467 residential lots, and 50, 38 and 51 commercial and industrial lots, respectively. PEC has a continuing program to plat the properties that it owns. Purchasers of lots and parcels frequently exchange their property after the initial purchase for other property interests offered by PEC. Additionally, PEC is required from time to time to cancel the purchase of lots and parcels as a result of payment defaults or customer cancellations following inspections of the property and pursuant to contractual provisions. A substantial portion of PEC's sales of retail lots and land parcels have been in its Calvada subdivisions, containing approximately 30,000 lots in the Pahrump valley, in Nye County, Nevada, located approximately 60 miles from Las Vegas. The lots are designated as single family residential, multiple family residential, mobile home, hotel/motel, industrial or commercial. PEC owns a privately owned public utility company that provides water and sewer service to portions of the subdivisions and two golf courses that are available to property owners and the public. The community of Pahrump has a population estimated at approximately 25,000 and contains an urgent care medical facility, shopping, churches, fast food restaurants, hotel/casino facilities and several schools. The following table illustrates certain statistics regarding the Pahrump valley subdivisions: Number of acres acquired since 1969................................. 18,777 Number of lots platted.............................................. 29,849 Net number of lots sold through August 31, 1997..................... 29,346 Percent of lots sold through August 31, 1997........................ 98% Number of platted lots available for sale at August 31, 1997........ 503 Number of acres available for platting.............................. 207 Number of lots to be platted........................................ 615 FOR THE YEAR ENDED AUGUST 31, 1997: Number of lots sold................................................. 1,509 Number of lots canceled............................................. (401) Number of lots exchanged............................................ (730) ------ Number of lots sold, net of cancellations and exchanges............. 378 ======
Central Nevada Utilities Company (CNUC), a wholly-owned subsidiary of PEC, operates a privately owned public sewer and water utility for portions of PEC's Nevada subdivisions and certain other properties located within that subsidiary's certificated service area (which is subject to the regulation of the Public Utilities Commission of Nevada). PEC also sells larger unimproved tracts of land in Colorado. PEC has acquired unimproved land in Huerfano County, Colorado, which is being sold for recreational use in parcels of at least 35 acres, at prices ranging from $11,250 to $20,500 depending on location and size. These parcels are sold without any planned improvements and without water rights, which rights have been reserved by PEC. Substantially all of the parcels have been sold, with approximately 81 parcels remaining in inventory. PEC has also acquired improved and unimproved land in Park County, Colorado, which is being sold for recreational use in parcels typically ranging in size from 5 to 9 acres or larger and at prices ranging from $13,995 to $22,195 depending on location and size. These parcels are sold without any planned improvements, except for a recreational facility which includes a basketball court, baseball field and picnic facilities. 7 8 The following table illustrates certain statistics regarding the parcels in Huerfano and Park Counties, Colorado: Number of acres acquired since 1969................................. 51,709 Number of parcels platted........................................... 2,997 Net number of parcels sold through August 31, 1997.................. 2,802 Percent of parcels sold through August 31, 1997..................... 94% Number of platted parcels available for sale at August 31, 1997..... 195 FOR THE YEAR ENDED AUGUST 31, 1997: Number of parcels sold.............................................. 638 Number of parcels canceled.......................................... (285) Number of parcels exchanged......................................... (269) ------ Number of lots sold, net of cancellations and exchanges............. 84 ======
For the fiscal years ended August 31, 1997, 1996 and 1995, PEC's net revenue from land sales was approximately $16.6 million, $18 million and $20.8 million, respectively, representing approximately 24.7%, 29.6% and 38% of total revenues, respectively. TRUST ARRANGEMENTS Title to certain of PEC's resort properties and land parcels in Huerfano County, Colorado is held in trust by trustees to meet regulatory requirements which were applicable at the time of the commencement of sales. In connection with sales of timeshare interests pursuant to "right-to-use" or installment sales contracts, title to certain of PEC's resort properties in the states of Nevada and Hawaii are held in trust by trustees to meet requirements of certain state regulatory authorities. Prior to 1988, PEC sold timeshare interests in certain of its resorts in the state of Nevada pursuant to "right-to-use" contracts and continues in other resorts to sell under installment sales contracts under which the purchaser does not receive a deed until the purchase price is paid in full. In addition, PEC offers "right-to-use" interests in its resort in Hawaii, since it is on leased property. In connection with the registration of the sale of such timeshare interests, the Department of Real Estate of the state of Nevada and the Department of Commerce and Consumer Affairs of the state of Hawaii require that title to the related resorts be placed in trust. CUSTOMER FINANCING PEC provides financing to virtually all the purchasers of its timeshare interests, retail lots and land parcels who make a down payment equal to at least 10% of the purchase price. The financing is generally evidenced by nonrecourse installment sale contracts as well as notes secured by deeds of trust. Currently, the term of the financing generally ranges from two to twelve years, with principal and interest payable in equal monthly payments. Interest rates are fixed and generally range from 0% to 16% per year based on prevailing market rates and the amount of the down payment made relative to the sales price. PEC has a sales program whereby no stated interest rate is charged on those sales where the aggregate down payment is at least 50% of the purchase price and the balance is payable in 24 or fewer monthly payments. PEC believes its financing is attractive to purchasers who find it convenient to handle all facets of the purchase through a single source. At August 31, 1997, PEC had a serviced portfolio of 18,136 notes receivable relating to sales of timeshare interests and land, which receivables had an aggregate outstanding principal balance of $118.6 bmillion, a weighted-average maturity of approximately 6.5 years and a weighted-average interest rate of 11.5%. PEC has 6 financing arrangements with 5 institutional lenders for the financing of customer receivables, which provide for borrowings of up to an aggregate of $137.5 million. These lines of credit bear interest at variable rates tied to the prime rate and the one-month and 90 day London Interbank Offering Rate (LIBOR) and are secured by timeshare and land receivables and inventory. At August 31, 1997, an aggregate of $62.1 million was outstanding under such lines of credit and $75.4 million was available for borrowing. PEC periodically sells its timeshare and land receivables to various third party purchasers and uses a portion of the sales proceeds to reduce the outstanding balances of its lines of credit, thereby increasing the borrowing 8 9 availability under such lines by the amount of prepayment. The sales have resulted in yields to the purchaser less than the weighted-average yield on the receivables, with PEC entitled to retain the difference, the estimated value of which is carried as interest only receivables. The sales agreements generally provide for PEC to continue servicing the sold receivables, and require that PEC repurchase or replace accounts that have become more than 90 days contractually delinquent, or as to which certain warranties and representations are determined to be incorrect. In addition, the sales agreements generally require the maintenance of cash reserve accounts for losses and contain minimum net worth requirements and other covenants, the non-compliance with which would allow the purchaser to replace PEC as the servicer. The sales agreements for timeshare receivables contain certain covenants that generally require PEC to use its best efforts to remain the manager of the related resorts and to cause the Associations to maintain appropriate insurance and pay the real estate taxes. Performance by PEC of such covenants generally is guaranteed by the Company. The principal balances of receivables sold by PEC were $30.1 million, $16 million and $32.5 million during fiscal 1997, 1996 and 1995, respectively. At August 31, 1997, PEC was contingently liable to replace or repurchase receivables sold with recourse in the aggregate amount of $84 million, if and as such receivables become delinquent. Delinquencies greater than 60 days have declined 57.8% in fiscal 1997 from fiscal 1996 due to intensive collection efforts focused on PEC timeshare and land receivables. However, there was an increase in cancellations to $20.3 million during fiscal 1997 from $17.2 million in fiscal 1996, an 18.3% increase. PEC charges off or fully reserves all receivables that are more than 90 days delinquent. The following table sets forth information with respect to receivables owned and sold that were more than 60 but less than 90 days delinquent, excluding accounts that have been fully reserved or charged-off, as of the dates indicated (thousands of dollars):
AUGUST 31, -------------------------------------------------------- 1997 1996 1995 1994 1993 -------- -------- -------- -------- -------- 60-day delinquent........................ $ 1,076 $ 2,547 $ 2,330 $ 2,144 $ 2,930 Total receivables........................ $133,753 $128,299 $120,675 $109,360 $103,280 60-day delinquency percentage............ 0.80% 1.99% 1.93% 1.96% 2.84%
PEC provides an allowance for cancellations at the time it recognizes revenues from sales of timeshare interests, which PEC believes, based on its experience and its analysis of economic conditions, is adequate to absorb losses on receivables that become uncollectible. Upon the sale of the receivables, the allowance related to those receivables is reduced and the reserve for notes receivable sold with recourse is appropriately increased. MARKETING PEC markets timeshare interests and land through on-site and off-site sales offices. PEC's sales staff receives commissions based on net sales volume. PEC maintains fully-staffed on-site sales offices at its timeshare properties in Las Vegas and Reno, Nevada; Steamboat Springs, Colorado; Indian Shores and Orlando, Florida; as well as the Las Vegas principal offices, and at its land projects in Nevada and Colorado. At its other timeshare properties, brokers for PEC maintain smaller on-site sales offices staffed with one to two sales associates. PEC also maintains off-site sales offices in West Covina, California, Dallas, Texas and Denver, Colorado. PEC's marketing efforts are targeted primarily at tourists meeting its customer profile. Currently, approximately 36.9% of sales are made through the Las Vegas sales office. One of the principal sales techniques utilized by PEC in Las Vegas is to offer pre-screened potential customers a gift such as show tickets in exchange for attending PEC's sales presentations. In addition, to show tickets, other inducements such as local tour packages, dinners, and short-term room accommodations are also offered. The marketing techniques utilized at PEC's sales offices at locations other than Las Vegas include (i) exhibition booths located at shows, fairs and other attractions, that generate inquiries from prospective customers, whom PEC then contacts by telephone, (ii) referrals from existing customers, (iii) limited direct mail programs, and (iv) brokers specializing in lead generation. Various premiums and inducements are offered to prospective customers to obtain their attendance at sales presentations, including the offer of short-term accommodations at certain of PEC's timeshare resorts. 9 10 As part of its marketing strategy, PEC maintains an internal exchange program. This program enables owners of PEC's timeshare interests to exchange their occupancy right in the resort in which they own an interest for an occupancy right at the same or a different time in another of PEC's timeshare resorts. In addition, PEC has a sales program pursuant to which purchasers of its timeshare interests, retail lots and land may exchange their equity interests in one property for an interest in another of PEC's properties. For example, a purchaser of a timeshare interest in one of PEC's timeshare resorts may exchange his equity interest for an interest in a different unit within the same resort, for an interest in one of PEC's other resorts or for a retail lot or land parcel. The agreement of sale for a timeshare interest or land may be rescinded within various statutory rescission periods. For land sales made at a location other than the property, the customer may generally cancel the contract within a specified period, usually five months from the date of purchase, provided that the contract is not in default, and provided the customer has completed a developer guided inspection and tour of the subject property first, and then requests the cancellation. At August 31, 1997, $308,000 of recognized sales remained subject to such cancellation. If a customer defaults after all rescission and cancellation periods have expired, all payments are generally retained by PEC, and the customer forfeits all rights to the property. SEASONALITY Sales of timeshare interests and land are somewhat seasonal. For the fiscal years ended August 31, 1997, 1996 and 1995, quarterly sales as a percentage of annual sales, for each of the fiscal quarters averaged: quarters ended November 30 -- 24.8%, quarters ended February 28 -- 22.9%, quarters ended May 31 -- 29.1%, and quarters ended August 31 -- 23.2%. The majority of the Company's customers are tourists. The Company's major marketing area, Las Vegas, Nevada, reaches peaks of tourist activity at periods different from the Company's other major marketing areas, such as Reno, Nevada and Denver, Park and Huerfano Counties, Colorado, which are more active in summer than in winter. The Company's other major marketing areas, Honolulu, Hawaii, and Orlando, Florida, are not subject to seasonality. The Company is not dependent upon a limited number or segment of customers whose loss would have a material adverse effect on the Company. COMPETITION The timeshare and real estate industries are highly competitive. Competitors in the timeshare and real estate business include hotels, other timeshare properties and real estate properties. Certain of the Company's competitors are substantially larger and have more capital and other resources than the Company. PEC's timeshare plans compete directly with many other timeshare plans, some of which are in facilities located in Las Vegas, Reno, Lake Tahoe, Honolulu, Atlantic City, Orlando, Tampa, and Steamboat Springs. In recent years, several major lodging, hospitality and entertainment companies have begun to develop and market timeshare properties. In 1996, approximately 38.4% of timeshare resorts were located in the Mountain/Pacific region of the United States, 30.5% in Florida, 15.2% were located in foreign countries, 5.3% in the Northeast region, 4% in the Southwest region and 3.3% in each of the Midwest and Southeast regions of the United States according to ARDA data. In addition, PEC competes with condominium projects and with traditional hotel accommodations in these areas. Certain of these competing projects and accommodations are larger and more luxurious than PEC's facilities. There are currently available approximately 104,000 hotel and motel rooms in Las Vegas, Nevada; 36,000 in Honolulu, Hawaii; 23,000 in Washoe County, Nevada, which includes Reno and Lake Tahoe; 96,000 in the Orlando, Florida metropolitan area; 24,000 in the Indian Shores, Florida area; 18,000 in Atlantic City, New Jersey and 3,000 in Steamboat Springs, Colorado. GOVERNMENT REGULATION The Company's timeshare and real estate operations are subject to extensive regulation, potential suspension and licensing requirements by federal and state authorities. The following is a summary of the regulations applicable to the Company. 10 11 ENVIRONMENTAL REGULATION Under various federal, state and local environmental laws, ordinances and regulations, a current or previous owner or operator of real estate may be required to investigate and clean up hazardous or toxic substances or chemical releases at such property, and may be held liable to a governmental entity or to third parties for property damage, personal injury and investigation and cleanup costs incurred by such parties in connection with the contamination. Such laws typically impose cleanup responsibility and liability without regard to whether the owner knew of or caused the presence of the contaminants, and the liability under such laws has been interpreted to be joint and several unless the harm is divisible and there is a reasonable basis for allocation of responsibility. The costs of investigation, remediation or removal of such substances may be substantial, and the presence of such substances, or the failure to properly remediate such property, may adversely affect the owner's ability to sell or rent such property or to borrow using such property as collateral. Persons who arrange for the disposal or treatment of hazardous or toxic substances also may be liable for the costs of removal or remediation of such substances at the disposal or treatment facility, whether or not the facility is owned or operated by such person. In addition, the owner or former owners of a site may be subject to common law claims by third parties based on damages and costs resulting from environmental contamination emanating from a site. TIMESHARE REGULATION Nevada Revised Statutes Chapter 119A requires the Company to give each customer a Public Offering Statement that discloses all aspects of the timeshare program, including the terms and conditions of sale, the common facilities, the costs to operate and maintain common facilities, the Company's history and all services and facilities available to the purchasers. Section 514E of the Hawaii Revised Statutes provides for similar information to be provided to all prospective purchasers through the use of the Hawaii Disclosure Statement, just as Chapter 721 of the Florida Statutes similarly provides through the use of a Public Offering Statement. Section 11000, et seq., of the California Business and Professions Code also provides for similar information to be provided to all prospective purchasers through the use of an Out-of-state Timeshare Permit issued by the California Department of Real Estate. Section 45 of the New Jersey Statutes Annotated provides for similar information to be provided to all prospective purchasers through the use of a Public Offering Statement. The Texas Register at 22 Texas Administrative Code, Section 543 provides for similar information to be provided to all prospective purchasers through the use of the Texas Timeshare Disclosure Statement, and similarly, the Mississippi Real Estate Commission requires that the situs state Public Offering Statement provides prospective purchasers with the same information. Title 12, Article 61 of the Colorado Revised Statutes provides for similar information to be provided to all prospective purchasers in their contracts of sales or by separate written documents. Nevada and Colorado require a five day rescission period for all timeshare purchasers. The rescission period required by Hawaii and New Jersey is seven days. The rescission period required by Florida is ten days. The rescission period in California, Mississippi and Texas for out-of-state sales is five days. The Nevada, California, New Jersey, Hawaii, Colorado, Texas, Florida, and Mississippi timeshare statutes have stringent restrictions on sales and advertising practices and require the Company to utilize licensed sales personnel. LENDING REGULATION PEC is subject to various federal lending regulations related to marketing, financing and selling consumer receivables. These federal regulations include: Fair Housing Act, Americans With Disabilities Act, Interstate Land Sales Full Disclosure Act, Truth-In-Lending Act, Real Estate Settlement Procedures Act, Equal Credit Opportunity Act, Federal Trade Commission Telemarketing Rule, Federal Communications Commission Telephone Census Protection Act, Federal Trade Commission Act (Unfair or Deceptive Act or Practices) and Fair Debt Collections Practices Act. The Company believes that it has made all required filings with state, city and county authorities and is in material compliance with all federal, state and local regulations governing timeshare interests. The Company believes that such regulations have not had a material adverse effect on any phase of the Company's operations, including the overall cost of acquiring property. Compliance with or changes in official interpreta- 11 12 tions of regulations might, however, impose additional compliance costs on the Company that cannot be predicted. REAL ESTATE REGULATION The real estate industry is subject to extensive regulation. The Company is subject to compliance with various federal, state and local environmental, zoning and other statutes and regulations regarding the acquisition, subdivision, development and sale of real estate and various aspects of its financing operations. The Interstate Land Sales Full Disclosure Act establishes strict guidelines with respect to the subdivision and sale of land in interstate commerce. The U.S. Department of Housing and Urban Development (HUD) has enforcement powers with respect to this statute. In many instances (e.g., Huerfano County, Colorado land sales), the Company has been exempt from HUD registration requirements because of the size or number of the subdivided parcels and the limited nature or type of its offerings. The Company registers its timeshare properties with various state agencies. The Company must disclose financial information concerning the property, evidence of title, a description of the intended manner of offering, proposed advertising materials, and must bear the costs of such registration, which include legal and filing fees. The Company believes that it is in compliance, in all material respects, with all applicable federal, state and local regulations. The Company believes that such regulations have not had a material adverse effect on any phase of its operations. Compliance with future changes in regulations might, however, impose additional compliance costs on the Company that cannot be predicted. The city and county governments in areas where the Company operates have enacted licensing and other ordinances that affect timeshare projects. EMPLOYEES As of August 31, 1997, PEC had 1,332 employees, of whom 1,208 were full-time employees and 124 were part-time employees. Full-time employees were comprised of the following: 600 sales and marketing officers and personnel, 287 general and administrative officers, managers and support staff, 310 hotel personnel, and 11 utility company personnel. None of PEC's employees are represented by a collective bargaining unit. The Company believes that its relations with its employees are satisfactory. As of August 31, 1997, MMC had 405 employees, none of which is represented by a collective bargaining unit. At September 2, 1997, the Company distributed all of its 10 million shares of MMC stock in the Spin-off. See "Item 1. Business -- General," "Item 7. MD&A -- Discontinued Operations of MMC" and Note 5 of Notes to Consolidated Financial Statements. ITEM 2. PROPERTIES At August 31, 1997, the Company had 502 residential, commercial and industrial lots, 195 recreational land parcels, 1,215 recreational vehicle pads, and 9,124 timeshare interests in its inventory. In addition, the Company maintains the following properties: The Company's principal executive offices are located at 4310 Paradise Road, Las Vegas, Nevada 89109, where it occupies approximately 31,000 square feet of office space in a building it owns. Title to the property is held by the Company. The Company owns a second office building located in Las Vegas, Nevada. This building has approximately 60,000 square feet of office space, of which the Company occupies approximately 30,000 square feet. The remaining approximately 30,000 square feet is leased to tenants on a short-term basis. The Company leases an executive office at 1125 N.E. 125th Street in North Miami, Florida, comprising approximately 3,200 square feet, at a rental of $2,400 per month. The lease expires in August 1998. MMC's corporate headquarters is located in 45,950 square feet of office space at 1000 Parkwood Circle, Atlanta, Georgia. MMC also leases 10,478 square feet of office space at its prior headquarters location in Atlanta, Georgia, and leases office space on short-term or month-to-month leases in Waldwick, New Jersey; 12 13 Kansas City, Missouri; Austin, Texas; Oklahoma City, Oklahoma; Seattle, Washington; Waterford, Michigan; Columbus, Ohio; Elmhurst, Illinois; Philadelphia, Pennsylvania; Denver, Colorado; Richmond, Virginia; Scottsdale, Arizona; Patchogue, New York; Woburn, Massachusetts; Dublin, California; Stuart, Florida; Las Vegas, Nevada; Miami Lakes, Florida; and Brentwood, Tennessee. Subsequent to the Spin-off, MMC will retain the above described properties. See "Item 1. Business General," "Item 7. MD&A -- Discontinued Operations of MMC" and Note 5 of notes to Consolidated Financial Statements. The Company leases various other facilities on a short-term or month-to-month basis for off-site sales offices in various cities throughout the United States. ITEM 3. LEGAL PROCEEDINGS In the matter of the PEC Apartment Subsidiaries litigation previously reported upon, an order for judgment of $3,346,000 was rendered against PEC on its limited guaranty, in connection with the defendants' counterclaim. Pursuant to a stipulation between the parties dated as of May 15, 1995, PEC paid the amount of $2,900,000 on June 15, 1995 in full settlement of this matter. Because the reserve recorded in the financial statements of the Company exceeded the amount of the settlement, the Company recognized a gain on discontinued operations of $873,000, net of taxes of $450,000 in fiscal 1995. Following the Company's November 10, 1995 announcement disclosing certain accounting adjustments, an action was filed on November 13, 1995, in the United States District Court, District of Nevada (Court) by Christopher Dunleavy, as a purported class action against the Company, certain of the Company's officers and directors and the Company's independent auditors. The complaint alleges, among other things, that the defendants violated Section 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5 thereunder in connection with the preparation and issuance of certain of the Company's financial reports issued in 1994 and 1995, including certain financial statements reported on by the Company's independent auditors. The complaint also alleges that one of the director defendants violated the federal securities laws by engaging in "insider trading." The named plaintiff seeks to represent a class consisting of purchasers of Mego Financial's common stock between January 14, 1994 and November 9, 1995, and seeks damages in an unspecified amount, costs, attorney's fees and such other relief as the court may deem just and proper. On November 16, 1995, a second action was filed in the Court by Alan Peyser as a purported class action against the Company and certain of its officers and directors, which was served on the Company on December 20, 1995. The complaint alleges, among other things, that the defendants violated the federal securities laws by making statements and issuing certain financial reports in 1994 and 1995 that overstated the Company's earnings and business prospects. The named plaintiff seeks to represent a class consisting of purchasers of Mego Financial's common stock between November 28, 1994 and November 9, 1995. The complaint seeks damages in an unspecified amount, cost, attorney's fees and such other relief as the Court may deem just and proper. On or about June 10, 1996, the Dunleavy Action and Peyser Action were consolidated under the caption "In re Mego Financial Corp. Securities Litigation," Master File No. CV-9-95-01082-LD (RLJ), pursuant to a stipulation by the parties. On December 26, 1996, in the above captioned matter, Michael Nadler filed a purported class action complaint against the Company, certain of the Company's officers and directors, and the Company's independent auditors. The complaint alleges that the defendants violated the federal securities laws and common law and contain allegations similar to those contained in the Dunleavy and Peyser complaints. On February 13, 1997, defendants moved to dismiss Nadler's complaint. On March 13, 1997, Nadler filed a "Motion for the Filing of a Consolidated Complaint and a Class Certification Motion, the Holding of a Pretrial Conference and the Suspension of Briefing on Defendants' Motions to Dismiss." The Company opposed that motion. On March 31, 1997, the Court, among other things, denied without prejudice to refiling after either the filing of a consolidated complaint or a ruling on Nadler's motion for the filing of a consolidated complaint, and defendants' motions to dismiss Nadler's complaint. 13 14 On May 12, 1997, counsel for the plaintiffs in the Dunleavy and Peyser actions, and counsel for the defendants executed a Memorandum of Understanding with respect to a proposed settlement. The proposed settlement, which is subject to a number of conditions, including approval by the Court, calls for certification, for settlement purposes only, of a class consisting of all purchasers of Mego Financial stock (excluding the defendants and their respective directors, executive officers, partners and affiliates and their respective immediate families, heirs, successors and assigns) during the period from January 14, 1994 through November 9, 1995, inclusive, and for creation of a settlement fund of $1.725 million. The portion of this amount to be contributed by the Company, net of anticipated directors and officers insurance proceeds and contribution by another defendant, is not expected to have a material adverse effect on the Company. The parties anticipate submitting papers to the Court in due course seeking approval of the settlement. Final approval of the settlement is expected to dispose of all class claims in the Litigation, including those asserted by Nadler. The Company believes that it has substantial defenses to all of the complaints that have been filed against it described above, and that the likelihood of a material liability being incurred by the Company is remote. However, the Company presently cannot predict the outcome of this matter. On November 22, 1996, D. Anthony Pullella filed an action in the Superior Court, Chancery Division, Atlantic County, New Jersey (Case No. ATL-C-175-96) against Brigantine Preferred Properties, Inc. ("BPP") and the Brig, Inc., subsidiaries of PEC. The complaint requests an order requiring the sale to the Plaintiff of the restaurant and bar facility in the Brigantine Inn Resort Club, pursuant to alleged obligations in a lease and management agreement, and also asks for unspecified compensatory and punitive damages. On September 10, 1997, BPP filed an answer and counterclaim in this action. In its counterclaim, BPP requests an order terminating the management agreement for the failure of Pullella to perform all of his obligations under such agreement, the return of Pullella's 1% interest in the Brig, Inc., the subsidiary of the Company holding the liquor license, and overdue rent of approximately $25,500. The Company believes that the defendants have valid defenses to the complaint, valid claims in the counterclaim and does not believe that the matter will have a material adverse effect on the business or financial condition of the Company. In the general course of business the Company, at various times, has been named in other lawsuits. The Company believes that it has meritorious defenses to these lawsuits and that resolution of these matters will not have a material adverse affect on the business or financial condition of the Company. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS No matters were submitted to a vote of the Company's security holders during the fourth quarter of the fiscal year ended August 31, 1997. However, on September 9, 1997, the Company held its annual meeting of shareholders at which the 6 incumbent Directors were re-elected, and the amendment to the Company's Stock Option Plan to increase by 500,000 shares the number of shares of the Company's common stock reserved for issuance under such plan was submitted for approval and approved by the Company's Shareholders. 14 15 PART II ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED SECURITY HOLDER MATTERS MARKET INFORMATION The Company's common stock is traded in the over-the-counter market and since April 1, 1994, prices have been quoted on the Nasdaq National Market, under the symbol MEGO. Prior to April 1, 1994, the common stock was quoted on the Nasdaq Small Cap Market under the symbol MEGO and, prior to May 1, 1994, was traded on the Boston Stock Exchange under the symbol MGO. The following table sets forth the high and low sales prices of the common stock as reported on the Nasdaq National Market for the periods presented:
HIGH LOW ----- ---- Fiscal Year 1996: First Quarter.................................................. $11 1/8 $4 1/2 Second Quarter................................................. 8 5/8 6 Third Quarter.................................................. 9 3/4 7 3/4 Fourth Quarter................................................. 9 3/8 5 3/8 Fiscal Year 1997: First Quarter.................................................. 10 5 5/8 Second Quarter................................................. 9 1/4 7 1/4 Third Quarter.................................................. 8 1/8 5 1/2 Fourth Quarter................................................. 9 1/4 6 3/8 Fiscal Year 1998: First Quarter (through November 7, 1997)(1).................... 8 3/16 2 3/4
- --------------- (1) On September 2, 1997, the Company distributed all of its 10 million shares of MMC's common stock to the Company's shareholders in the Spin-off. The Company believes the decline in the closing price of the common stock on September 3, 1997 to $3 1/8 per share from the closing price on September 2, 1997 of $8 per share is directly attributable to the Spin-off. As of November 7, 1997, there were 1,739 holders of record of the 21,009,506 outstanding shares of common stock. The closing sales price for the common stock on November 7, 1997 was $5.00. See "Item 1. Business -- General," "Item 7. MD&A -- Discontinued Operations of MMC" and Note 3 of Notes to Consolidated Financial Statements. The Company did not pay any cash dividends on its common stock during the fiscal years ended August 31, 1997 and 1996. The Company intends to retain future earnings for the operation and expansion of its business and does not currently anticipate paying cash dividends on its common stock. Any future determination as to the payment of such cash dividends would depend on a number of factors including future earnings, results of operations, capital requirements, the Company's financial condition and any restrictions under credit agreements existing from time to time, as well as such other factors as the Board of Directors might deem relevant. No assurance can be given that the Company will pay any dividends in the future. ITEM 6. SELECTED CONSOLIDATED FINANCIAL DATA The selected financial data set forth below have been derived from the consolidated financial statements of the Company and its subsidiaries. The consolidated financial statements as of August 31, 1997 and 1996 and for each of the three years in the period ended August 31, 1997 have been audited by Deloitte & Touche LLP, independent auditors, and are included elsewhere herein. The consolidated financial statements as of August 31, 1995, 1994 and 1993 and for the years ended August 31, 1994 and 1993 have been audited by Deloitte & Touche LLP, independent auditors, and are not included herein. 15 16 Certain reclassifications have been made to conform prior years with the current year presentation. As a result of the Spin-off, all fiscal years presented reflect the financial results of MMC as a discontinued operation as of September 1, 1993. See "Item 1. Business -- General," "Item 7. MD&A -- Discontinued Operations of MMC" and Note 3 of Notes to Consolidated Financial Statements for additional information regarding the Spin-off. The selected financial information set forth below should be read in conjunction with the consolidated financial statements, the related notes thereto and "Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations" included elsewhere herein (thousands of dollars, except per share amounts): CONSOLIDATED SELECTED FINANCIAL DATA(1)(2)(3)
FOR THE YEARS ENDED AUGUST 31, -------------------------------------------------------------- 1997 1996 1995 1994(4) 1993(4) ---------- ---------- ---------- ---------- ---------- INCOME STATEMENT DATA: REVENUES OF CONTINUING OPERATIONS: - ---------------------------------------- Timeshare interest sales, net......... $ 32,253 $ 27,778 $ 20,682 $ 19,521 $ 21,735 Land sales, net....................... 16,626 17,968 20,812 13,534 13,198 Gain on sale of notes receivable...... 2,013 1,116 1,586 875 631 Interest income....................... 7,168 6,594 7,238 8,089 9,094 Financial income...................... 2,922 1,253 508 30 13 Other(5).............................. 6,514 5,943 6,687 5,969 5,401 ---------- ---------- ---------- ---------- ---------- Total revenues of continuing operations....................... 67,496 60,652 57,513 48,018 50,072 ---------- ---------- ---------- ---------- ---------- COSTS AND EXPENSES OF CONTINUING OPERATIONS: - ---------------------------------------- Cost of sales(6)...................... 10,477 8,099 7,749 6,992 8,548 Commissions and selling............... 34,078 30,351 23,690 18,949 20,079 Depreciation.......................... 1,964 1,526 1,131 1,072 980 Interest expense...................... 8,458 7,314 6,306 4,707 4,441 General and administrative............ 17,175 15,849 12,909 11,274 10,027 Payments to assignors................. -- -- 7,252 8,526 4,632 ---------- ---------- ---------- ---------- ---------- Total costs and expenses of continuing operations............ 72,152 63,139 59,037 51,520 48,707 ---------- ---------- ---------- ---------- ---------- INCOME (LOSS) FROM CONTINUING OPERATIONS BEFORE INCOME TAXES................... (4,656) (2,487) (1,524) (3,502) 1,365 INCOME TAXES (BENEFIT).................. (12,662) (1,068) 1,016 761 2,218 ---------- ---------- ---------- ---------- ---------- INCOME (LOSS) FROM CONTINUING OPERATIONS............................ 8,006 (1,419) (2,540) (4,263) (853) INCOME (LOSS) FROM DISCONTINUED OPERATIONS, NET OF INCOME TAXES AND MINORITY INTEREST (7)................. 11,334 6,270 3,434 (1,511) (126) GAIN ON PRIOR DISCONTINUED OPERATIONS, NET OF INCOME TAXES OF $450(8)........ -- -- 873 -- -- ---------- ---------- ---------- ---------- ---------- NET INCOME (LOSS)....................... 19,340 4,851 1,767 (5,774) (979) CUMULATIVE PREFERRED STOCK DIVIDENDS(9).......................... -- 240 360 360 -- ---------- ---------- ---------- ---------- ---------- NET INCOME (LOSS) APPLICABLE TO COMMON STOCK................................. $ 19,340 $ 4,611 $ 1,407 $ (6,134) $ (979) ========== ========== ========== ========== ==========
16 17
FOR THE YEARS ENDED AUGUST 31, 1997 1996 1995 1994(4) 1993(4) ---------- ---------- ---------- ---------- ---------- PER SHARE DATA(10): PRIMARY: Income (loss) from continuing operations....................... $ 0.41 $ (0.08) $ (0.14) $ (0.24) $ (0.05) Income (loss) from discontinued operations....................... 0.58 0.33 0.19 (0.08) (0.01) Gain on prior discontinued operations....................... -- -- 0.05 -- -- Cumulative preferred stock dividends........................ -- (0.01) (0.02) (0.02) -- ---------- ---------- ---------- ---------- ---------- Net income (loss) applicable to common stock..................... $ 0.99 $ 0.24 $ 0.08 $ (0.34) $ (0.06) ========== ========== ========== ========== ========== Weighted-average number of common shares and common share equivalents outstanding.......... 19,528,470 19,087,387 18,087,153 17,820,170 17,145,101 ========== ========== ========== ========== ========== FULLY-DILUTED(11): Income (loss) from continuing operations....................... $ 0.41 $ (0.08) $ (0.14) Income from discontinued operations....................... 0.58 0.33 0.18 Gain on prior discontinued operations....................... -- -- 0.05 Cumulative preferred stock dividend......................... -- (0.01) (0.02) ---------- ---------- ---------- Net income applicable to common stock..................... $ 0.99 $ 0.24 $ 0.07 ========== ========== ========== Weighted-average number of common shares and common share equivalents outstanding.......... 19,602,967 19,087,387 18,939,201 ========== ========== ========== BALANCE SHEET DATA: Total assets.......................... $ 178,303 $ 145,505 $ 107,910 $ 87,319 $ 91,153 Net assets of discontinued operations......................... 53,276 30,514 19,234 4,139 N/A Total liabilities excluding subordinated debt.................. 100,745 109,963 76,328 67,796 66,144 Subordinated debt(12)................. 4,321 9,691 9,352 -- -- Redeemable preferred stock............ -- -- 3,000 3,000 3,000 Total stockholders' equity............ 73,237 25,851 19,230 16,523 22,009
- --------------- (1) On September 2, 1997, the Company distributed all of its 10 million shares of MMC's common stock to the Company's shareholders in a tax-free Spin-off. The operations of MMC have been reclassified as discontinued operations and prior years' Consolidated Financial Statements of the Company included herein reflect the reclassification accordingly. See "Item 1. Business -- General," "Item 7. MD&A -- Discontinued Operations of MMC" and Note 3 of Notes to Consolidated Financial Statements. (2) At August 31, 1993, effective September 1, 1992, the Company adopted the provisions of Statement of Financial Accounting Standards (SFAS) No. 109 (SFAS 109), requiring an asset/liability approach for financial accounting and reporting of income taxes. See Notes 5 and 17 of Notes to Consolidated Financial Statements. (3) The income statement data, per share data and balance sheet data herein for the five fiscal years are not necessarily indicative of the results to be expected in the future. Certain reclassifications have been made to conform prior years with the current presentation. (4) The Company has restated certain of its previously issued financial statements including for the year ended August 31, 1994, upon which its independent auditors had rendered unqualified opinions. The financial data presented herein gives effect to those restatements. (5) Other revenues include incidental operations, management fees from owners' associations, and amortization of negative goodwill. 17 18 (6) Direct cost of sales includes costs of sales of timeshare interests, land and incidental operations. (7) Income from discontinued operations, net of taxes and minority interest, includes the net income from MMC, after tax, reduced by the related minority interests and certain general and administrative expense related to the discontinued operations. Income from discontinued operations, net of taxes and minority interest, during fiscal 1993 relates to the minority interest in income of an 80% owned subsidiary. (8) A gain on discontinued operations of $873,000 after deducting $450,000 of tax was recognized in fiscal 1995. See Note 3 of Notes to Consolidated Financial Statements. (9) See Note 16 of Notes to Consolidated Financial Statements. (10) No cash dividends per common share were declared during the fiscal years included herein. (11) Fully-diluted earnings per share are not presented for the fiscal years ended August 31, 1994 and 1993 because the effect would have been anti-dilutive. (12) In payment of the exercise price of $4,250,000 of warrants exercised for 1,000,000 shares of the Company's common stock by the Assignors, the subordinated debt due to the Assignors was reduced by that amount in August 1997. See Note 15 of Notes to Consolidated Financial Statements and "Item 13. Certain Relationships and Related Transactions." ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS SPECIAL CAUTIONARY NOTICE REGARDING FORWARD-LOOKING STATEMENTS The following Management's Discussion and Analysis of Financial Condition and Results of Operations and the foregoing Business sections contain certain forward-looking statements and information relating to the Company that are based on the beliefs of management as well as assumptions made by and information currently available to management. Such forward-looking statements include, without limitation, the Company's expectation and estimates as to the Company's business operations, including the introduction of new timeshare and land sales programs and future financial performance, including growth in revenues and net income and cash flows. In addition, included herein the words "anticipates," "believes," "estimates," "expects," "plans," "intends" and similar expressions, as they relate to the Company or its management, are intended to identify forward-looking statements. Such statements reflect the current views of the Company's management with respect to future events and are subject to certain risks, uncertainties and assumptions. In addition, the Company specifically advises readers that the factors listed under the caption "Liquidity and Capital Resources" could cause actual results to differ materially from those expressed in any forward-looking statement. Should one or more of these risks or uncertainties materialize, or should underlying assumptions prove incorrect, actual results may vary materially from those described herein as anticipated, believed, estimated or expected. The following discussion and analysis should be read in conjunction with the Consolidated Financial Statements, including the notes thereto, contained elsewhere herein. GENERAL The business of the Company after the acquisition of PEC (see "Item 1. Business" and "Item 13. Certain Relationships and Related Transactions"), and following the Spin-off, is primarily the marketing, financing, and sale of timeshare interests, retail lots and land parcels, and servicing the related notes receivable. Discontinued Operations of Mego Mortgage Corporation The Company formed MMC in June 1992 as a wholly-owned subsidiary and operated MMC as such until November 1996. MMC is a specialized consumer finance company that originates, purchases, sells, securitizes and services consumer loans consisting primarily of conventional uninsured home improvement and debt consolidation loans which are generally secured by liens on residential property. 18 19 In November 1996, MMC consummated the IPO and as a result, the Company's ownership of MMC was reduced to approximately 81.3% of the outstanding common stock. On September 2, 1997, the Company distributed all of its 10 million shares of MMC's common stock to the Company's shareholders in the Spin-off. To fund MMC's past operations and growth and in conjunction with filing consolidated tax returns, MMC incurred debt and other obligations due to the Company and its subsidiary, PEC. The amount of debt due to the Company was $10.1 million at August 31, 1997 and $12.8 million at August 31, 1996, of which $3.4 million was paid in October 1997 together with $500,000 advanced by the Company to MMC in September 1997. It is not anticipated that the Company will provide funds to MMC or guarantee MMC's indebtedness in the future, although it may do so. MMC also has agreements with PEC for providing management services and loan servicing. The accompanying Consolidated Statements of Operations reflect the operating results of MMC as discontinued operations in accordance with APB Opinion No. 30. For additional information see Note 3 of Notes to Consolidated Financial Statements and "Item 1. Business -- General." The Consolidated Statements of Operations reflect the continuing and discontinued operations of the Company for the fiscal years ended August 31, 1997, 1996 and 1995. Consolidated Pro Forma Statements of Operations of the continuing operations are presented below for the fiscal years ended August 31, 1997, 1996 and 1995 and for each of the quarters of fiscal 1997 and 1996. These unaudited Consolidated Pro Forma Statements of Operations are based on the historical statements of the periods presented and provide an understanding of the results of the Company on a stand-alone basis excluding the operations of MMC and the prior discontinued operations in fiscal 1995. The following Consolidated Pro Forma Statements of Operations give effect to the Spin-off as if it had occurred September 1, 1994 (thousands of dollars):
FOR THE YEARS ENDED AUGUST 31, -------------------------------- PRO FORMA 1997 1996 1995 - ------------------------------------------------------------- -------- ------- ------- REVENUES: Timeshare interest and land sales, net....................... $ 48,879 $45,746 $41,494 Gain on sale of receivables.................................. 2,013 1,116 1,586 Interest income.............................................. 7,168 6,594 7,238 Financial income and other................................... 9,436 7,196 7,195 -------- ------- ------- Total revenues..................................... 67,496 60,652 57,513 -------- ------- ------- EXPENSES: Direct costs of timeshare interest and land sales............ 7,493 5,842 5,141 Operating expenses........................................... 56,201 49,983 40,338 Interest expense............................................. 8,458 7,314 6,306 Payments to assignors........................................ -- -- 7,252 -------- ------- ------- Total expenses............................................. 72,152 63,139 59,037 -------- ------- ------- Loss before income taxes..................................... (4,656) (2,487) (1,524) Income taxes (benefit)....................................... (12,662) (1,068) 1,016 -------- ------- ------- Income (loss) from continuing operations..................... 8,006 (1,419) (2,540) Cumulative preferred stock dividends......................... -- 240 360 -------- ------- ------- Net income (loss) applicable to common stock................. $ 8,006 $(1,659) $(2,900) ======== ======= =======
19 20
FOR THE THREE MONTHS ENDED ---------------------------------------------------------------- AUGUST 31, MAY 31, FEBRUARY 28, NOVEMBER 30, PRO FORMA 1997 1997 1997 1996 - ------------------------------------------- ------------ --------- -------------- -------------- REVENUES: Timeshare interest and land sales, net..... $ 12,774 $ 13,202 $ 11,956 $ 10,947 Gain on sale of receivables................ 620 503 441 449 Interest income............................ 1,828 1,941 1,762 1,637 Financial income and other................. 2,219 2,609 2,493 2,115 ------- ------- ------- ------- Total revenues................... 17,441 18,255 16,652 15,148 ------- ------- ------- ------- EXPENSES: Direct costs of timeshare interest and land sales.................................... 2,501 1,746 1,612 1,634 Operating expenses......................... 14,967 14,326 14,014 12,894 Interest expense........................... 2,107 2,084 2,116 2,151 ------- ------- ------- ------- Total expenses................... 19,575 18,156 17,742 16,679 ------- ------- ------- ------- Income (loss) before income taxes.......... (2,134) 99 (1,090) (1,531) Income tax benefit......................... (7,653) (2,084) (2,458) (467) ------- ------- ------- ------- Net income (loss).......................... $ 5,519 $ 2,183 $ 1,368 $ (1,064) ======= ======= ======= =======
FOR THE THREE MONTHS ENDED ---------------------------------------------------------------- AUGUST 31, MAY 31, FEBRUARY 28, NOVEMBER 30, PRO FORMA 1996 1996 1996 1995 - ------------------------------------------- ------------ --------- -------------- -------------- REVENUES: Timeshare interest and land sales, net..... $ 10,345 $ 12,449 $ 11,159 $ 11,793 Gain on sale of receivables................ 251 394 39 432 Interest income............................ 2,361 1,843 1,366 1,024 Financial income and other................. 2,627 2,374 836 1,359 ------- ------- ------- ------- Total revenues................... 15,584 17,060 13,400 14,608 ------- ------- ------- ------- EXPENSES: Direct costs of timeshare interest and land sales.................................... 1,499 1,447 1,387 1,509 Operating expenses......................... 14,209 13,641 11,007 11,126 Interest expense........................... 2,278 2,856 1,057 1,123 ------- ------- ------- ------- Total expenses................... 17,986 17,944 13,451 13,758 ------- ------- ------- ------- Income (loss) before income taxes.......... (2,402) (884) (51) 850 Income taxes (benefit)..................... (595) (485) (122) 134 ------- ------- ------- ------- Net income (loss).......................... (1,807) (399) 71 716 Cumulative preferred stock dividends....... 60 40 60 80 ------- ------- ------- ------- Net income (loss) applicable to common stock.................................... $ (1,867) $ (439) $ 11 $ 636 ======= ======= ======= =======
The unaudited consolidated pro forma financial information is presented for informational purposes only and should be read in conjunction with the Company's historical Consolidated Financial Statements and Notes thereto and "Management's Discussion and Analysis of Financial Condition and Results of Operations" set forth herein. The pro forma financial statements should not be considered indicative of the operating results which the Company will achieve in the future if it were operated on an independent, stand-alone basis because, among other things, these statements are based on historical rather than prospective information and upon certain assumptions which are subject to change. The unaudited Consolidated Pro Forma Statements of Operations of the Company reflect, in management's opinion, all adjustments necessary to fairly state the pro forma results of operations for the periods presented and to make the unaudited pro forma statements not misleading. 20 21 PEC PEC recognizes revenue primarily from sales of timeshare interests and land sales in resort areas, gain on sale of receivables and interest income. PEC sells its consumer receivables while generally retaining the servicing rights. Revenue from sales of timeshare interests and land is recognized after the requisite rescission period has expired and at such time as the purchaser has paid at least 10% of the sales price for sales of timeshare interests and 20% of the sales price for land sales. Land sales typically meet these requirements within eight to ten months of closing, and sales of timeshare interests typically meet these requirements at the time of sale. The sales price, less a provision for cancellation, is recorded as revenue and the allocated cost related to such net revenue of the timeshare interest or land parcel is recorded as expense in the year that revenue is recognized. When revenue related to land sales is recognized, the portion of the sales price attributable to uncompleted required improvements, if any, is deferred. Notes receivable with payment delinquencies of 90 days or more have been considered in determining the allowance for cancellations. Cancellations occur when the note receivable is determined to be uncollectible and the related collateral, if any, has been recovered. Cancellation of a note receivable in the year the revenue is recognized is deemed to not represent a sale and is accounted for as a reversal of the revenue with an adjustment to cost of sales. Cancellation of a note receivable subsequent to the year the revenue was recognized is charged to the allowance for cancellations. Gain on sale of notes receivable includes the present value of the differential between contractual interest rates charged to borrowers on notes receivable sold by PEC and the interest rates to be received by the purchasers of such notes receivable, after considering the effects of estimated prepayments and a normal servicing fee. PEC retains certain participations in cash flows from the sold notes receivable and generally retains the associated servicing rights. PEC generally sells its notes receivable at par value. The present values of expected net cash flows from the sale of notes receivable are recorded at the time of sale as interest only receivables. Interest only receivables are amortized as a charge to income, as payments are received on the retained interest differential over the estimated life of the underlying notes receivable. Interest only receivables are recorded at the lower of unamortized cost or estimated fair value. The expected cash flows used to determine the interest only receivables asset have been reduced for potential losses under recourse provisions of the sales agreements. Reserve for notes receivable sold with recourse represents PEC's estimate of the fair value of its future credit losses to be incurred over the lives of the notes receivable in connection with the recourse provisions of the sales agreements and is shown separately as a liability in the Company's Consolidated Statements of Financial Condition. In discounting cash flows related to notes receivable sales, PEC defers servicing income at an annual rate of 1% and discounts cash flows on its sales at the rate it believes a purchaser would require as a rate of return. Earned servicing income is included under the caption of financial income. The cash flows were discounted to present value using a discount rate which averaged 15% in each of fiscal years 1997, 1996 and 1995. PEC has developed its assumptions based on experience with its own portfolio, available market data and ongoing consultation with its investment bankers. In determining expected cash flows, management considers economic conditions at the date of sale. In subsequent periods, these estimates may be revised as necessary using the original discount rate, and any losses arising from prepayment and loss experience will be recognized as realized. Provision for cancellations relating to notes receivable is recorded as expense in amounts sufficient to maintain the allowance at a level considered adequate to provide for anticipated losses resulting from customers' failure to fulfill their obligations under the terms of their notes receivable. PEC records provision for cancellations at the time revenue is recognized, based on historical experience and current economic factors. The related allowance for cancellations represents PEC's estimate of the amount of the future credit losses to be incurred over the lives of the notes receivable. The allowance for cancellations is reduced by actual cancellations experienced, including cancellations related to previously sold notes receivable which were reacquired pursuant to the recourse obligations discussed herein. Such allowance is also reduced to establish the separate liability for reserve for notes receivable sold with recourse. PEC's judgment in determining the 21 22 adequacy of this allowance is based upon a periodic review of its portfolio of notes receivable. These reviews take into consideration changes in the nature and level of the portfolio, current economic conditions which may affect the purchasers' ability to pay, changes in collateral values, estimated value of inventory that may be reacquired and overall portfolio quality. Changes in the allowance as a result of such reviews are included in the provision for cancellations. Recourse to PEC on sales of notes receivable is governed by the agreements between the purchasers and PEC. The reserve for notes receivable sold with recourse represents PEC's estimate of the fair value of future credit losses to be incurred over the lives of the notes receivable. A liability for reserve for notes receivable sold with recourse is established at the time of each sale based upon PEC's estimate of future recourse obligations under each agreement of sale. For notes receivable sold between September 30, 1992 and December 31, 1996, the liability was determined in accordance with Emerging Issues Task Force (EITF) Issue No. 92-2, on a "discounted to present value" basis using an interest rate equivalent to the risk-free market rate for securities with a duration similar to that estimated for the underlying notes receivable. Effective January 1, 1997, the estimated liability is recorded at its fair value as a result of the adoption of SFAS 125 (as hereinafter defined). Fees for servicing notes receivable originated or acquired by PEC and sold with servicing rights retained are generally based on a stipulated percentage of the outstanding principal balance of such notes receivable and are recognized when earned. Interest received on notes receivable sold, less amounts paid to investors, is reported as financial income. Interest only receivables are amortized systematically to reduce notes receivable servicing income to an amount representing normal servicing income and the present value discount. Late charges and other miscellaneous income are recognized when collected. Costs to service notes receivable are recorded to expense as incurred. Interest income represents the interest received on loans held in PEC's portfolio, the accretion of the discount on the interest only receivables and interest on cash funds. Total costs and expenses consist primarily of commissions and selling expenses, general and administrative expenses, direct costs of sales of timeshare interests and land, depreciation and amortization and interest expense. Commissions and selling costs directly attributable to unrecognized sales are accounted for as deferred selling costs until such time as the sale is recognized. The Company incurs a portion of operating expenses of the timeshare owners' associations based on ownership of unsold timeshare interests at each of the respective timeshare properties. These costs are referred to as "association assessments" and are included in the Consolidated Statements of Operations under the caption of general and administrative expenses. Management fees received from the associations are included under the caption of other revenues. These fees are not deemed to be the result of a separate revenue generating line of business since the management activities to which they relate are part of the support of the timeshare business and the fees are actually a reduction of the expense the Company incurs to fulfill obligations regarding timeshares. The following table sets forth certain data regarding notes receivable additions and servicing through sales of timeshare interests and land:
FOR THE YEARS ENDED AUGUST 31, ----------------------------- 1997 1996 ------------ ------------ Principal balance of notes receivable additions......... $ 51,086,183 $ 48,463,383 ============ ============ Number of notes receivable additions, net of upgrades and downgrades........................................ 5,540 5,040 ============ ============ Notes receivable serviced at end of period.............. $118,641,311 $120,708,887 ============ ============
Land sales as of August 31, 1997 exclude $11.9 million of sales not yet recognized under generally accepted accounting principles (GAAP) since the requisite payment amounts have not yet been received. If ultimately recognized, revenues from these sales would be reduced by a related provision for cancellations of $1.7 million, estimated deferred selling costs of $3.2 million and cost of sales of $1.1 million. REAL ESTATE RISK Real estate development involves significant risks, including risks that suitable properties will not be available at reasonable prices, that acquisition, development and construction financing may not be available 22 23 on favorable terms or at all, that infrastructure and construction costs may exceed original estimates, that construction may not be completed on schedule, and that upon completion of construction and improvements, properties may not be sold on favorable terms or at all. In addition, PEC's timeshare activities, as well as its ownership, improvement, subdivision and sale of land, are subject to comprehensive federal, state and local laws regulating environmental and health matters, protection of endangered species, water supplies, zoning, land development, land use, building design and construction and other matters. Such laws and difficulties in obtaining, or the failure to obtain, the requisite licenses, permits, allocations, authorizations and other entitlements pursuant to such laws can adversely impact the development and completion of PEC's projects. The enactment of "slow-growth" or "no-growth" initiatives in any area where PEC sells land or timeshare interests could also delay or preclude entirely the development of such properties. RESTATEMENT AND SEC INVESTIGATION As previously reported, the Company has restated certain of its previously issued financial statements, including for the year ended August 31, 1994, upon which its independent auditors had rendered unqualified opinions. As a result of the restatement of the Company's financial statements and certain trading in its common stock, the Securities and Exchange Commission (SEC) has commenced a formal investigation to determine, among other things, whether the Company, and/or its officers and directors, violated applicable federal securities laws in connection with the preparation and filing of the Company's previously issued financial statements or such trading. Possible penalties for violation of federal securities laws include civil remedies, such as fines and injunctions, as well as criminal sanctions. CERTAIN PAYMENTS AND AMORTIZATION OF NEGATIVE GOODWILL In connection with the assignment to the Company in 1988 by affiliates of certain officers and directors of the Company (Assignors) of the right to acquire PEC, the Company became obligated to make quarterly payments to the Assignors equal to 63% of the cash balances of PEC, during the 7-year period ended January 31, 1995, that could be used to pay a dividend without violating PEC's loan agreements. Accrual of amounts owed under such assignment agreement to the Assignors ended on January 31, 1995, when their right to the accrual expired, at which time PEC owed the Assignors $13.3 million. On March 2, 1995, $10 million of such amount was converted to subordinated debt. See Notes 15 and 20 of Notes to the Consolidated Financial Statements for further discussion. At the time of the acquisition of PEC, the underlying book value of the net assets acquired exceeded the purchase price paid by the Company by $42.3 million, resulting in the creation of negative goodwill (Revaluation Adjustment). Of this amount, $20 million was not amortized but was instead reduced as additional payments were accrued to the Assignors. Amounts accrued to the Assignors in excess of $20 million were expensed as such accruals were made. The amortization of the remaining $22.3 million of the Revaluation Adjustment was directly affected by the level of collections of the receivables of PEC included in the acquired assets. As proceeds of these receivables were collected, through installment payments or sale, a portion of the Revaluation Adjustment included as a contra account in notes receivable was recorded to income as amortization of negative goodwill, which amortization was completed at February 28, 1995. The Company also amortizes over a five-year period ending February 1998 negative goodwill related to the excess of the underlying book value over the purchase price paid in 1993 for the acquisition of the minority interest of Vacation Spa Resorts, Inc. (VSR), formerly an 80%-owned subsidiary. The Consolidated Financial Statements of the Company accordingly reflect amortization of a portion of the Revaluation Adjustment (Revaluation Amortization), amortization of the negative goodwill associated with the acquisition of the VSR minority interest and accrual of payments to the Assignors. RESULTS OF OPERATIONS Year Ended August 31, 1997 Compared to Year Ended August 31, 1996 PEC Total revenues for PEC increased 11.1% or $6.7 million to $67.4 million during fiscal 1997 from $60.7 million during fiscal 1996 primarily due to an increase in timeshare sales to $32.3 million in fiscal 1997 23 24 from $27.8 million in fiscal 1996 and an increase in gain on sale of notes receivable and interest income from $7.7 million to $9.1 million. Timeshare interests and land sales, net, increased to $48.9 million in fiscal 1997 from $45.7 million in fiscal 1996, an increase of 6.8%. Gross sales of timeshare interests increased to $39.9 million in fiscal 1997 from $33.2 million in fiscal 1996, an increase of 20.1%. Net sales of timeshare interests increased to $32.3 million from $27.8 million, an increase of 16.1%. The provision for cancellations represented 19.1% and 16.3% of gross sales of timeshare interests for the years ended August 31, 1997 and 1996, respectively. The increase in the provision for cancellations was primarily due to higher cancellation experience during the current fiscal year. During the first quarter of fiscal 1997, the Ramada Vacation Suites at Indian Shores, Florida was completed and 360 timeshare interests in that resort were sold through August 31, 1997. The number of cancellations during fiscal 1997 was 1,496 compared to 1,216 during fiscal 1996. The number of exchanges, generally for timeshares, which are primarily made for upgrades, during fiscal 1997 was 3,749 compared to 3,305 during fiscal 1996. Gross sales of land decreased to $19.2 million in fiscal 1997 from $22.3 million in fiscal 1996, a decrease of 13.9%. Net sales of land decreased to $16.6 million in fiscal 1997 from $18 million in fiscal 1996, a decrease of 7.5%. The provision for cancellations decreased to 13.6% for the year ended August 31, 1997 from 19.6% of gross sales of land for the year ended August 31, 1996, primarily due to a decrease in cancellation experience from the prior years. The 1997 decrease in gross land sales was the result of PEC's emphasis shift, as part of its strategic plan, from sales of land, to sales of timeshare interests due both to its diminishing inventory of land available for sale and its increasing inventory of timeshare interests from the opening of new timeshare resorts. The shift from land sales to timeshare sales is due primarily to the reduction of PEC's current land inventory which has not been fully replenished with additional land due generally to the unavailability of suitable land at acceptable prices. Gain on sale of receivables increased to $2 million for fiscal 1997 from $1.1 million for fiscal 1996. This increase resulted from sales of timeshare receivables and land receivables increasing to $30.1 million in fiscal 1997 from $16 million in fiscal 1996. PEC periodically sells receivables to reduce the outstanding balances under its lines of credit. Interest income increased to $7.1 million in fiscal 1997 from $6.6 million for fiscal 1996, primarily due to the increased average outstanding portfolio of timeshare notes receivable. Financial income increased to $2.9 million in fiscal 1997 from $1.3 million in fiscal 1996, an increase of 133.2%. The increase is a result of the increased number of loans serviced by PEC, generating increased servicing fees. As a result of the foregoing, total PEC revenues increased to $67.4 million during fiscal 1997 from $60.7 million during fiscal 1996. Total costs and expenses increased to $69.2 million for fiscal 1997 from $59.3 million for fiscal 1996, an increase of 16.6%. The increase resulted primarily from an increase in commissions and selling expense to $34.1 million from $30.4 million, an increase of 12.3%; an increase in general and administrative expenses to $15.6 million from $13.7 million, an increase of 13.4%, and an increase in direct costs of timeshare interest sales to $5.9 million from $4 million, an increase of 48.1%. PEC's commissions and selling expenses increased primarily as a result of increased sales and costs relating to the establishment of new marketing programs during fiscal 1997 and strategies designed to increase sales of timeshare interests, market research costs, additional staffing, increased advertising costs and additional sales offices. The increase in general and administrative expenses is primarily due to increases in payroll related to hiring of additional administrative personnel and Association costs related to a higher level of unsold timeshare inventory. In June 1997, sales commenced at PEC's new Orlando, Florida timeshare property and 1,122 new upscale, luxury timeshare interests in Las Vegas are expected to become available for sale in September 1997. The increase in direct costs of timeshare sales is directly attributable to the higher costs to develop new timeshare inventory. As a percentage of gross sales of timeshare interests and land, commissions and selling expenses relating thereto increased to 57.7% in fiscal 1997 from 54.7% in fiscal 1996, and cost of sales increased to 12.7% in 24 25 fiscal 1997 from 10.5% in fiscal 1996. Sales prices of timeshare interests are typically lower than those of land, while selling costs per sale, other than commissions, are approximately the same in amount for timeshare interests and land; accordingly, PEC generally realizes lower profit margins from sales of timeshare interests than from sales of land. Depreciation expense increased to $2 million in fiscal 1997 from $1.5 million in fiscal 1996, an increase of 28.7%. The increase is a result of the additions made to property and equipment during fiscal 1997 to support continued growth. Property and equipment, net of accumulated depreciation, increased to $24.2 million at August 31, 1997 from $19.4 million at August 31, 1996, an increase of 24.9%. Interest expense increased to $7.1 million in fiscal 1997 from $5.6 million in fiscal 1996, an increase of 25.7%. The increase is a result of an increase in the average outstanding balance of notes and contracts payable during fiscal 1997 compared to fiscal 1996. A loss before income taxes of $1.8 million was recorded in fiscal 1997 compared to pre-tax income of $1.3 million in fiscal 1996. The decrease is largely due to the increase in commissions and selling expense and in general and administrative expense, together with a decrease in land sales, the effect of which was partially offset by an increase in timeshare sales. No income tax provision or benefit was recorded for fiscal 1997 compared to $455,000 in income tax provision for fiscal 1996. As part of an arrangement between PEC and the Company, regarding payment of taxes (the Tax Sharing Arrangement), PEC will not recognize a tax benefit for periods in which it records a loss. See Note 20 of Notes to Consolidated Financial Statements. As a result of the foregoing, PEC reported a net loss of $1.8 million during fiscal 1997 compared to net income of $882,000 during fiscal 1996. Company (consolidated) Income from continuing operations increased $9.4 million to income of $8 million in fiscal 1997 from a loss of $1.4 million in fiscal 1996, due principally to the recording of a $12.7 million income tax benefit. This increase was partially offset by a decrease of $2.6 million in PEC net income, due to increased expenses related to expansion of selling operations. See prior discussion for PEC. Income from discontinued operations, net of taxes and minority interest, increased 80.8% to $11.3 million during fiscal 1997 from $6.3 million during fiscal 1996 due to the growth and profitability of MMC. Income from discontinued operations represents net income from MMC of $14.8 million reduced by minority interest of $2.4 million and $1.1 million in general and administrative expenses related to the discontinued operations. See "Item 1. Business -- General," "Item 7. MD&A -- Discontinued Operations of MMC" and Note 3 of Notes to Consolidated Financial Statements. Total costs and expenses during fiscal 1997 were $72.2 million, an increase of 14.3% over $63.1 million in fiscal 1996. Commissions and selling expenses and general and administrative expenses increased 10.9% for fiscal 1997 compared to fiscal 1996 due primarily to the expansion of timeshare marketing efforts by PEC. Additionally, Mego Financial (parent only) continues to incur interest on subordinated debt. Total general and administrative expenses for Mego Financial (parent only) were primarily comprised of professional services, external financial reporting expenses, and regulatory and other public company corporate expenses. The income tax benefit for fiscal 1997 was $12.7 million compared to an income tax benefit of $1.1 million for fiscal 1996. The increase in the benefit was primarily due to the application of net operating loss (NOL) carryforwards and changes in certain income tax liability reserves. The changes in certain income tax liability reserves are a result of facts and circumstances determined in an extensive review and analysis of the Company's federal income tax liability completed in fiscal 1997. See Notes 5 and 17 of Notes to Consolidated Financial Statements. Net income applicable to common stock increased to $19.3 million during fiscal 1997 from $4.6 million during fiscal 1996, primarily due to the foregoing. 25 26 Year Ended August 31, 1996 Compared to Year Ended August 31, 1995 PEC Total revenues for PEC increased 6.7% or $3.8 million during fiscal 1996 compared to fiscal 1995 primarily due to an increase in net timeshare sales to $27.8 million in fiscal 1996 from $20.7 million in fiscal 1995. Timeshare interests and land sales, net, increased to $45.7 million in fiscal 1996 from $41.5 million in fiscal 1995, an increase of 10.2%. Gross sales of timeshare interests increased to $33.2 million in fiscal 1996 from $26.3 million in fiscal 1995, an increase of 26.3%. Net sales of timeshare interests increased to $27.8 million from $20.7 million, an increase of 34.3%. The provision for cancellations represented 16.3% and 21.3% of gross sales of timeshare interests for the years ended August 31, 1996 and 1995, respectively. The decrease in the provision for cancellations was primarily due to an improvement in historical performance of cancellations, resulting in a lower allowance requirement. Gross sales of land decreased to $22.3 million in fiscal 1996 from $24.7 million in fiscal 1995, a decrease of 9.6%. Net sales of land decreased to $18 million in fiscal 1996 from $20.8 million in fiscal 1995, a decrease of 13.7%. The provision for cancellations represented 19.6% and 15.8% of gross sales of land for the years ended August 31, 1996 and 1995, respectively. The 1996 decrease in gross land sales was the result of PEC shifting its emphasis as part of its strategic plan from sales of land to sales of timeshare interests due both to its diminishing inventory of land available for sale and its increasing inventory of timeshare interests from the opening of new timeshare resorts. The shift from land sales to timeshare sales was caused primarily by the reduction of PEC's current land inventory which has not been fully replenished with additional land due to the general unavailability of suitable land at acceptable prices. Gain on sale of receivables decreased to $1.1 million for fiscal 1996 from $1.6 million for fiscal 1995. This decrease resulted from sales of timeshare receivables and land receivables decreasing to $16 million in fiscal 1996 from $32.5 million in fiscal 1995. PEC periodically sells receivables to reduce the outstanding balances under its lines of credit. Interest income decreased to $6.6 million in fiscal 1996 from $6.8 million for fiscal 1995, primarily due to a relatively flat interest rate environment combined with a decrease in the average balance of notes receivable outstanding. Financial income increased to $1.3 million in fiscal 1996 from $580,000 in fiscal 1995, an increase of 146.7%. The increase is a result of the increased number of loans serviced by PEC, generating increased servicing fees. Revenues from incidental operations decreased to $3 million in fiscal 1996 from $3.8 million in fiscal 1995, a decrease of 21.7%, primarily due to a decrease in utility fees partially offset by an increase in golf fee revenue. As a result of the foregoing, total PEC revenues increased to $60.7 million during fiscal 1996 from $56.9 million during fiscal 1995. Total costs and expenses increased to $59.3 million for fiscal 1996 from $48.5 million for fiscal 1995, an increase of 22.2%. The increase resulted primarily from an increase in commissions and selling expenses to $30.4 million from $23.7 million, an increase of 28.1%; an increase in general and administrative expenses to $13.7 million from $11.2 million, an increase of 21.7%, and an increase in direct costs of timeshare interest sales to $4 million from $3 million, an increase of 34.3%. PEC's commissions and selling expenses increased primarily as a result of costs relating to the establishment of new marketing programs and strategies designed to increase sales of timeshare interests, market research costs, additional staffing, increased advertising costs, costs associated with the re-naming of PEC's timeshare resorts to Ramada Vacation Suites and additional sales offices. The increase in general and administrative expenses is primarily due to increases in payroll related to hiring of additional administrative personnel, maintenance fees related to unsold timeshare inventory, owners' association costs and professional fees. The increase in direct costs of timeshare interest sales is primarily due to the increased volume of sales. As a percentage of gross sales of timeshare interests and 26 27 land, commissions and selling expenses relating thereto increased to 54.7% in fiscal 1996 from 46.5% in fiscal 1995, and cost of sales increased to 10.5% in fiscal 1996 from 10.1% in fiscal 1995. Sales prices of timeshare interests are typically lower than those of land while selling costs are generally the same for timeshare interests and land; accordingly, PEC generally realizes lower profit margins from sales of timeshare interests than sales of land. Depreciation expense increased to $1.5 million in fiscal 1996 from $1.1 million in fiscal 1995, an increase of 34.9%. The increase is a result of the additions made to property and equipment during fiscal 1996. Property and equipment, net of accumulated depreciation increased to $19.4 million at August 31, 1996 from $12.3 million at August 31, 1995, an increase of 58.3%. Interest expense increased to $5.6 million in fiscal 1996 from $4.7 million in fiscal 1995, an increase of 20.1%. The increase is a result of an increase in average outstanding balances of notes and contracts payable, including two additional lines of credit. Income before income taxes decreased to $1.3 million in fiscal 1996 from $8.3 million in fiscal 1995, a decrease of 83.9%. The decrease is primarily due to the increase in commissions and selling expenses and general and administrative expenses. As a result of the foregoing, PEC's net income decreased to $882,000 in fiscal 1996 compared to $6.3 million in fiscal 1995. Company (consolidated) Loss from continuing operations decreased $1.1 million to $1.4 million in fiscal 1996 from $2.5 million in fiscal 1995, due principally to no payments to assignors during 1996 compared to $7.3 million during 1995. This was partially offset by a decrease of $5.4 million in PEC net income, due to increased expenses related to the expansion of selling and marketing operations. See prior discussion for PEC. Income from discontinued operations, net of taxes, increased 82.6% to $6.3 million during fiscal 1996 from $3.4 million during fiscal 1995 as a result of MMC's continued growth and profitability. Income from discontinued operations of $6.3 million during fiscal 1996 includes net income from MMC of $6.9 million reduced by $650,000 in general and administrative expense related to the discontinued operations. See "Item 1. Business -- General," "Item 7. MD&A -- Discontinued Operations of MMC" and Note 3 of Notes to Consolidated Financial Statements. Total costs and expenses during fiscal 1996 were $63.1 million, an increase of 6.9% over $59 million in fiscal 1995. Commissions and selling expense and general and administrative expense increased 26.2% for fiscal 1996 compared to fiscal 1995 due primarily to the expansion of timeshare and land marketing efforts in PEC. Additionally, Mego Financial (parent only) incurred interest expense related to the Assignors in fiscal 1995 and subordinated debt in 1996 and 1995. Total general and administrative expenses for Mego Financial (parent only) were primarily comprised of professional services, external financial reporting expenses, and regulatory and other public company corporate expenses. The income tax benefit for fiscal 1996 was $1.1 million compared to an income tax provision of $1 million for fiscal 1995. The change from an income tax provision to a tax benefit was primarily due to increased losses from the continuing operations of PEC and Mego Financial (parent only). Net income applicable to common stock increased to $4.6 million during fiscal 1996 from $1.4 million during fiscal 1995 primarily due to the foregoing. See Note 19 of Notes to Consolidated Financial Statements. LIQUIDITY AND CAPITAL RESOURCES Cash and cash equivalents for the Company was $10.4 million at August 31, 1997 compared to $2.7 million at August 31, 1996. The increase was primarily due to proceeds from the exercise of stock options and warrants in August 1997 prior to the Spin-off. The Company's principal cash requirements relate to PEC's acquisition of timeshare properties and land and the payment of commissions and selling expenses in 27 28 connection with timeshare and land sales and Mego Financial's payment of interest on subordinated debt. PEC requires continued access to sources of debt financing and sales in the secondary market for receivables. PEC PEC's cash requirements arise from the acquisition of timeshare properties and land, payments of operating expenses, payments of taxes and dividends to Mego Financial, payments of principal and interest on debt obligations, and payments of commissions and selling expenses in connection with sales of timeshare interests and land. Commissions and selling expenses payable by PEC in connection with sales of timeshare interests and land typically exceed the down payments received at the time of sale, as a result of which PEC generates a cash shortfall. This cash shortfall and PEC's other cash requirements are funded primarily through sales of receivables, PEC's lines of credit in the aggregate amount of $137.5 million and cash flows from operations. At August 31, 1997, no commitments existed for material capital expenditures. At August 31, 1997, PEC had arrangements with 5 institutional lenders under 6 agreements for the financing of receivables in connection with sales of timeshare interests and land and the acquisition of timeshare properties and land, which provide for 6 lines of credit of up to an aggregate of $137.5 million. Such lines of credit are secured by timeshare and land receivables and mortgages. At August 31, 1997, an aggregate of $62.1 million was outstanding under such lines of credit, and $75.4 million was available for borrowing. At August 31, 1997 and 1996, $62.1 million and $65.9 million, respectively, had been borrowed under these lines. Under the terms of these lines of credit, PEC may borrow 70% to 85% of the balances of the pledged timeshare and land receivables. Summarized lines of credit information and accompanying notes relating to these six lines of credit outstanding at August 31, 1997, consist of the following (thousands of dollars):
BORROWING MAXIMUM AMOUNT AT BORROWING REVOLVING AUGUST 31, 1997 AMOUNT EXPIRATION DATE(F) MATURITY DATE INTEREST RATE - --------------- --------- ------------------ -------------- -------------------- $39,113 $75,000 (a) May 15, 2000 Various Prime + 2.0 - 2.25% 4,599 15,000 (b) May 30, 1998 Various Prime + 2.0% 6,365 15,000 (c) March 29, 1998 March 29, 1999 LIBOR + 4.25% 4,140 (c) February 6, 15,000 1998 August 6, 1999 LIBOR + 4.25% 4,500 10,000 (d) August 1, 2000 August 1, 2003 Prime + 2.25% 3,372 7,500 (e) April 30, 1998 May 31, 2002 Prime + 2.0%
- --------------- (a) Restrictions include PEC's requirement to maintain a minimum tangible net worth of $20 million with such amount increasing each fiscal quarter after August 31, 1997 by an amount equal to 50% of PEC's consolidated net income for each quarter up to a maximum requirement of $25 million. The maximum borrowing amount was increased from $57 million to $75 million as of May 15, 1997. At August 31, 1997, $24.6 million was outstanding related to financings at prime +2%, of which $18 million of loans secured by land receivables mature May 15, 2010 and $6.6 million of loans secured by timeshare receivables mature May 15, 2007. The outstanding borrowing amount includes $3 million in acquisition and development (A&D) financing maturing May 20, 1998 and $5.9 million maturing July 1, 2003 for the financing of corporate office buildings; both loans are amortizing loans and bear interest at prime +2.25%. The remaining A&D and receivables loans and a resort lobby loan outstanding of $5.7 million are at prime +2% and mature between January 31, 1998 and May 15, 2000. (b) Restrictions include PEC's requirement to maintain a minimum tangible net worth of $25 million during the life of the loan. These credit lines include available financing for A&D and receivables. At August 31, 1997, $1.1 million was outstanding under the A&D loan which matured in November 1997 and is currently being extended to May 1999, and $3.5 million maturing June 1, 2002, was outstanding under the receivables loan. (c) Restrictions include PEC's requirement to maintain a minimum tangible net worth of $17 million during the life of the loan. These credit lines include available financings for A&D and receivables, however only the A&D lines are currently outstanding and bear interest at 90 day LIBOR +4.25%. The available 28 29 receivable financings would be at 90 day LIBOR +4% and have maturity dates of June 2005 and August 2005. (d) Restrictions include PEC's requirement to maintain a minimum tangible net worth of $25 million. This credit line is for the purpose of financing receivables and costs of remodeling. (e) Restrictions include PEC's requirement to maintain a minimum tangible net worth of $15 million. This credit line is for the purpose of financing receivables. (f) Revolving expiration dates represent the expiration of the revolving features of the lines of credit, at which time the credit lines become loans with fixed maturities. A schedule of the cash shortfall arising from recognized and unrecognized sales for the periods indicated is set forth below (thousands of dollars):
FOR THE YEARS ENDED AUGUST 31, ---------------------------------- 1997 1996 1995 -------- -------- -------- Commissions and selling expenses attributable to recognized and unrecognized sales................ $ 34,388 $ 29,863 $ 23,969 Less: Down payments................................ (13,966) (13,231) (12,796) -------- -------- -------- Cash Shortfall..................................... $ 20,422 $ 16,632 $ 11,173 ======== ======== ========
During the fiscal years ended August 31, 1997 and 1996, PEC sold notes receivable of $30.1 million and $16 million from which $25.3 million and $9.7 million of the sales proceeds were used to pay down debt during the fiscal years ended August 31, 1997 and 1996, respectively. The receivables, which have interest rates depending on the transaction ranging from 12.3% - 14.3% and 11.8% - 13.9% in fiscal 1997 and fiscal 1996, respectively, were sold to yield returns of 9% - 9.8% and 8.3% - 10.6% in fiscal 1997 and fiscal 1996, respectively, to the purchasers, with any excess interest received from the obligors being payable to PEC. At August 31, 1997, PEC was contingently liable to replace or repurchase notes receivable sold with recourse totaling $84 million. PEC sells notes receivable subject to recourse provisions as contained in each agreement. PEC is obligated under these agreements to replace or repurchase accounts that become over 90 days delinquent or are otherwise subject to replacement or repurchase. The repurchase provisions provide for substitution of receivables as recourse for $82.6 million of sold notes receivable and cash payments for repurchase relating to $1.4 million of sold notes receivable. At August 31, 1997 and 1996, the undiscounted amounts of the recourse obligations on such notes receivable were $9.7 million and $9.6 million, respectively. PEC periodically reviews the adequacy of this liability. These reviews take into consideration changes in the nature and level of the portfolio, current and future economic conditions which may affect the obligors' ability to pay, changes in collateral values, estimated value of inventory that may be reacquired and overall portfolio quality. Recourse to PEC on sales of notes receivable is governed by the agreements between the purchasers and PEC. The reserve for notes receivable sold with recourse represents PEC's estimate of its probable future credit losses to be incurred over the lives of the notes receivable. Proceeds from the sale of notes receivable sold with recourse were $30.1 million and $16 million for the years ended August 31, 1997 and 1996, respectively. A liability for reserve for notes receivable sold with recourse is established at the time of each sale based upon PEC's analysis of all probable losses resulting from PEC's recourse obligations under each agreement of sale. For notes receivable sold between September 30, 1992 and December 31, 1996, the liability was determined in accordance with EITF Issue No. 92-2, on a "discounted to present value" basis using an interest rate equivalent to the risk-free market rate for securities with a duration similar to that estimated for the underlying notes receivable. Effective January 1, 1997, the estimated liability is recorded at its fair value as a result of the adoption of SFAS 125. During fiscal years 1997 and 1996, PEC provided cash of $6.8 million and used cash of $15.9 million in operating activities, respectively. This increase was primarily due to increased notes receivable sales and payments on notes receivable. During fiscal years 1997 and 1996, PEC used cash of $1.5 million and $13.2 million in investing activities, respectively, which decreased as a result of a decline in purchases for 29 30 property and equipment and decreased advances to the parent in fiscal 1997. During fiscal years 1997 and 1996, PEC used cash of $5.6 million and provided cash of $26.4 million from financing activities, respectively, as a result of decreased borrowings and increased paydowns applied to such borrowings. Company (consolidated) At January 31, 1995, when accrual of payments to assignors ceased, $13.3 million was payable to the Assignors. On March 2, 1995, the Assignors agreed to defer payment of $10 million (Subordinated Debt) of the amounts due to them pursuant to an amendment to the Assignment and Assumption Agreement providing for the subordination of such amounts to payment of debt for money borrowed by the Company or obligations of the Company's subsidiaries guaranteed by the Company. Warrants (Warrants) to purchase 1 million shares of common stock, at an exercise price of $4.25 per share (the closing market price per share on March 2, 1995), were granted to the Assignors in consideration of the payment deferral and subordination. These Warrants were exercised in August 1997 in a non-cash transaction, whereby the Subordinated Debt was reduced by $4.25 million. Interest on the Subordinated Debt was to be paid semiannually at the rate of 10% per year starting September 1, 1995, and the Subordinated Debt was to be repaid in 7 equal semiannual payments commencing March 1, 1997. On June 14, 1995, the Company paid an aggregate of $809,000 to the Assignors, including interest in the amount of $59,000. In January 1997, the outstanding balance of payable to Assignors of $2.6 million (including interest of $45,000) was paid in full. Effective March 1, 1997, the Assignors received the first of what was originally 7 equal semiannual payments of $1,429,000 plus interest related to the repayment of the Subordinated Debt. However, in connection with the reduction of the Subordinated Debt in August 1997, payments aggregating $4.25 million were deemed paid and the semiannual payments will resume in March 1999, with a partial payment in September 1998. The Subordinated Debt is collateralized by a pledge of PEC's outstanding stock. Interest of $45,000 was paid during fiscal 1997 related to amounts payable to the Assignors and interest on Subordinated Debt of $1.2 million was paid during fiscal 1997. See "Item 13. Certain Relationships and Related Transactions" and Note 15 of Notes to Consolidated Financial Statements. During fiscal years 1997 and 1996, the Company provided cash of $32.5 million and used cash of $9.3 million in operating activities, respectively. The increase was due primarily to increased notes receivable sales and payments on notes receivables. During fiscal 1997 and 1996, the Company used cash of $19.8 million and $11.3 million, in discontinued operations, respectively. The increase was the result of continued growth of MMC. During fiscal years 1997 and 1996, the Company used cash of $7 million and $9.1 million in investing activities, respectively, which decreased as a result of a decline in purchases of property and equipment. During fiscal years 1997 and 1996, the Company provided cash of $1.9 million and $25.9 million in financing activities, respectively, as a result of decreased borrowings and increased paydowns applied to such borrowings. Capital expenditures during fiscal years 1997 and 1996 were $8.9 million and $20.9 million, respectively, for the acquisition of timeshare and land inventory and $6.8 million and $8.7 million, respectively, for the purchase of property and equipment. The Company made additional capital expenditures in 1997 for renovation of future timeshare inventory, refurbishment of present timeshare inventory and the acquisition of replacement equipment. No commitments existed at August 31, 1997 for material capital expenditures. The Company is currently in the process of conforming all of its computerized systems to be year 2000 (Y2000) compliant. Many of these systems are already Y2000 compliant and the Company expects such systems to be in full compliance before the end of 1999. The Company believes that its capital requirements will be met from cash balances, internally generated cash, existing lines of credit, sales of receivables, and the modification, replacement or addition to its lines of credit and new financings. 30 31 The components of the Company's debt, including lines of credit consist of the following (thousands of dollars):
AUGUST 31, ------------------- 1997 1996 ------- ------- Notes collateralized by receivables...................... $31,489 $38,178 Mortgages collateralized by real estate properties....... 32,311 31,078 Installment contracts and other notes payable............ 1,769 996 ------- ------- Total.......................................... $65,569 $70,252 ======= =======
FINANCIAL CONDITION August 31, 1997 Compared to August 31, 1996 Cash and cash equivalents increased 278.4% to $10.4 million at August 31, 1997 from $2.7 million at August 31, 1996, primarily as a result of the receipt of proceeds in connection with the exercise of common stock options and warrants in August 1997. Notes receivable, net, decreased 15.6% to $34.3 million at August 31, 1997 from $40.6 million at August 31, 1996 primarily as a result of increased receivable sales of $30.1 million during fiscal 1997 compared to $16 million during fiscal 1996. Receivable sales of $19.7 million and $10.4 million were recorded to two different financial institutions during fiscal 1997. The Company provides allowance for cancellations in amounts which, in the Company's judgment, will be adequate to absorb losses on notes receivable that may become uncollectible. The Company's judgment in determining the adequacy of this allowance is based on its continual review of its portfolio which utilizes historical experience and current economic factors. These reviews take into consideration changes in the nature and level of the portfolio, historical rates, collateral values, and current and future economic conditions which may affect the obligors' ability to pay, collateral values and overall portfolio quality. Changes in the aggregate of the allowance for cancellations, excluding discounts, and the reserve for notes receivable sold with recourse for the fiscal years ended August 31, 1997 and 1996, consisted of the following (thousands of dollars):
FOR THE YEARS ENDED AUGUST 31, -------------------------------- 1997 1996 1995 -------- ------- ------- Balance at beginning of year................................. $ 19,924 $18,821 $16,875 Provision for cancellations................................ 10,219 9,778 9,495 Amounts charged to allowance for cancellations and reserve for notes receivable sold with recourse................. (10,616) (8,675) (7,549) -------- ------- ------- Balance at end of year....................................... $ 19,527 $19,924 $18,821 ======== ======= =======
The allowance for cancellations and the reserve for notes receivable sold with recourse consisted of the following at these dates (thousands of dollars):
FOR THE YEARS ENDED AUGUST 31, ------------------------------- 1997 1996 1995 ------- ------- ------- Allowance for cancellations, excluding discounts.............. $10,824 $11,512 $11,677 Reserve for notes receivable sold with recourse............... 8,703 8,412 7,144 ------- ------- ------- Total............................................... $19,527 $19,924 $18,821 ======= ======= =======
31 32 Timeshare and land sales, net, increased to $48.9 million at August 31, 1997 from $45.7 million at August 31, 1996 which increased net notes receivable. Timeshare and land sales, net, are set forth in the following table (thousands of dollars):
FOR THE YEARS ENDED AUGUST 31, ------------------- 1997 1996 $ CHANGE % CHANGE ------- ------- -------- -------- Timeshare sales, net............................... $32,253 $27,778 $ 4,475 16.1% Land sales, net.................................... 16,626 17,968 (1,342) (7.5) ------- ------- ------ Total timeshare and land sales, net........... $48,879 $45,746 $ 3,133 6.8 ======= ======= ======
The implementation of SFAS No. 125 requires the reclassification of excess servicing rights as interest only receivables which are carried at fair market value. Interest only receivables increased 53.5% to $3.3 million at August 31, 1997 from $2.1 million at August 31, 1996. See Note 5 of Notes to Consolidated Financial Statements. Timeshare interests held for sale and land and improvements inventory increased 4% to $37.3 million at August 31, 1997 from $35.9 million at August 31, 1996 primarily as a result of the opening of the Indian Shores and Orlando timeshare resorts during fiscal 1997. Property and equipment, net, increased 24.9% to $24.2 million at August 31, 1997 from $19.4 million at August 31, 1996 due to increased capital expenditures related to expansion of CNUC and the expansion of various other Company facilities. Net assets of discontinued operations increased 74.6% to $53.3 million at August 31, 1997 from $30.5 million at August 31, 1996 primarily due to the growth and earnings of MMC. The $53.3 million represents the net assets of MMC at August 31, 1997 of $53.1 million and the Company's receivable of $10.1 million from MMC less the minority interest of $9.9 million at August 31, 1997. Of the $10.1 million, $9.7 million is due from MMC to the Company and $446,000 is due from MMC to PEC. After the Spin-off, MMC is obligated to pay the debt due to the Company, $3.9 million of which was paid in October 1997, under the terms of an agreement. See "Item 13. Certain Relationships and Related Transactions." Notes and contracts payable decreased 6.7% to $65.6 million at August 31, 1997 from $70.3 million at August 31, 1996 due to increased paydowns of debt with proceeds from receivable sales during fiscal 1997. Accounts payable and accrued liabilities increased to $17.2 million at August 31, 1997 from $15.6 million at August 31, 1996, primarily as a result of increases in accrued payroll, interest and other unpaid operational costs. Reserve for notes receivable sold with recourse increased 3.5% to $8.7 million at August 31, 1997 from $8.4 million at August 31, 1996 due to increased receivable sales. Recourse to the Company on sales of notes receivable is governed by the agreements between the purchasers and the Company. Income taxes payable decreased 38.1% to $6.2 million at August 31, 1997 from $10.1 million at August 31, 1996 primarily due to the application of NOL carryforwards and changes in certain income tax liability reserves. The changes in certain income tax liability reserves are a result of facts and circumstances determined in an extensive review and analysis of the Company's federal income tax liability completed in fiscal 1997. See Note 19 of Notes to Consolidated Financial Statements. Stockholders' equity increased 183.3% to $73.2 million at August 31, 1997 from $25.9 million at August 31, 1996 as a result of net income applicable to common stock of $19.3 million during fiscal 1997, the gain on sale of MMC stock of $13.1 million in November 1996, warrants valued at $3 million, issued in connection with a loan purchase commitment and the proceeds from the exercise of common stock warrants and options of $11.9 million. August 31, 1996 Compared to August 31, 1995 Cash and cash equivalents decreased 58.4% to $2.7 million at August 31, 1996 from $6.6 million at August 31, 1995 primarily as a result of the timing of receivable originations, sales and borrowings. 32 33 Restricted cash decreased 44.5% to $2.2 million at August 31, 1996 from $3.9 million at August 31, 1995 due to a reduced portfolio of loans sold, some of which are subject to restricted cash deposits. Notes receivable, net, increased 26.3% to $40.6 million at August 31, 1996 from $32.2 million at August 31, 1995 primarily as a result of increased sale of timeshare interests and land sales. Timeshare and land sales, net, increased to $45.7 million at August 31, 1996 from $41.5 million at August 31, 1995 which increased net notes receivable. Timeshare and land sales, net are set forth in the following table (thousands of dollars):
FOR THE YEARS ENDED AUGUST 31, ------------------- 1997 1996 $ CHANGE % CHANGE ------- ------- -------- -------- Timeshare sales, net............................... $27,778 $20,682 $ 7,096 34.3% Land sales, net.................................... 17,968 20,812 (2,844) (13.7) ------- ------- ------ Total timeshare and land sales, net........... $45,746 $41,494 $ 4,252 10.2 ======= ======= ======
Timeshare interests held for sale and land and improvements inventory increased 72.4% to $35.9 million at August 31, 1996 from $20.8 million at August 31, 1995 primarily as a result of additional inventory in Nevada previously under construction and made available for sale in fiscal 1996. Net assets of discontinued operations increased 58.7% to $30.5 million at August 31, 1996 from $19.2 million at August 31, 1995 primarily due to the growth and earnings of MMC. The $30.5 million represents the net assets of MMC at August 31, 1996 of $17.7 million and the Company's receivable from MMC at August 31, 1997 in the amount of $12.8 million. Of the $12.8 million, $12 million was due from MMC to the Company and $819,000 was due from MMC to PEC. Property and equipment, net, increased 58.3% to $19.4 million at August 31, 1996 from $12.3 million at August 31, 1995 due to increased purchases of office equipment related to facility expansion. Notes and contracts payable increased 62.4% to $70.3 million at August 31, 1996 from $43.3 million at August 31, 1995 due to additional borrowings to acquire additional inventory and other assets. Accounts payable and accrued liabilities increased 32.6% to $15.6 million at August 31, 1996 from $11.8 million at August 31, 1995, primarily as a result of increases in accrued payroll, interest and other unpaid operational costs. Reserve for notes receivable sold with recourse increased 17.7% to $8.4 million at August 31, 1996 from $7.1 million at August 31, 1995. Recourse to the Company on sales of notes receivable is governed by the agreements between the purchasers and the Company. Income taxes payable increased 28.4% to $10.1 million at August 31, 1996 from $7.8 million at August 31, 1995 due to increased income. Stockholders' equity increased 34.4% to $25.9 million at August 31, 1996 from $19.2 million at August 31, 1995 primarily as a result of net income applicable to common stock of $4.6 million during fiscal 1996. EFFECTS OF CHANGING PRICES AND INFLATION The Company's operations are sensitive to increases in interest rates and to inflation. Increased borrowing costs resulting from increases in interest rates may not be immediately recoverable from prospective purchasers. Inflationary increases are difficult to pass on to customers since increases in sales prices often result in lower sales closing rates and higher cancellations. The Company's notes receivable consist primarily of fixed-rate long term installment contracts that do not increase or decrease as a result of changes in interest rates charged to the Company. In addition, delinquency and cancellation rates may be affected by changes in the national economy. 33 34 SEASONALITY Sales of timeshare interests and land are somewhat seasonal. For the fiscal years ended August 31, 1997, 1996 and 1995, quarterly sales as a percentage of annual sales, for each of the fiscal quarters averaged: quarters ended November 30 -- 24.8%, quarters ended February 28 -- 22.9%, quarters ended May 31 -- 29.1%, and quarters ended August 31 -- 23.2%. The majority of the Company's customers are tourists. The Company's major marketing area, Las Vegas, Nevada, reaches peaks of tourist activity at periods different from the Company's other major marketing areas, such as Reno, Nevada, and Denver, Park and Huerfano Counties, Colorado, which are more active in summer than in winter. The Company's other major marketing areas, Honolulu, Hawaii, and Orlando, Florida, are not subject to seasonality. The Company is not dependent upon a limited number of customers whose loss would have a material adverse effect on the Company. RECENT ACCOUNTING PRONOUNCEMENTS The Financial Accounting Standards Board (the FASB) issued Statement No. 121 "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed Of" (SFAS 121). SFAS 121 requires that long-lived assets and certain identifiable intangibles be reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. SFAS 121 was effective for fiscal years beginning after December 15, 1995. The adoption of SFAS 121 did not have a material adverse effect on the Company's results of operations or financial condition. The FASB issued SFAS No. 123, "Accounting for Stock-Based Compensation," (SFAS 123), which established financial accounting and reporting standards for stock-based employee compensation plans and for transactions in which an entity issues its equity instruments to acquire goods or services from nonemployees. Those transactions must be accounted for based on the fair value of the consideration received or the fair value of the equity instruments issued, whichever is more reliably measurable. SFAS 123 is effective for fiscal years beginning December 15, 1995. The Company elected to continue to apply the provisions of Accounting Principles Board (APB) Opinion No. 25, "Accounting for Stock Issued to Employees," as permitted by SFAS 123, and, accordingly, provides pro forma disclosure in Note 18 of Notes to Consolidated Financial Statements. Statement No. 125, "Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities," (SFAS 125) was issued by the FASB in June 1996. SFAS 125 provides accounting and reporting standards for transfers and servicing of financial assets and extinguishments of liabilities. This statement also provides consistent standards for distinguishing transfers of financial assets that are sales from transfers that are secured borrowings. It requires that liabilities and derivatives incurred or obtained by transferors as part of a transfer of financial assets be initially measured at fair value. SFAS 125 also requires that servicing assets be measured by allocating the carrying amount between the assets sold and retained interests based on their relative fair values at the date of transfer. Additionally, this statement requires that the servicing assets and liabilities be subsequently measured by (a) amortization in proportion to and over the period of estimated net servicing income or loss and (b) assessment for asset impairment or increased obligation based on their fair values. SFAS 125 requires that the Company's excess servicing rights be measured at fair market value and be reclassified as interest only receivables and accounted for in accordance with SFAS No. 115 "Accounting for Certain Investments in Debt and Equity Securities" (SFAS 115). As required by SFAS 125, the Company adopted the new requirements effective January 1, 1997. Implementation of SFAS 125 did not have any material impact on the financial statements of the Company, as the book value of the Company's interest only receivables approximated fair value. SFAS No. 128, "Earnings per Share," (SFAS 128) was issued by the FASB in March 1997, effective for financial statements issued after December 15, 1997. SFAS 128 provides simplified standards for the computation and presentation of earnings per share (EPS), making EPS comparable to international standards. SFAS 128 requires dual presentation of "Basic" and "Diluted" EPS, by entities with complex capital structures, replacing "Primary" and "Fully-diluted" EPS under APB Opinion No. 15. See Note 5 of Notes to Consolidated Financial Statements for further discussion and SFAS 128 pro forma calculations. 34 35 ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA The following Consolidated Financial Statements of the Company and its subsidiaries are included herewith:
PAGE ----------- Independent Auditors' Report.................................................... F-2 Consolidated Statements of Financial Condition at August 31, 1997 and 1996...... F-3 Consolidated Statements of Operations -- Years Ended August 31, 1997, 1996 and 1995.......................................................................... F-4 - F-5 Consolidated Statements of Stockholders' Equity -- Years Ended August 31, 1997, 1996 and 1995................................................................. F-6 Consolidated Statements of Cash Flows -- Years Ended August 31, 1997, 1996 and 1995.......................................................................... F-7 - F-8 Notes to Consolidated Financial Statements -- Years Ended August 31, 1997, 1996 and 1995................................................................. F-9 - F-40
All other schedules are omitted because of the absence of conditions under which they are required or because the required information is included in the financial statements. ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE Not applicable. 35 36 PART III ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE COMPANY DIRECTORS, EXECUTIVE OFFICERS AND KEY EMPLOYEES The following table sets forth certain information with respect to the directors, executive officers and key employees of the Company.
NAME AGE POSITION - ------------------------- ---- -------------------------------------------------------------- Robert Nederlander 64 Chairman of the Board, Chief Executive Officer and Director Jerome J. Cohen 69 President and Director Don A. Mayerson 70 Executive Vice President, General Counsel and Secretary Herbert B. Hirsch 61 Senior Vice President, Chief Financial Officer, Treasurer and Director Eugene I. Schuster 60 Vice President and Director Jon A. Joseph 50 Vice President and Associate General Counsel Charles G. Baltuskonis 47 Vice President and Chief Accounting Officer John E. McConnaughy, Jr. 68 Director Wilbur L. Ross, Jr. 59 Director Frederick H. Conte 45 Executive Vice President and Chief Operating Officer of PEC Stuart Harelik 57 Senior Vice President Marketing and Sales of PEC
Robert Nederlander has been the Chairman of the Board and Chief Executive Officer of the Company since January 1988, when affiliates of the Assignors, including Mr. Cohen, acquired approximately 43% of the outstanding common stock of the Company (Share Acquisition). See "Item 13. Certain Relationships and Related Transactions." Mr. Nederlander is the Chairman of the Executive Committee and a member of the Audit Committee. Since July 1995, Mr. Nederlander has served on the Board of Directors of HFS, which, together with its subsidiary, entered into an agreement in April 1995 with the Company pursuant to which the Company is licensed to use the "Ramada" name in its timeshare operations. Mr. Nederlander has been Chairman of the Board of Riddell Sports Inc. since April 1988 and was Riddell Sports Inc.'s Chief Executive Officer from April 1988 through March 1993. From February 1992 until June 1992, Mr. Nederlander was also Riddell Sports Inc.'s interim President and Chief Operating Officer. Since November 1981, Mr. Nederlander has been President and a director of the Nederlander Organization, Inc., owner and operator of one the world's largest chains of legitimate theaters. Mr. Nederlander served as the Managing General Partner of the New York Yankees from August 1990 until December 1991, and has been a limited partner since 1973. Since October 1985, Mr. Nederlander has been President of Nederlander Television and Film Productions, Inc.; Vice Chairman of the Board from February 1988 to early 1993 of Vacation Spa Resorts, Inc., an affiliate of the Company; and Chairman of the Board of Allis-Chalmers Corp. from May 1989 to 1993, and from 1993 to 1996 as Vice Chairman. Mr. Nederlander remains a director of Allis-Chalmers Corp. Mr. Nederlander was elected to the Board of Directors of MMC in September 1996. In October 1996, Mr. Nederlander became a director of News Communications Inc., a publisher of community oriented free circulation newspapers. Mr. Nederlander was a senior partner in the law firm of Nederlander, Dodge and Rollins in Detroit, Michigan, from 1960 to 1989. Mr. Nederlander does not currently serve on a full time basis in his capacities with the Company. Jerome J. Cohen has been the President and a Director of the Company since the Share Acquisition. Mr. Cohen serves as a member of the Executive Committee and is Chairman of the Board of MMC, and is President and Chief Executive Officer of PEC. From April 1992 to June 1997, Mr. Cohen was a director of Atlantic Gulf Communities Inc., formerly known as General Development Corporation, a publicly held company engaged in land development, land sales and utility operations in Florida and Tennessee. Don A. Mayerson has been the Secretary of the Company since the Share Acquisition and the Executive Vice President and General Counsel of the Company since April 1988. Mr. Mayerson has served as a director of MMC since 1992 and served as Vice President, General Counsel and Secretary of MMC from 1992 to September 1996. 36 37 Herbert B. Hirsch has been the Senior Vice President, Chief Financial Officer, Treasurer and a Director of the Company since the Share Acquisition. Mr. Hirsch serves as a member of the Executive Committee and serves as a director of MMC and served as Vice President, Chief Financial Officer and Treasurer of MMC from 1992 to September 1996. Eugene I. Schuster has been a Vice President and a Director of the Company since the Share Acquisition. Mr. Schuster is a member of the Stock Option Committee. Mr. Schuster has also been Chief Executive Officer and Chairman of the Board of Directors of Venture Funding, Ltd., a business development corporation, since its inception in May 1983. Since February 1986, Mr. Schuster has been the President and Chief Executive Officer and a director of Quest BioTechnology, Inc., a publicly held biotechnology research and development firm. Since September 1985, Mr. Schuster has been a director of Wavemat, Inc., a publicly held company engaged in the manufacture and sale of microwave equipment for advanced materials processing. Since January 1988, Mr. Schuster has been the Chairman and from May 1988 through February 1995 was Chief Executive Officer, of Cellex Biosciences, Inc., a publicly held manufacturer of automated cell culture systems. Mr. Schuster is Chairman and Chief Executive Officer of Art Renaissance, Inc., a privately held company which operates several chains of retail art galleries. Mr. Schuster does not currently serve on a full time basis in his capacities with the Company. Charles G. Baltuskonis has been Chief Accounting Officer of the Company since April 1997. He is a certified public accountant and served as Senior Vice President and Controller of Chase Federal Bank from May 1995 to March 1997. Prior to that date, he was Chief Financial Officer of F&C Bancshares and First Coastal Bank, a Senior Vice President -Finance of Bank of New England, and was a Senior Manager with the public accounting firm of Ernst & Young. John E. McConnaughy, Jr. has been a Director of the Company since 1984. Mr. McConnaughy serves as Chairman of the Audit Committee and a member of the Stock Option and Executive Incentive Compensation Committees. Mr. McConnaughy was Chairman and Chief Executive Officer of Peabody International Corp. from 1969 to 1986. He was Chairman and Chief Executive Officer of GEO International Corp. (GEO), a nondestructive testing, screen printing and oil field services company, from 1981 to 1992. GEO was spun off in 1981 and became publicly held. On October 25, 1993 GEO filed for protection under Chapter 11 of the U.S. Bankruptcy Code. Mr. McConnaughy has been a director of Oxigene, Inc., Texstar Corporation, MAI Corporation, Akzona Corp., First Bank Corp. (New Haven), Beringer Co., Inc. the Pullman Co., Moore McCormack Resources and Peabody International Corp. He is currently on the Board of Directors of Transact International, Inc., DeVlieg Bullard, Inc., Levcor International, Inc., Riddell Sports, Inc. and Wave Systems, Inc. He is also Chairman of the Board of Excellence Group, Inc., a privately held cable company. Mr. McConnaughy is on the Board of Trustees and Executive Committee of the Strang Cancer Prevention Center and is Chairman of the Board of the Harlem School of the Arts. Wilbur L. Ross, Jr. has been a Director of the Company since 1984. Mr. Ross serves as a member of the Audit, Stock Option and Executive Incentive Compensation Committees. Mr. Ross has been a Senior Managing Director of Rothschild Inc., an investment banking firm, since August 1976. Mr. Ross serves as a director of Syms Corporation and is Chief Executive Officer and a director of News Communications, Inc. and is a director of KTI, Inc. COMPLIANCE WITH SECTION 16(a) OF THE SECURITIES EXCHANGE ACT OF 1934 Section 16(a) of the Securities Exchange Act of 1934, as amended, requires the Company's Directors and executive officers, and persons who own more than ten percent of the Company's outstanding common stock, to file with the SEC initial reports of ownership and reports of changes in ownership of common stock. Such persons are required by SEC regulation to furnish the Company with copies of all such reports they file. To the Company's knowledge, based solely on a review of the copies of such reports furnished to the Company and written representations that no other reports were required, all Section 16(a) filing requirements applicable to its officers, Directors and greater than ten percent beneficial owners have been satisfied. 37 38 KEY EMPLOYEES Frederick H. Conte has been with PEC since 1978, and has been its Executive Vice President and Chief Operating Officer since February 1988. Stuart Harelik has been the Senior Vice President of Marketing and Sales of PEC since March 1989. Jon A. Joseph has been a Vice President and Associate General Counsel of the Company since July 1995. Mr. Joseph was Executive Vice President of Valley Bank of Nevada from 1984 to 1991. In 1991, Valley Bank of Nevada was acquired by Bank of America. Mr. Joseph remained with the legal department of Bank of America until June 1, 1995. ADDITIONAL INFORMATION CONCERNING OFFICERS AND DIRECTORS The Company's officers are elected annually by the Board of Directors and serve at the discretion of the Board of Directors. The Company's directors hold office until the next annual meeting of shareholders and until their successors have been duly elected and qualified. The Company reimburses all directors for their expenses in connection with their activities as directors of the Company. Directors of the Company who are also employees of the Company do not receive additional compensation for their services as directors. Members of the Board of Directors of the Company who are not employees of the Company receive an annual fee of $40,000. Directors are also reimbursed for their expenses incurred in attending meetings of the Board of Directors and its committees. ITEM 11. EXECUTIVE COMPENSATION The following table sets forth information concerning the annual and long-term compensation earned by the Company's chief executive officer and each of the five other most highly compensated executive officers whose annual salary and bonus during the fiscal years presented exceeded $100,000 (Named Executive Officers). The Company did not grant any stock options to the Named Executive Officers during the fiscal year ended August 31, 1997.
LONG-TERM COMPENSATION AWARDS ANNUAL COMPENSATION ---------------------------- ------------------------------------------- NUMBER OF FISCAL OTHER ANNUAL OPTIONS ALL OTHER NAME AND PRINCIPAL POSITION YEAR SALARY BONUS(A) COMPENSATION GRANTED(B) COMPENSATION(C) - ------------------------------- ------ -------- -------- ------------ ---------- --------------- Robert Nederlander............. 1995 $126,925 $ -- $ -- -- $ 1,500 Chairman of the Board and 1996 150,000 2,885 3,789 -- 2,293 Chief Executive Officer 1997 150,000 2,885 4,378 -- 2,010 Jerome J. Cohen................ 1995 $300,000 $120,369 $3,227 -- $ 2,250 President 1996 300,000 216,666 6,279 -- 2,250 1997 300,002 368,800 7,259 -- 2,329 Don A. Mayerson................ 1995 $200,000 $ 49,686 $ -- -- $ 2,250 Executive Vice President, 1996 200,000 86,680 5,305 -- 2,250 General Counsel and Secretary 1997 200,000 147,520 6,132 -- 2,381 Herbert B. Hirsch.............. 1995 $200,000 $ 49,686 $ -- -- $ 2,250 Senior Vice President, Chief 1996 200,000 86,680 1,512 -- 2,250 Financial Officer and 1997 200,000 147,520 1,743 -- 2,319 Treasurer Stuart Harelik................. 1995 $125,000 $438,064 $ -- -- $ 2,250 Senior Vice President 1996 125,000 411,766 -- -- 2,250 Marketing and Sales of PEC 1997 125,000 450,064 -- -- 1,605
- --------------- (a) Mr. Harelik receives a contingent bonus based on a percentage of the sales made in excess of specified sales levels as set forth in his contract of employment which expires August 31, 2000. On April 13, 1996, pursuant to contractual arrangements, incentive compensation attributable to the year ended August 31, 1995 was paid to Messrs. Cohen, Mayerson and Hirsch and is included in the above table as 1995 compensation. In January 1997, pursuant to contractual arrangements, incentive compensation attributa- 38 39 ble to the year ended August 31, 1996 was paid to Messrs. Cohen, Mayerson and Hirsch and is included in the above table as 1996 compensation. Incentive compensation attributable to the year ended August 31, 1997 payable to Messrs. Cohen, Mayerson, Hirsch and Harelik, but not yet paid, is included in the above table as 1997 compensation. (b) The Company adopted the Stock Option Plan on November 17, 1993, and options were granted to certain executive officers on December 22, 1993 and subsequently to other employees, subject to shareholder approval of the Stock Option Plan. The Stock Option Plan was approved by the shareholders on February 9, 1994. One-fifth of each grant to the Named Executive Officers became exercisable on December 22, 1994 and an additional one-fifth became exercisable on December 22, 1995 and December 22, 1996. In August 1997, in connection with the approval by the Company's Board of Directors of the distribution to the holders of record of the Company's common stock as of August 27, 1997 of all 10 million shares of Mego Mortgage Corporation's common stock held by the Company in the Spin-off, the Stock Option Committee accelerated the vesting of all such options, excluding those options granted subsequent to February 26, 1997. See "Aggregated Fiscal Year-End Option Table" and "Stock Option Plan." (c) Represents the Company's discretionary matching contributions of 25% of the employee's contribution to the Company's 401(k) Plan on behalf of the employee. The following table sets forth certain information concerning stock options exercised by the Named Executive Officers during the year ended August 31, 1997. There were no unexercised options held by the Named Executive Officers at August 31, 1997. On September 3, 1997, an aggregate of 45,000 in options were granted to the Named Executive Officers. AGGREGATED FISCAL YEAR-END OPTION TABLE
NET SHARES ACQUIRED UPON EXERCISE OF OPTIONS DURING FISCAL 1997(1) --------------------------- NAME NUMBER VALUE REALIZED - -------------------------------------------------------------------- ------ -------------- Robert Nederlander(2)............................................... 24,155 $214,376 Jerome J. Cohen(2).................................................. 25,141 219,984 Don A. Mayerson(2).................................................. 25,141 219,984 Herbert B. Hirsch(2)................................................ 25,141 219,984 Stuart Harelik(3)................................................... 15,778 135,109
- --------------- (1) The aggregate number of options exercised for the shares acquired during fiscal 1997 for the Named Executive Officers was 165,000. These options were exercised by withholding or surrendering the appropriate number of shares to cover the exercise cost in lieu of payment of cash to the Company. The value realized for each Named Executive Officer was computed by multiplying the net number of shares acquired by the fair market value price on the date of exercise. (2) Each of the Named Executive Officers exercised 35,000 options during fiscal 1997. (3) Stuart Harelik exercised 25,000 options during fiscal 1997. EMPLOYMENT AGREEMENTS The Company has entered into an employment agreement with Jerome J. Cohen which expires on January 31, 2000. The agreement provides for an annual base salary of $300,000 plus 2.5% of Incentive Income as defined in the Company's Incentive Plan (See "Executive Incentive Compensation Plan"). Mr. Cohen's employment agreement does not provide for an early termination bonus or other additional compensation based on performance. PEC has entered into an employment contract with Stuart Harelik which expires on August 31, 2000, and provides for an annual base salary of $125,000. In addition, Mr. Harelik is to receive a contingent bonus 39 40 each year equal to the sum of 1.25% of Net Sales (as defined in the employment agreement) in excess of $20 million up to $50 million plus 0.75% of Net Sales in excess of $50 million. The Company has entered into an employment agreement with Jon A. Joseph which expires on August 31, 2000 and provides for an annual base salary of $175,000 and a minimum annual bonus of $25,000. STOCK OPTION PLAN Under the Company's Stock Option Plan, 525,000 shares of common stock were reserved for issuance upon exercise of options. In 1997, the Company's Board of Directors approved an amendment to the Stock Option Plan to increase by 500,000 shares the number of shares of common stock reserved for issuance pursuant to the Company's Stock Option Plan, subject to approval by the Company's shareholders. The amendment was approved by the shareholders at the Annual Meeting held September 9, 1997, resulting in an aggregate of 1,025,000 shares of common stock reserved for issuance pursuant to the Stock Option Plan of which 461,000 had been issued due to the exercise of options through August 31, 1997. The Stock Option Plan is designed to serve as an incentive for retaining qualified and competent employees. The Stock Option Committee of the Company's Board of Directors, administers and interprets the Stock Option Plan and is authorized, in its discretion, to grant options thereunder to all eligible employees of the Company, including officers of the Company. The Stock Option Plan provides for the granting of both "incentive stock options" (as defined in Section 422A of the Internal Revenue Code) and nonstatutory stock options. Options can be granted under the Stock Option Plan on such terms and at such prices as determined by the Board, or a committee thereof, except that the per share exercise price of options may not be less than 80% of the fair market value of the common stock on the date of grant, and, in the case of an incentive stock option, the per share exercise price may not be less than 100% of such fair market value. In the case of incentive stock options granted to a 10% shareholder, the per share exercise price may not be less than 110% of the fair market value of the common stock on the date of grant and shall expire five years from the date of grant. The aggregate fair market value of the shares covered by incentive stock options granted under the Stock Option Plan that become exercisable by a grantee for the first time in any calendar year is subject to a $100,000 limit. Options granted under the Stock Option Plan are exercisable after the period or periods specified in the option agreement. Options granted under the Stock Option Plan are not exercisable after the expiration of ten years from the date of grant (except in the case of options granted to 10% shareholders) and are not transferable other than by will or by the laws of descent and distribution. In August 1997, in connection with the Spin-off of MMC, the Stock Option Committee accelerated the vesting of all options granted, excluding those granted subsequent to February 26, 1997. As of August 31, 1997, an aggregate of 455,000 of such options were exercised. In September 1997, subsequent to the Spin-off, an additional 873,000 incentive stock options were granted under the Stock Option Plan to employees at fair market value, which was authorized by the Stock Option Committee, of which 15,000 are subject to future shareholder approval of certain amendments to the Stock Option Plan in accordance with applicable law. COMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION The Board of Directors has not designated a Compensation Committee, but has delegated the responsibility and authority for setting and overseeing the administration of policy which governs the compensation of all of the Company's employees (with the exception of Messrs. Nederlander, Cohen, Mayerson, Hirsch and Schuster) to its President, Jerome J. Cohen. The compensation paid to Messrs. Nederlander, Cohen, Mayerson, Hirsch and Schuster is determined by the Board of Directors. The directors who are also executive officers of the Company do not participate in deliberations of the Board of Directors of the Company concerning their own compensation. 40 41 EXECUTIVE INCENTIVE COMPENSATION PLAN On June 22, 1994, effective for the year ended August 31, 1995, the Board of Directors of the Company approved and adopted an Executive Incentive Compensation Plan (Incentive Plan) for executives and other key employees of the Company and its subsidiaries who contribute to the success of the Company. Under the terms of the Incentive Plan, awards of incentive compensation are determined by the Incentive Compensation Committee of the Board of Directors of the Company, which committee shall be composed of not less than two members. The Incentive Plan provides that the Board of Directors may amend, suspend or terminate the Incentive Plan at any time. Incentive Compensation for any fiscal year is defined as an amount equal to 7.5% of incentive income (Incentive Income) for such year. Incentive Income for any fiscal year is defined as the amount reported as income before taxes in the consolidated financial statements of the Company for such year. The maximum amount of all awards of Incentive Compensation for any fiscal year shall not exceed (a) 7.5% of Incentive Income for such year, reduced by (b) the amount of Incentive Income which must be paid by the Company to employees pursuant to any contractual obligation of the Company, increased by (c) any unawarded Incentive Compensation carried forward from a prior fiscal year. On June 22, 1994, the Board of Directors also approved an employment agreement with Mr. Jerome J. Cohen, President of the Company, and agreements with Messrs. Don A. Mayerson and Herbert B. Hirsch, executive officers of the Company, pursuant to which Messrs. Cohen, Mayerson and Hirsch are entitled to receive 2.5%, 1% and 1% respectively, of Incentive Income of the Company, as defined in the Incentive Plan, for the five-year period commencing with fiscal 1995, which amounts would directly reduce the amounts available for awards under the Incentive Plan. On September 2, 1997, the Board of Directors increased the annual salaries of Messrs. Nederlander and Schuster to $200,000 and $75,000, respectively. At that meeting, the Board also authorized agreements with Messrs. Mayerson and Hirsch pursuant to which the Company would pay them, as a separation payment, $250,000 and $150,000, respectively, at such time as they no longer are employed by the Company. SPLIT-DOLLAR INSURANCE PLAN On April 5, 1995, the Board of Directors of the Company established a split-dollar life insurance plan (SplitDollar Plan) pursuant to which the Company pays the premiums for certain "second to die" life insurance policies on the lives of Robert Nederlander, Jerome J. Cohen, Don A. Mayerson and Herbert B. Hirsch, executive officers of the Company (Messrs. Nederlander, Cohen and Hirsch are also directors of the Company), and their respective spouses, for a period not to exceed five years, at an annual aggregate premium outlay of $400,000. Each policy is in the name of a trust established for family beneficiaries selected by each executive. On August 3, 1995, the Company approved a life insurance policy for Mr. Schuster at an annual cost of $100,000 for a period of five years. Pursuant to the plan, and with respect to each policy, after ten years, or earlier upon the deaths of the respective insured parties, or certain other events, the Company will receive the amount of premiums paid on the policy. 41 42 ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT The following table sets forth, as of November 13, 1997, information with respect to the beneficial ownership of the Company's common stock by (i) each person known by the Company to be the beneficial owner of more than 5% of the outstanding shares of common stock, (ii) each director of the Company, (iii) each of the Named Executive Officers (as defined in "Item 11. Executive Compensation"), and (iv) all directors and executive officers of the Company as a group. Unless otherwise noted, the Company believes that all persons named in the table have sole voting and investment power with respect to all shares of common stock beneficially owned by them.
PERCENTAGE OF NAME AND ADDRESS OF AMOUNT AND NATURE OF OUTSTANDING COMMON BENEFICIAL OWNER OR IDENTITY OF GROUP BENEFICIAL OWNERSHIP(1) STOCK OWNED - --------------------------------------------------------- ----------------------- ------------------ Robert Nederlander(2).................................... 2,036,852 9.7% Eugene I. Schuster and Growth Realty Inc.(GRI)(3)........ 1,933,634 9.2 Jerome J. Cohen(4)....................................... 1,101,964 5.2 Herbert B. Hirsch(5)..................................... 1,684,864 8.0 Don A. Mayerson(6)....................................... 828,555 3.9 John E. McConnaughy, Jr.(7).............................. 593,077 2.8 Wilbur L. Ross, Jr.(8)................................... 152,500 * Stuart Harelik(9)........................................ 25,700 * FBR Ashton, Limited Partnership and affiliates(10)....... 1,318,140 6.3 All Officers and Directors as a Group (8 persons)(11).... 8,357,146 39.8
- --------------- * Less than 1%. (1) A person is deemed to be the beneficial owner of securities that can be acquired by such person within 60 days from November 13, 1997 upon the exercise of options or warrants. Each beneficial owner's percentage ownership is determined by assuming that options and warrants that are held by such person (but not those held by any other person) and that are exercisable within 60 days from the applicable date have been exercised. (2) 810 Seventh Avenue, 21st Floor, New York, New York 10019. Includes 250,000 shares held by an affiliate of Mr. Nederlander. Does not include 100,000 shares of common stock owned by the Robert E. Nederlander Foundation, an entity organized and operated exclusively for charitable purposes (the Foundation), of which Mr. Nederlander is President. Mr. Nederlander disclaims beneficial ownership of the shares owned by the Foundation. See "Item 13. Certain Relationships and Related Transactions." (3) 321 Fisher Building, Detroit, Michigan 48202. Consists of 1,683,634 shares held of record by GRI, a wholly-owned subsidiary of Venture Funding, Ltd. of which Mr. Schuster is a principal shareholder, Director and Chief Executive Officer, and 250,000 shares held of record by Growth Realty Holdings L.L.C., a limited liability corporation owned by Mr. Schuster, GRI and Mr. Schuster's three children. See "Item 13. Certain Relationships and Related Transactions." (4) 1125 N. E. 125th Street, Suite 206, North Miami, Florida 33161. Excludes 93,503 shares owned by Mr. Cohen's spouse and 500,000 shares owned by a trust for the benefit of his children over which Mr. Cohen does not have any investment or voting power, as to which he disclaims beneficial ownership. Also excludes 30,000 shares of common stock owned by the Rita and Jerome J. Cohen Foundation, Inc., an entity organized and operated exclusively for charitable purposes (the Cohen Foundation), of which Mr. Cohen is President. Mr. Cohen disclaims beneficial ownership of the shares owned by the Cohen Foundation. (5) 230 East Flamingo Road, Las Vegas, Nevada 89109. (6) 1125 N. E. 125th Street, Suite 206, North Miami, Florida 33161. (7) 1011 High Ridge Road, Stamford, Connecticut 06905. Excludes 3,000 shares owned by a member of Mr. McConnaughy's family, as to which Mr. McConnaughy does not have any investment or voting power, and as to which he disclaims beneficial ownership. 42 43 (8) 1251 Avenue of the Americas, 51st Floor, New York, New York 10020. Excludes 15,000 shares owned by a member of Mr. Ross' family and 250,000 shares owned by Rothschild, Inc., of which Mr. Ross is a Managing Director, over which Mr. Ross does not have any investment or voting power, and as to which he disclaims beneficial ownership. (9) 4310 Paradise Road, Las Vegas, Nevada 89109. (10) 1001 19th Street North, Arlington, VA 22209. Based upon a Schedule 13D dated September 11, 1997 filed jointly with the SEC. Includes 1,204,940 shares of common stock as to which FBR Ashton, Limited Partnership (Ashton) has sole voting and dispositive power, 53,200 shares as to which FBR Opportunity Fund, Ltd. Class A (Opportunity Fund) has sole voting and dispositive power, and 60,000 shares as to which Emanuel J. Friedman has sole voting and dispositive power. Friedman, Billings, Ramsey Investment Management, Inc. (Investment Management) serves as general partner and discretionary investment manager to Ashton; FBR Offshore Management (Offshore Management) serves as discretionary manager to Opportunity Fund. Mr. Friedman serves as portfolio manager for Ashton and Opportunity Fund. Ashton, Opportunity Fund and Mr. Friedman each disclaims beneficial ownership of shares owned by the others. Investment Management, Offshore Management and Mr. Friedman each disclaims beneficial ownership of shares owned by the others. (11) See Notes (2)-(9). ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS Purchase of Preferred Equities Corporation. Pursuant to a Stock Purchase and Redemption Agreement dated October 6, 1987 and amended October 25, 1987, Comay Corp., an affiliate of Messrs. Cohen and Mayerson (Comay), GRI, an affiliate of Mr. Schuster, RRE Corp., an affiliate of Mr. Nederlander (together with its assignee, RER Corp., another affiliate of Mr. Nederlander, RER), and H&H Financial Inc., an affiliate of Mr. Hirsch (H&H), obtained the rights (PEC Purchase Rights) to acquire PEC, a privately-held Nevada corporation engaged in retail land sales, resort time-sharing and other real estate related activities. (Comay, GRI, RER and H&H are collectively referred to as the Assignors). Certain Arrangements Between the Company and Affiliates of Certain Officers and Directors. Pursuant to the Assignment and Assumption Agreement, dated February 1, 1988 as subsequently amended, the Assignors assigned (Assignment) their PEC Purchase Rights to the Company. As part of the consideration for the Assignment to the Company, the Assignors were entitled to receive from the Company, on a quarterly basis until January 31, 1995, amounts equal in the aggregate to 63% of the "Unrestricted Cash Balances" of PEC. The Assignment and Assumption Agreement defines Unrestricted Cash Balances of PEC as the cash on hand and on deposit of PEC and its subsidiary as of the end of a fiscal quarter that could be used to make a dividend or other payment to the Company without violating the most restrictive loan agreement to which PEC is a party or by which PEC is bound. On January 31, 1995, at which point the accrual of payments ceased, the Company owed the Assignors an aggregate of $13.3 million pursuant to the Assignment and Assumption Agreement. Pursuant to an amendment (the Amendment) to the Assignment and Assumption Agreement, dated March 2, 1995, the Assignors agreed to defer payment of the $10 million of Subordinated Debt and to subordinate the payment of such amount to them to the Company's repayment of certain borrowings and the repayment of certain obligations of subsidiaries of the Company, the repayment of which obligations were guaranteed by the Company. In consideration of the payment deferral and subordination described above, Warrants for 1 million shares of common stock at an exercise price of $4.25 per share (the closing market price per share on March 2, 1995) were granted to the Assignors. The Warrants were exercised in August 1997 in a non-cash transaction whereby the Subordinated Debt was reduced by $4.25 million. The Amendment calls for interest to be paid semiannually on the Subordinated Debt at the rate of 10% per annum starting September 1, 1995, and seven equal semiannual payments of $1.4 million plus interest, which commenced March 1, 1997. However, in connection with the reduction of the Subordinated Debt, payments accumulating $4.25 million have been deemed paid and the semiannual payments will resume in March 1999, with a partial payment in September 1998, pursuant to the Third Amendment to the Assignment and Assumption Agreement. The 43 44 Subordinated Debt is collateralized by a pledge of PEC's outstanding stock. In addition to the Subordinated Debt, at May 31, 1995, $3.3 million was payable to the Assignors, which amount bore interest at the rate of 10% per year, payable semiannually pursuant to the provisions of the Assignment and Assumption Agreement (Unsubordinated Amount). During fiscal 1997, the Company paid an aggregate of $1.2 million to the Assignors, all of which represented interest. The Unsubordinated Amount was paid in full in January 1997. In April 1995, PEC entered into an arrangement with HFS, of which Mr. Nederlander became a director in July 1995. See "Business -- Preferred Equities Corporation -- Timeshare Properties and Sales." Transactions with MMC. The Company formed MMC in June 1992 as a wholly-owned subsidiary and operated MMC as such until November 1996. MMC is a specialized consumer finance company that originates, purchases, sells, securitizes and services consumer loans consisting primarily of conventional uninsured home improvement and debt consolidation loans which are generally secured by liens on residential property. In November 1996, MMC consummated the IPO and as a result, the Company's ownership of MMC was reduced to approximately 81.3% of the outstanding common stock. On September 2, 1997, Mego Financial distributed all of its 10 million shares of MMC's common stock to Mego Financial's shareholders in the Spin-off. To fund MMC's past operations and growth and in conjunction with filing consolidated income tax returns, MMC incurred debt to the Company and its subsidiary, PEC. The amount of intercompany debt was $10.1 million at August 31, 1997 and $12.8 million at August 31, 1996 of which $3.4 million was paid in October 1997 together with $500,000 advanced by the Company to MMC in September 1997. Prior to the IPO, the Company had guaranteed MMC's obligations under MMC's credit agreements and an office lease. The guarantees of MMC's credit agreements were released upon consummation of the IPO. MMC did not pay any compensation to the Company for such guarantees. On August 29, 1997, MMC and the Company entered into an agreement (the Payment Agreement) with respect to MMC's repayment after the Spin-off of (i) a portion of the debt owed by MMC to the Company as of May 31, 1997 aggregating approximately $3.4 million (the May Amounts) and (ii) debt owed by MMC to the Company as of August 31, 1997 in addition to the May Amounts (the Excess Amounts). The May Amounts consist of a portion of the debt owed by MMC to the Company as of May 31, 1997 in respect of funds advanced by the Company to MMC through such date, the portion of the Warrant Value (as hereinafter defined) amortized through such date and amounts owed under the tax allocation and indemnification agreement between the Company and MMC as of such date. The Excess Amounts consist of funds advanced by the Company to MMC during the period commencing June 1, 1997 and ended August 31, 1997 (the Excess Period), the portion of the Warrant Value amortized during the Excess Period and amounts accrued under the tax allocation and indemnification agreement during the Excess Period. Warrants valued at $3 million (Warrant Value) were issued by the Company to a financial institution in connection with MMC's agreement with that financial institution to purchase up to $2 billion of loans from MMC. Pursuant to the Payment Agreement, MMC agreed to repay the May Amounts upon the earlier to occur of (i) the first consummation after the date of the agreement of a public or private debt or equity transaction by MMC of at least $25 million in amount or (ii) August 31, 1998. MMC repaid the May Amounts plus $500,000 advanced by Mego Financial in September 1997 with a portion of the net proceeds of a private placement of MMC's subordinated notes in October 1997. MMC has further agreed to repay the Excess Amounts upon the earlier to occur of (i) the second consummation after the date of the agreement of a public or private debt or equity transaction by MMC of at least $25 million in amount or (ii) August 31, 1998. The amount of the amortization of the Warrant Value for each of the months of September, October, November and December 1997 will be payable January 31, 1998. Commencing in January 1998, the unpaid balance of the Warrant Value will continue to be amortized on a monthly basis and the amount of such amortization will be due and payable within 30 days from the end of each fiscal quarter. Under the Payment Agreement, the Company may, but is not obligated to, make advances to PEC on behalf of MMC. Advances, if any, by the Company on behalf of MMC to PEC will be due and payable within 30 days after the close of the month in which such advance was made. Under the Payment Agreement, any amount owed by MMC to the Company that is not paid when due will bear interest from such due date until 44 45 paid at the rate of 10% per annum It is not anticipated that the Company will provide funds to MMC or guarantee MMC's indebtedness in the future, although it may do so. MMC also has agreements with PEC for the provision of management services and loan servicing. Tax Sharing and Indemnity Agreement. For taxable periods up to the date of the Spin-off, the results of operations of MMC are includable in the income tax returns filed by the Company's affiliated group for federal income tax purposes. Following the Spin-off, MMC will remain liable for any amounts payable to the Company pursuant to the tax sharing agreements in effect prior to the date of the Spin-off. From and after the date of the Spin-off, MMC no longer will file consolidated returns with the Company's affiliated group but will file separate consolidated returns with its subsidiaries. PEC is under the same tax sharing arrangement as MMC was prior to the IPO. Management Services Provided by PEC to MMC. MMC and PEC were parties to a management services arrangement (the Management Arrangement) pursuant to which certain executive, accounting, legal, management information, data processing, human resources, advertising and promotional personnel of PEC provided services to MMC on an as needed basis. For the years ended August 31, 1997, 1996 and 1995, approximately $967,000, $671,000 and $690,000, respectively, of the salaries and expenses of certain employees of PEC were attributable to and paid by MMC in connection with services rendered by such employees to MMC. In addition, during the years ended August 31, 1997, 1996 and 1995, MMC paid PEC for developing certain computer programming, incurring costs of $0, $56,000 and $36,000, respectively. MMC has entered into a formal management services agreement with PEC, effective as of September 1, 1996, pursuant to which PEC has agreed to provide the following services to MMC for an aggregate annual fee of approximately $967,000 payable monthly: strategic planning, management and tax, accounting and finance, legal, management information systems, insurance management, human resources, and purchasing. Servicing Agreement between PEC and MMC. Prior to September 1, 1996, MMC had an arrangement with PEC pursuant to which it paid annual servicing fees at an annual rate of 50 basis points on the principal balance of loans serviced. For the years ended August 31, 1997, 1996 and 1995, MMC paid servicing fees to PEC of approximately $1.9 million, $709,000 and $232,000, respectively. MMC has entered into a servicing agreement with PEC (the Servicing Agreement), providing for the payment of servicing fees at an annual rate of 50 basis points on the principal balance of loans serviced per year. The Servicing Agreement was modified effective September 1, 1997, to provide for the payment of servicing fees at an annual rate of 40 basis points on the principal balance of loans serviced per year, reducing to 35 basis points per year on the later to occur of (i) January 1, 1998 or (ii) the first day of the month following the month in which MMC's loan portfolio serviced by PEC equals or exceeds $1 billion. For the years ended August 31, 1997, 1996 and 1995, MMC incurred interest expense in the amount of $16,000, $29,000 and $85,000, respectively, related to fees payable to PEC for these services. The interest rates were based on PEC's average cost of funds and equaled 10.48% in 1997, 10.68% in 1996 and 11.8% in 1995. 45 46 PART IV ITEM 14. EXHIBITS, FINANCIAL STATEMENTS, SCHEDULES AND REPORTS ON FORM 8-K (a) Certain documents filed as part of Form 10-K. See Item 8 above for a list of financial statements included as part of this Annual Report on Form 10-K. (b) Reports on Form 8-K. A current report on Form 8-K was filed on September 17, 1997. Such report related to the Spin-off transaction on September 2, 1997. (c) Exhibits.
EXHIBIT NUMBER DESCRIPTION ----------- ------------------------------------------------------------------------- 2.1(1) Disclosure Statement dated October 3, 1983, together with Schedules A through G and Debtors' Plan, filed as Exhibit (2) to Mego International (a predecessor of the Company) Form 10-K for the year ended February 28, 1983, and incorporated herein by reference. 2.2(8) Articles of Merger of Vacation Spa Resorts, Inc. with and into Preferred Equities Corporation dated March 10, 1993, Agreement and Plan of Merger dated as of July 24, 1992, among Preferred Equities Corporation and Vacation Spa Resorts, Inc., Amendment to Agreement and Plan of Merger dated July 14, 1992, and Amendment to Agreement and Plan of Merger dated December 7, 1992. 3.1(a)(1) Certificate of Incorporation of the Company, as amended, filed as Exhibit 3.1 to the Company's Form 10-K for the fiscal year ended August 31, 1987 and incorporated herein by reference. 3.1(b)(5) Certificate of Amendment of the Certificate of Incorporation of the Company, dated June 19, 1992. 3.1(c)(8) Certificate of Amendment of the Certificate of Incorporation of the Company, dated August 26, 1993. 3.2(1) By-laws of the Company, as amended. 3.3(10) Mego Mortgage Corporation Amended and Restated Certificate of Incorporation of Mego Mortgage Corporation. 3.4(10) Mego Mortgage Corporation By-laws of Mego Mortgage Corporation, as amended. 4.1(10) Mego Mortgage Corporation Specimen Common Stock Certificate. 10.4(a)(1) Stock Purchase Agreement dated October 25, 1987 by and among the Company, and Robert Nederlander, Jerome J. Cohen, Don A. Mayerson, Herbert Hirsch and Growth Realty Inc. ("GRI") (collectively, the "Purchasers") filed as Exhibit A to a Schedule 13D dated October 25, 1987, filed by Jerome J. Cohen, et al., and incorporated herein by reference. 10.4(b)(1) Letter dated January 7, 1988 from the Purchasers of the Company, updating representations made by the Company, in the Stock Purchase Agreement (Exhibit 10.5(a)) filed as Exhibit 10.2 to a Current Report on Form 8-K of the Company, dated January 7, 1988, and incorporated herein by reference. 10.5(a)(1) Assignment Agreement dated October 25, 1987 by and among Comay Corp. ("Comay"), GRI, RER Corp. ("RER") (as successor in interest to RRE Corp.) and H&H Financial, Inc. ("H&H") (collectively the "Assignors") and the Company, with respect to shares of Common Stock of Preferred Equities Corporation ("PEC"), filed as Exhibit B to a Schedule 13D dated October 25, 1987 filed by Jerome J. Cohen, et al., and incorporated herein by reference.
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EXHIBIT NUMBER DESCRIPTION ----------- ------------------------------------------------------------------------- 10.5(b)(1) Assignment and Assumption Agreement dated February 1, 1988 by and among the Assignors and the Company filed as Exhibit 10.2 to a Current Report of Form 8-K of the Company, dated February 1, 1988 and incorporated herein by reference. 10.5(c)(1) Amendment to Exhibit 10.6(b) dated as of July 29, 1988 filed as Exhibit 10.3 to a Current Report on Form 8-K of the Company, dated August 1, 1988 and incorporated herein by reference. 10.6(a)(1) Stock Purchase and Redemption Agreement dated as of October 6, 1987 by and among PEC, Comay, GRI, RRE Corp., H&H, Linda Sterling and the 1971 Rosen Family Stock Trust filed as Exhibit C to a Schedule 13D dated October 25, 1987 filed by Jerome J. Cohen, et al., and incorporated herein by reference. 10.6(b)(1) Amendment dated as of October 25, 1987 of Exhibit 10.7(a) filed as Exhibit 10.3(b) to a Current Report on Form 8-K of the Company dated February 1, 1988, and incorporated herein by reference. 10.7(1) Loan and Security Agreement dated February 1, 1988 by and between the Company and Greyhound Real Estate Finance Company filed as Exhibit 10.7 to a Current Report on Form 8-K of the Company dated February 1, 1988 and incorporated herein by reference. 10.8(1) Pledge and Security Agreement dated February 1, 1988 by and among the Company and Comay, GRI, REF, H&H and PEC regarding the pledge of PEC stock pursuant to the Assignment Agreement and the Assignment and Assumption Agreement (Exhibits 10.6(a) and (b)) filed as Exhibit 10.8 to the Form 8 Amendment dated April 18, 1988 to a Current Report on Form 8-K of the Company dated February 1, 1988 and incorporated herein by reference. 10.9(1) Purchase Agreement dated June 30, 1988 by and among Preferred Equities Corporation ("PEC"), Southern Colorado Properties, Inc., Colorado Land and Grazing Company and The Oxford Finance Companies, Inc. filed as Exhibit 10.1 to a Quarterly Report of the Company on Form 10-Q for the quarter ended May 31,1988 and incorporated herein by reference. 10.10(2) Amendment to Exhibit 10.5(b), dated July 29, 1988. 10.11(3) Amended and Restated Loan and Security Agreement between Greyhound Real Estate Finance Company and Vacation Spa Resorts, Inc., dated May 10, 1989 and Amended and Restated Promissory Note and Guarantee and Subordination Agreement. 10.12(3) Amendment No. 2 to Loan and Security Agreement between Greyhound Real Estate Finance Company and Vacation Spa Resorts, Inc., dated April 16, 1990 and Amendment No. 2 to Promissory Note and Guarantee and Subordination Agreement. 10.13(3) Purchase Agreement dated 24th day of September, 1990 by and among Brigantine Inn, Ltd., Brigantine Preferred Properties, Inc. and Preferred Equities Corporation. 10.14(3) Purchase Agreement dated 24th day of September, 1990 by and among Brigantine Villas, L.P., Brigantine Preferred Properties, Inc., and Preferred Equities Corporation. 10.15(4) Amendment No. 3 to Loan and Security Agreement between Greyhound Real Estate Finance Company and Preferred Equities Corporation, dated May 31, 1991 and Amendment No. 2 to Promissory Note. 10.16(4) Amendment No. 3 to Loan and Security Agreement between Greyhound Real Estate Finance Company and Vacation Spa Resorts, Inc., dated May 31, 1991 and Amendment No. 2 to Promissory Note.
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EXHIBIT NUMBER DESCRIPTION ----------- ------------------------------------------------------------------------- 10.17(4) Loan and Security Agreement between Dorfinco Corporation and Preferred Equities Corporation, dated July 31, 1991 and related Promissory Note dated August 9, 1991. 10.18(4) Forbearance and Assumption Agreement, Guarantee and Second Amendment to Loan and Security Agreement between Chemical Bank of New Jersey, Brigantine Villas, L.P. and Brigantine Preferred Properties, Inc., dated June 12, 1991, Amended and Restated Promissory Note dated June 18, 1991, and Second Amendment to Mortgage dated June 18, 1991. 10.19(5) Stock Purchase Agreement dated August 13, 1992 between the Company and PEC. 10.20(5) Amendment No. 4 to Amended and Restated Loan and Security Agreement between Greyhound Real Estate Finance Company and Preferred Equities Corporation, dated January 13, 1992, and Amendment No. 3 to Amended and Restated Promissory Note. 10.21(5) Agreement to Wholesale Financing and related Promissory Note between ITT Commercial Finance Corp. and Calvada Homes, Inc., dated January 17, 1992. 10.22(5) Purchase and Sale Agreement between Golden West Homes and Calvada Homes, Inc., dated February 26, 1992. 10.23(5) Standard Form of Agreement between Owner and Contractor between Calvada Homes, Inc. and Emfad Enterprises, Inc., dated March 23, 1992. 10.24(5) Loan Modification and Extension Agreement between Valley Bank of Nevada and Preferred Equities Corporation dated January 30, 1992. 10.25(5) Amendment No. 2 to Amended and Restated Loan Agreement between Valley Bank of Nevada and Vacation Spa Resorts, Inc., dated February 20, 1992, and related Promissory Note dated February 20, 1992. 10.26(6) Purchase and Servicing Agreement dated as of October 15, 1992 among Vacation Spa Resorts, Inc. and Preferred Equities Corporation as Sellers, Preferred Equities Corporation as Servicer, and NBD Bank, N.A. as Purchaser. 10.27(6) Guaranty Agreement as of October 15, 1992 made by Vacation Spa Resorts, Inc., Preferred Equities Corporation, and the Company in favor of NBD Bank, N.A. 10.28(6) Letter from Greyhound Financial Corporation dated December 4, 1992 extending the borrowing term of the Amended and Restated Loan and Security Agreement dated May 10, 1992, between Greyhound Real Estate Finance Company and Preferred Equities Corporation and Loan and Security Agreement dated March 30, 1989, between Greyhound Real Estate Finance Company and Vacation Spa Resorts, Inc., to December 31, 1992. 10.29(7) Asset Sale Agreement dated December 22, 1992, by and between Brigantine Preferred Properties, Inc. as Seller, and The Oxford Finance Companies as Buyer. 10.30(7) Amendment No. 5 to Amended and Restated Loan and Security Agreement between Greyhound Real Estate Finance Company and Preferred Equities Corporation, dated February 23, 1993, Amendment No. 4 to Loan and Security Agreement between Greyhound Real Estate Finance Company and Vacation Spa Resorts, Inc., dated February 23, 1993. 10.31(7) First Amendment to Stock Purchase Agreement dated March 10, 1993, by and between the Company and Preferred Equities Corporation. 10.32.(7) Amendment No. 6 to Amended and Restated Loan and Security Agreement between Greyhound Real Estate Finance Company and Preferred Equities Corporation, dated June 28, 1993, and three(3) related Promissory Notes, relating to the Grand Flamingo Winnick, Grand Flamingo Fountains, and Preferred Equities Corporation corporate offices.
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EXHIBIT NUMBER DESCRIPTION ----------- ------------------------------------------------------------------------- 10.33(7) Second Amendment to Loan and Security Agreement dated June 30, 1993, between Dorfinco Corp. and Preferred Equities Corporation, and First Amendment to Promissory Note. 10.34(7) Agreement for Sale of Notes Receivable arising from Timeshares sales dated August 3, 1993, by and between Brigantine Properties, Inc. as Seller, and The Oxford Finance Companies as Buyer. 10.35(7) Purchase and Sale Agreement dated August 30, 1993, between Preferred Equities Corporation as Developer, and Marine Midland Bank, N.A., and Wellington Financial Corp. 10.36(7) Purchase Agreement dated August 31, 1993, between Mego Financial Corp. as Seller, and Legg Mason Special Investment Trust as Buyer, for the purchase of 300,000 shares of the Company's Preferred Stock. 10.37(8) Amended and Restated Loan Agreement between Bank of America Nevada and Preferred Equities Corporation, dated September 10, 1993. 10.38(8) Agreement for Line of Credit and Commercial Promissory Note between Mego Mortgage Corporation and First National Bank of Boston, dated January 4, 1994. 10.39(8) Amendment No. 7 to Amended and Restated Loan and Security Agreement between Greyhound Real Estate Finance Company and Preferred Equities Corporation, dated January 24, 1994. 10.40(8) Agreement between Mego Mortgage Corporation and Hamilton Consulting, Inc., dated January 31, 1994. 10.41(8) Loan Purchase and Sale Agreement dated March 22, 1994, between Mego Mortgage Corporation as Buyer, and Southwest Beneficial Finance, Inc. as Seller. 10.42(8) Amendment No. 8 to Amended and Restated Loan and Security Agreement between Greyhound Real Estate Finance Company and Preferred Equities Corporation, dated April 15, 1994. 10.43(8) Purchase and Servicing Agreement dated as of June 1, 1994, between Preferred Equities Corporation as Seller and Servicer, and NBD Bank, N.A. as Purchaser. 10.44(8) Purchase and Servicing Agreement dated as of July 6, 1994, between Preferred Equities Corporation as Seller, and First National Bank of Boston as Purchaser. 10.45(8) Amendment No. 9 to Amended and Restated Loan and Security Agreement between Greyhound Real Estate Finance Company and Preferred Equities Corporation, dated August 31, 1994, and Amendment No. 4 to Amended and Restated Promissory Note dated August 31, 1994, Amendment No. 6 to Loan and Security Agreement between Greyhound Real Estate Finance Company and Preferred Equities Corporation dated August 31, 1994, and Amendment No. 4 to Promissory Note dated August 31, 1994, between Preferred Equities Corporation as successor-in-interest to Vacation Spa Resorts, Inc., and Greyhound Financial Corporation. 10.46(8) Master Loan Purchase and Servicing Agreement dated as of August 26, 1994, between Mego Mortgage Corporation as Seller, and First National Bank of Boston, as Purchaser. 10.47(9) Third Amendment to Loan and Security Agreement and Assumption Agreement dated August 23, 1994, by and between Preferred Equities Corporation, Colorado Land and Grazing Corp. and Dorfinco Corporation. 10.48(9) General Loan and Security Agreement dated October 5, 1994, between Steamboat Suites, Inc. and Textron Financial Corporation.
49 50
EXHIBIT NUMBER DESCRIPTION ----------- ------------------------------------------------------------------------- 10.49(9) Purchase and Servicing Agreement, Second Closing, dated November 29, 1994, between Preferred Equities Corporation and NBD Bank, N.A. 10.50(9) Form of Agreement with respect to the Company's "Split-Dollar" Life Insurance Plan, including Form of Assignment of Limited Interest in Life Insurance as Collateral Security. 10.51(9) Construction Loan Agreement dated January 20, 1995, by and between Preferred Equities Corporation and NBD Bank. 10.52(9) Amendment No. 10 to Amended and Restated Loan and Security Agreement dated January 26, 1995, by and between Greyhound Financial Corporation and Preferred Equities Corporation. 10.53(9) Loan Agreement re: Calvada Golf Course dated January 31, 1995, by and among The First National Bank of Boston and Preferred Equities Corporation. 10.54(9) Second Amendment to Assignment and Assumption Agreement dated March 2, 1995, by and between RER Corp., Comay Corp., Growth Realty, Inc. and H&H Financial, Inc. and Mego Financial Corp. 10.55(9) First Amendment to General Loan and Security Agreement dated February 27, 1995, between Steamboat Suites, Inc. and Textron Financial Corporation. 10.56(9) Master Loan Purchase and Servicing Agreement dated April 1, 1995, by and between Greenwich Capital Financial Products, Inc. and Mego Mortgage Corporation. 10.57(9) Licensing Agreement dated April 18, 1995, by and among Hospitality Franchise Greenwich Capital Financial Products, Inc. and Mego Mortgage Corporation. 10.58(9) Purchase and Servicing Agreement, Third Closing, dated May 24, 1995, between NBD Bank, N.A. and Preferred Equities Corporation. 10.59(9) Participation and Servicing Agreement dated May 25, 1995, by and between Atlantic Bank, N.A. and Mego Mortgage Corporation. 10.60(9) Purchase and Servicing Agreement, dated as of August 31, 1995, between Preferred Equities Corporation, Colorado Land and Grazing Corp. and First National Bank of Boston. 10.61(9) Warehousing Credit and Security Agreement, dated as of August 11, 1995, between Mego Mortgage Corporation and First National Bank of Boston. 10.62(10) Mego Mortgage Corporation Stock Option Plan 10.63(10) Form of Tax Allocation and Indemnity Agreement entered into between Mego Mortgage Corporation and the Company. 10.64(10) Loan Program Sub-Servicing Agreement between Mego Mortgage Corporation and Preferred Equities Corporation dated as of September 1, 1996. 10.65(10) Servicing Agreement by and among Mego Mortgage FHA Title I Loan Trust 1996-1, First Trust of New York, National Association, as Trustee, Norwest Bank Minnesota, N.A. as Master Servicer and the Registrant, as Servicer dated as of March 21, 1996. 10.66(10) Loan Purchase Agreement between Financial Asset Securities Corp., as Purchaser, and the Mego Mortgage Corporation, as Seller, dated as of March 21, 1996. 10.67(11) Indemnification Agreement among MBIA Insurance Corporation, as Insurer, Mego Mortgage Corporation, as Seller and Greenwich Capital Markets, Inc. as Underwriter, dated as of March 29, 1996.
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EXHIBIT NUMBER DESCRIPTION ----------- ------------------------------------------------------------------------- 10.68(10) Pooling and Servicing Agreement, dated as of March 21, 1996, among Mego Mortgage Corporation, Financial Asset Securities Corp., as Depositor, First Trust of New York, National Association, as Trustee and Contract of Insurance Holder and Norwest Bank Minnesota, N.A., as Master Servicer. 10.69(11) Insurance Agreement among MBIA Insurance Corporation, as Insurer, Norwest Bank Minnesota, N.A., as Master Servicer, Mego Mortgage Corporation, as Seller, Servicer and Claims Administrator, Financial Asset Securities Corp., as Depositor, Greenwich Capital Financial Products, Inc., and First Trust of New York, National Association, as Trustee and Contract of Insurance Holder, dated as of March 21, 1996. 10.70(11) Credit Agreement dated as of June 28, 1996 between Mego Mortgage Corporation and First National Bank of Boston as Agent. 10.71(10) Loan Purchase Agreement dated as of August 1, 1996 between Financial Asset Securities Corp., as Purchaser, and Mego Mortgage Corporation, as Seller. 10.72(10) Pooling and Servicing Agreement dated as of August 1, 1996 between Financial Asset Securities Corp., as Purchaser, and Mego Mortgage Corporation, as Seller. 10.73(11) Amendment No. 1 to Warehousing Credit and Security Agreement dated as of August 9, 1996 between Mego Mortgage Corporation and First National Bank of Boston. 10.74(10) Office Lease by and between MassMutual and Mego Mortgage Corporation dated April 1996. 10.75(11) Amendment to Master Loan Purchase and Servicing Agreement between Greenwich Capital Financial Products, Inc., and Mego Mortgage Corporation dated February 1, 1996. 10.76(11) Amendment No. 2 to Master Loan Purchase and Servicing Agreement between Greenwich Capital Financial Products, Inc., and Mego Mortgage Corporation dated July 1, 1996. 10.77(10) Services and Consulting Agreement between Mego Mortgage Corporation and Preferred Equities Corporation dated as of September 1, 1996. 10.78(11) Employment Agreement between Mego Mortgage Corporation and Jeffrey S. Moore dated January 1, 1994. 10.79(11) Form of Indenture entered into between Mego Mortgage Corporation and the Indenture Trustee. 10.80(10) Master Repurchase Agreement dated as of September 4, 1996 between Mego Mortgage Corporation and Greenwich Capital Markets, Inc. 10.81(10) Letter agreement dated October 1, 1996 between Mego Mortgage Corporation and Greenwich Capital Markets, Inc. 10.82(10) Amended and Restated Master Loan Purchase and Servicing Agreement dated as of October 1, 1996 among Mego Mortgage Corporation, Mego Financial Corp. and Greenwich Capital Markets, Inc. 10.83(10) Form of Agreement entered into between Mego Mortgage Corporation and Mego Financial Corp. 10.84(10) Commitment letter between Mego Mortgage Corporation and Greenwich Capital Markets, Inc. dated September 17, 1996. 10.85(12) Amendment No. 11 to Amended and Restated Loan and Security Agreement dated September 22, 1995, by and between Finova Capital Corporation and Preferred Equities Corporation and related Promissory Note relating to Aloha Bay Phase II.
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EXHIBIT NUMBER DESCRIPTION ----------- ------------------------------------------------------------------------- 10.86(12) Amendment No. 12 to Amended and Restated Loan and Security Agreement dated September 29, 1995, by and between Finova Capital Corporation and Preferred Equities Corporation and Amended and Restated Promissory Note relating to Corporate Office Building. 10.87(12) Fourth Amendment to Loan and Security Agreement and Assumption Agreement dated September 30, 1995, by and between Preferred Equities Corporation, Colorado Land and Grazing Corp., Mego Financial Corp. and Dorfinco Corporation. 10.88(12) Request for Receivables Purchase dated November 16, 1995, by and between Preferred Equities Corporation as Seller and NBD Bank as Purchaser. 10.89(12) Second Amendment to General Loan and Security Agreement dated November 30, 1995, by and between Steamboat Suites, Inc. and Textron Financial Corporation and Restated and Amended Receivables Promissory Note. 10.90(12) Amendment No. 13 to Amended and Restated Loan and Security Agreement dated December 13, 1995, by and between Finova Capital Corporation and Preferred Equities Corporation and three (3) related Promissory Notes, relating to the Grand Flamingo Towers Lobby, Ida and Winnick Building Additions. 10.91(12) Purchase and Sale Agreement dated December 29, 1995, by and between Overlook Lodge Limited Liability Company as Seller and Preferred Equities Corporation as Purchaser. 10.92(12) Second Amendment to Purchase and Sale Agreement dated February 8, 1996, as previously amended by an Amendment to Purchase and Sale Agreement dated May 10, 1994, between Preferred Equities Corporation, Marine Midland Bank, and Wellington Financial Corp. 10.93(12) Acquisition and Construction Loan Agreement dated March 29, 1996, by and between Heller Financial, Inc. and Preferred Equities Corporation and three (3) related Promissory Notes; Acquisition Promissory Note, Revolving Renovation Promissory Note, and Receivables Promissory Note. 10.94(12) Construction Loan Agreement dated April 30, 1996, by and between Preferred Equities Corporation and NBD Bank and related Promissory Note. 10.95(12) Amendment No. 14 to Amended and Restated Loan and Security Agreement dated June 5, 1996, by and between Finova Capital Corporation and Preferred Equities Corporation and Second Amended and Restated Promissory Note, relating to Headquarters and FCFC Property. 10.96(12) Amendment No. 15 to Amended and Restated Loan and Security Agreement dated August 16, 1996, by and between Finova Capital Corporation and Preferred Equities Corporation; Amendment No. 7 to Loan and Security Agreement; Amendment No. 5 to Amended and Restated Promissory Note; Amendment No. 5 to Promissory Note; Amendment No. 1 to Promissory Note [Towers Lobby]. 10.97(12) Request for Receivables Purchase dated July 30, 1996, by and between Preferred Equities Corporation as Seller and NBD Bank as Purchaser. 10.98(12) Preferred Stock redemption agreement by and between Mego Financial Corp. and Legg Mason Special Investment Trust, Inc. 10.99(12) Amendment to Common Stock Purchase Warrant issued by Mego Financial Corp. to Legg Mason Special Investment Trust, Inc.
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EXHIBIT NUMBER DESCRIPTION ----------- ------------------------------------------------------------------------- 10.100(14) Third Amendment to General Loan and Security Agreement dated November 29, 1996 between Steamboat Suites, Inc. as Debtor and Textron Financial Corporation as Lender and the related Restated and Amended Receivables Promissory Note dated November 30, 1996 effective October 6, 1994. 10.101(14) Fifth Amendment to Loan and Security Agreement dated November 29, 1996 by and among Preferred Equities Corporation and Colorado Land and Grazing Corp. as Borrower; Mego Financial Corp. as Guarantor; and Dorfinco Corporation as Lender and the related Fourth Amendment to Promissory Note dated November 29, 1996. 10.102(14) Acquisition and Renovation Loan Agreement dated August 6, 1996 between Heller Financial, Inc. as Lender and Preferred Equities Corporation as Borrower; and Interval Receivables Loan and Security Agreement dated August 6, 1996 by and among Heller Financial, Inc. as Lender and Preferred Equities Corporation as Borrower and Mego Financial Corp. as Guarantor, and the three related Promissory Notes. 10.103(15) Subdivision Improvement Agreement dated March 7, 1995 between Preferred Equities Corporation and the Board of County Commissioners of the County of Nye, State of Nevada. 10.104(15) Subdivision Improvement Agreement dated February 20, 1996 between Preferred Equities Corporation and the Board of County Commissioners of the County of Nye, State of Nevada. 10.105(15) Subdivision Improvement Agreement dated February 20, 1996 between Preferred Equities Corporation and the Board of County Commissioners of the County of Nye, State of Nevada. 10.106(15) Subdivision Improvement Agreement dated December 17, 1996 between Preferred Equities Corporation and the Board of County Commissioners of the County of Nye, State of Nevada. 10.107(15) Subdivision Improvement Agreement dated December 17, 1996 between Preferred Equities Corporation and the Board of County Commissioners of the County of Nye, State of Nevada. 10.108(15) Subdivision Improvement Agreement dated December 17, 1996 between Preferred Equities Corporation and the Board of County Commissioners of the County of Nye, State of Nevada. 10.109(15) Subdivision Improvement Agreement dated December 17, 1996 between Preferred Equities Corporation and the Board of County Commissioners of the County of Nye, State of Nevada 10.110(15) Subdivision Improvement Agreement dated December 17, 1996 between Preferred Equities Corporation and the Board of County Commissioners of the County of Nye, State of Nevada 10.111(15) Employment Agreement between Mego Financial Corp. and Irving J. Steinberg dated August 1, 1996. 10.112(16) Employment Agreement between Jerome C. Cohen and Mego Financial Corp. dated September 1, 1996. 10.113(16) Purchase and Servicing Agreement between Preferred Equities Corporation as Seller and BankBoston, N.A. as Purchaser dated May 30, 1997. 10.114(16) Second Amended and Restated and Consolidated Loan and Security Agreement between Preferred Equities Corporation as Borrower and FINOVA Capital Corporation as lender, dated May 15, 1997.
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EXHIBIT NUMBER DESCRIPTION ----------- ------------------------------------------------------------------------- 10.115(16) Form of Owners Association Agreement between Resort Condominiums International, Inc. and Homeowners Associations with schedule listing the associations. 10.116(16) Loan Purchase Agreement dated as of November 1, 1996 between Financial Asset Securities Corp. and Mego Mortgage Corporation. 10.117(16) Pooling and Servicing Agreement dated as of November 1, 1996 among Financial Asset Securities Corp., Mego Mortgage Corporation, Norwest Bank Minnesota, N.A. and First Trust of New York, National Association. 10.118(16) Home Loan Purchase Agreement dated as of March 1, 1997 between Financial Asset Securities Corp. and Mego Mortgage Corporation. 10.119(16) Sale and Servicing Agreement dated as of March 1, 1997 among Mego Mortgage Home Loan Owner Trust 1997-1, Financial Asset Securities Corp., Mego Mortgage Corporation, Norwest Bank Minnesota, N.A. and First Trust of New York, National Association. 10.120(16) Trust Agreement dated as of March 1, 1997 among Financial Asset Securities Corp., Mego Mortgage Corporation, Wilmington Trust Company and First Trust of New York, National Association. 10.121(16) Home Loan Purchase Agreement dated as of May 1, 1997 between Financial Asset Securities Corp. and Mego Mortgage Corporation. 10.122(16) Sale and Servicing Agreement dated as of May 1, 1997 among Mego Mortgage Home Loan Owner Trust 1997-2, Financial Asset Securities Corp., Mego Mortgage Corporation, Norwest Bank Minnesota N.A. and First Trust of New York, National Association. 10.123(16) Trust Agreement dated as of May 1, 1997 among Financial Asset Securities Corp., Mego Mortgage Corporation, Wilmington Trust Company and First Trust of New York, National Association. 10.124(16) Home Loan Purchase Agreement dated as of June 14, 1997 between Financial Asset Securities Corp. and Mego Mortgage Corporation. 10.125(16) Sale and Servicing Agreement dated as of June 14, 1997 among Mego Mortgage Home Loan Owner Trust 1997-3, Financial Asset Securities Corp., Mego Mortgage Corporation, Norwest Bank Minnesota N.A. and First Trust of New York, National Association. 10.126(16) Trust Agreement dated as of June 14, 1997 among Financial Asset Securities Corp., Mego Mortgage Corporation, Wilmington Trust Company and First Bank National Association. 10.127(13) Agreement between Mego Financial Corp. and Mego Mortgage Corporation dated August 29, 1997. 10.128 Sub-Servicing Agreement dated September 1, 1996, as amended September 2, 1997, between Mego Financial Corp., Mego Mortgage Corporation and Preferred Equities Corporation. 10.129 Third Amendment to Assignment and Assumption Agreement by and between RER Corp., Comay Corp., Growth Realty, Inc. and H&H Financial, Inc. and Mego Financial Corp. dated August 20, 1997. 10.130 Loan and Security Agreement between Litchfield Financial Corporation and Preferred Equities Corporation dated July 30, 1997. 10.131 Employment Agreement between Stuart Harelik and Mego Financial Corp. dated October 9, 1996.
54 55
EXHIBIT NUMBER DESCRIPTION ----------- ------------------------------------------------------------------------- 10.132 Employment Agreement between Jon A. Joseph and Mego Financial Corp. dated August 31, 1997. 27.1 Financial Data Schedule (for SEC use only).
- --------------- (1) Filed as part of the Company's Form 10-K for fiscal year ended August 31, 1988 and incorporated herein by reference. (2) Filed as part of the Company's Form 10-K for fiscal year ended August 31, 1989 and incorporated herein by reference. (3) Filed as part of the Company's Form 10-K for fiscal year ended August 31, 1990 and incorporated herein by reference. (4) Filed as part of the Company's Form 10-K for fiscal year ended August 31, 1991 and incorporated herein by reference. (5) Filed as part of the Company's Registration Statement on Form S-4 originally filed August 31, 1992 and incorporated herein by reference. (6) Filed as part of the Company's Form 10-K for fiscal year ended August 31, 1992 and incorporated herein by reference. (7) Filed as part of the Company's Form 10-K for fiscal year ended August 31, 1993 and incorporated herein by reference. (8) Filed as part of the Company's Form 10-K for fiscal year ended August 31, 1994 and incorporated herein by reference. (9) Filed as part of the Company's Form 10-K for fiscal year ended August 31, 1995 and incorporated herein by reference. (10) Filed as part of the Registration Statement on Form S-1 filed by Mego Mortgage Corporation, as amended (File No. 333-12443), and incorporated herein by reference. (11) Filed as part of the Registration Statement on Form S-1 filed by Mego Mortgage Corporation, as amended (File No. 333-13421), and incorporated herein by reference. (12) Filed as part of the Company's Form 10-K for fiscal year ended August 31, 1996 and incorporated herein by reference. (13) Filed as part of Mego Mortgage Corporation's Form 10-K for fiscal year ended August 31, 1997 and incorporated herein by reference. (14) Filed as part of the Company's Form 10-Q for the quarter ended November 30, 1996 and incorporated herein by reference. (15) Filed as part of the Company's Form 10-Q for the quarter ended February 28, 1997 and incorporated herein by reference. (16) Filed as part of the Company's Form 10-Q for the quarter ended May 31, 1997 and incorporated herein by reference. (d) Financial Statement schedules required by Regulation S-X. No financial statement schedules are included because of the absence of the conditions under which they are required or because the information is included in the financial statements or the notes thereto. 55 56 SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, as amended, the Registrant has duly caused this Report to be signed on its behalf by the undersigned, thereunto duly authorized. MEGO FINANCIAL CORP. Date: November 26, 1997 By: /s/ Jerome J. Cohen ------------------------------------ Jerome J. Cohen, President and Director Pursuant to the requirements of the Securities Exchange Act of 1934, this Report has been signed below by the following persons on behalf of the Registrant in the capacities and on the date(s) indicated.
SIGNATURE TITLE DATE - ---------------------------------- ---------------------------------- ------------------ /s/ Robert Nederlander Chairman of the Board, Chief November 26, 1997 - ---------------------------------- Executive Officer and Director Robert Nederlander /s/ Jerome J. Cohen President and Director November 26, 1997 - ---------------------------------- Jerome J. Cohen /s/ Herbert B. Hirsch Senior Vice President, Chief November 26, 1997 - ---------------------------------- Financial Officer, Treasurer and Herbert B. Hirsch Director /s/ Eugene I. Schuster Vice President and Director November 26, 1997 - ---------------------------------- Eugene I. Schuster /s/ Charles G. Baltuskonis Vice President and Chief November 26, 1997 - ---------------------------------- Accounting Officer Charles G. Baltuskonis /s/ Wilbur L. Ross, Jr. Director November 26, 1997 - ---------------------------------- Wilbur L. Ross, Jr. /s/ John E. McConnaughy, Jr. Director November 26, 1997 - ---------------------------------- John E. McConnaughy, Jr.
56 57 MEGO FINANCIAL CORP. AND SUBSIDARIES INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
PAGE NO. -------- Independent Auditors' Report....................................................... F-2 Financial Statements: Consolidated Statements of Financial Condition at August 31, 1997 and 1996......... F-3 Consolidated Statements of Operations -- Years Ended August 31, 1997, 1996 and 1995............................................................................. F-4 Consolidated Statements of Stockholders' Equity -- Years Ended August 31, 1997, 1996 and 1995.................................................................... F-6 Consolidated Statements of Cash Flows -- Years Ended August 31, 1997, 1996 and 1995............................................................................. F-7 Notes to Consolidated Financial Statements......................................... F-9
F-1 58 INDEPENDENT AUDITORS' REPORT To the Board of Directors and Stockholders of Mego Financial Corp. and Subsidiaries Las Vegas, Nevada We have audited the accompanying consolidated statements of financial condition of Mego Financial Corp. and its subsidiaries (the "Company") as of August 31, 1997 and 1996, and the related consolidated statements of operations, stockholders' equity, and cash flows for each of the three years in the period ended August 31, 1997. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these 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, such consolidated financial statements present fairly, in all material respects, the financial position of Mego Financial Corp. and its subsidiaries at August 31, 1997 and 1996, and the results of its operations and its cash flows for each of the three years in the period ended August 31, 1997 in conformity with generally accepted accounting principles. DELOITTE & TOUCHE LLP San Diego, California November 6, 1997 F-2 59 MEGO FINANCIAL CORP. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION (thousands of dollars, except per share amounts)
AUGUST 31, --------------------- 1997 1996 -------- -------- ASSETS Cash and cash equivalents.............................................. $ 10,376 $ 2,742 Restricted cash........................................................ 2,049 2,183 Notes receivable, net of allowance for cancellations and discounts of $11,341 and $11,964 at August 31, 1997 and 1996, respectively........ 34,274 40,610 Interest only receivables, at fair value............................... 3,296 2,147 Timeshare interests held for sale...................................... 35,088 33,691 Land and improvements inventory........................................ 2,206 2,185 Other investments...................................................... 2,149 1,972 Property and equipment, net of accumulated depreciation of $15,292 and $13,271 at August 31, 1997 and 1996, respectively.................... 24,220 19,397 Deferred selling costs................................................. 3,153 2,901 Prepaid debt expenses.................................................. 1,286 787 Other assets........................................................... 6,930 6,376 Net assets of discontinued operations.................................. 53,276 30,514 -------- -------- TOTAL ASSETS................................................. $178,303 $145,505 ======== ======== LIABILITIES AND STOCKHOLDERS' EQUITY Liabilities: Notes and contracts payable.......................................... $ 65,569 $ 70,252 Accounts payable and accrued liabilities............................. 17,202 15,596 Payable to assignors................................................. -- 2,579 Reserve for notes receivable sold with recourse...................... 8,703 8,412 Deposits............................................................. 2,983 2,971 Negative goodwill.................................................... 53 82 Income taxes payable................................................. 6,235 10,071 -------- -------- Total liabilities before subordinated debt................... 100,745 109,963 -------- -------- Subordinated debt...................................................... 4,321 9,691 -------- -------- Redeemable preferred stock, Series A, 12% cumulative preferred stock, $.01 par value, $10 redemption value, 0 shares issued and outstanding at August 31, 1997 and 1996.......................................... -- -- -------- -------- Stockholders' equity: Preferred stock, $.01 par value (authorized -- 5,000,000 shares)..... -- -- Common stock, $.01 par value (authorized -- 50,000,000 shares; issued and outstanding -- 21,009,506 and 18,433,121 at August 31, 1997 and 1996, respectively)........................................... 210 184 Additional paid-in capital........................................... 34,524 6,504 Retained earnings.................................................... 38,503 19,163 -------- -------- Total stockholders' equity................................... 73,237 25,851 -------- -------- TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY................... $178,303 $145,505 ======== ========
See notes to consolidated financial statements. F-3 60 MEGO FINANCIAL CORP. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF OPERATIONS (thousands of dollars, except per share amounts)
FOR THE YEARS ENDED AUGUST 31, ---------------------------------------- 1997 1996 1995 ---------- ---------- ---------- REVENUES OF CONTINUING OPERATIONS Timeshare interest sales, net................................... $ 32,253 $ 27,778 $ 20,682 Land sales, net................................................. 16,626 17,968 20,812 Gain on sale of notes receivable................................ 2,013 1,116 1,586 Interest income................................................. 7,168 6,594 7,238 Financial income................................................ 2,922 1,253 508 Incidental operations........................................... 3,050 2,995 3,825 Other........................................................... 3,464 2,948 2,862 ---------- ---------- ---------- Total revenues of continuing operations.................. 67,496 60,652 57,513 ---------- ---------- ---------- COSTS AND EXPENSES OF CONTINUING OPERATIONS Direct cost of: Timeshare interest sales...................................... 5,922 3,998 2,977 Land sales.................................................... 1,571 1,844 2,164 Incidental operations......................................... 2,984 2,257 2,608 Commissions and selling......................................... 34,078 30,351 23,690 Depreciation.................................................... 1,964 1,526 1,131 Interest expense................................................ 8,458 7,314 6,306 General and administrative...................................... 17,175 15,849 12,909 Payments to assignors........................................... -- -- 7,252 ---------- ---------- ---------- Total costs and expenses of continuing operations........ 72,152 63,139 59,037 ---------- ---------- ---------- LOSS FROM CONTINUING OPERATIONS BEFORE INCOME TAXES............... (4,656) (2,487) (1,524) INCOME TAXES (BENEFIT)............................................ (12,662) (1,068) 1,016 ---------- ---------- ---------- INCOME (LOSS) FROM CONTINUING OPERATIONS.......................... 8,006 (1,419) (2,540) INCOME FROM DISCONTINUED OPERATIONS NET OF INCOME TAXES OF $9,062, $4,235 AND $2,277 FOR 1997, 1996 AND 1995, RESPECTIVELY, AND MINORITY INTEREST OF $2,358 FOR 1997............................ 11,334 6,270 3,434 GAIN ON PRIOR DISCONTINUED OPERATIONS, NET OF INCOME TAXES OF $450............................................................ -- -- 873 ---------- ---------- ---------- NET INCOME........................................................ 19,340 4,851 1,767 CUMULATIVE PREFERRED STOCK DIVIDENDS.............................. -- 240 360 ---------- ---------- ---------- NET INCOME APPLICABLE TO COMMON STOCK............................. $ 19,340 $ 4,611 $ 1,407 ========== ========== ========== EARNINGS (LOSS) PER COMMON SHARE Primary: Income (loss) from continuing operations...................... $ 0.41 $ (0.08) $ (0.14) Income from discontinued operations........................... 0.58 0.33 0.19 Gain on prior discontinued operations......................... -- -- 0.05 Cumulative preferred stock dividends.......................... -- (0.01) (0.02) ---------- ---------- ---------- Net income applicable to common stock......................... $ 0.99 $ 0.24 $ 0.08 ========== ========== ========== Weighted-average number of common shares and common share equivalents outstanding......................................... 19,528,470 19,087,387 18,087,153 ========== ========== ========== Fully-diluted: Income (loss) from continuing operations...................... $ 0.41 $ (0.08) $ (0.14) Income from discontinued operations........................... 0.58 0.33 0.18 Gain on prior discontinued operations......................... -- -- 0.05 Cumulative preferred stock dividends.......................... -- (0.01) (0.02) ---------- ---------- ---------- Net income applicable to common stock......................... $ 0.99 $ 0.24 $ 0.07 ========== ========== ========== Weighted-average number of common shares and common share equivalents outstanding......................................... 19,602,967 19,087,387 18,939,201 ========== ========== ==========
See notes to consolidated financial statements. F-4 61 MEGO FINANCIAL CORP. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (thousands of dollars, except per share amounts)
COMMON STOCK $.01 PAR VALUE ADDITIONAL ------------------- PAID-IN RETAINED SHARES AMOUNT CAPITAL EARNINGS TOTAL ---------- ------ ---------- -------- ------- Balance at September 1, 1994................... 18,086,750 $180 $ 3,198 $ 13,145 $16,523 Issuance of 1,000,000 common stock warrants in connection with subordinated debt valued at $1.30 per share.............................. -- -- 1,300 -- 1,300 Issuance of common stock in connection with exercise of stock options.................... 806 -- -- -- -- Dividends on preferred stock................... -- -- -- (360) (360) Net income..................................... -- -- -- 1,767 1,767 ---------- ---- ------- ------- ------- Balance at August 31, 1995..................... 18,087,556 180 4,498 14,552 19,230 Issuance of common stock in connection with exercise of stock options.................... 2,218 1 9 -- 10 Issuance of common stock in connection with redemption of preferred stock................ 343,347 3 1,997 -- 2,000 Dividends on preferred stock................... -- -- -- (240) (240) Net income..................................... -- -- -- 4,851 4,851 ---------- ---- ------- ------- ------- Balance at August 31, 1996..................... 18,433,121 184 6,504 19,163 25,851 Gain on sale of stock of subsidiary............ -- -- 13,085 -- 13,085 Issuance of warrants in connection with commitment received.......................... -- -- 3,000 -- 3,000 Issuance of common stock in connection with the exercise of common stock warrants............ 2,300,000 23 11,712 -- 11,735 Issuance of common stock in connection with exercise of stock options.................... 276,385 3 223 -- 226 Net income..................................... -- -- -- 19,340 19,340 ---------- ---- ------- ------- ------- Balance at August 31, 1997..................... 21,009,506 $210 $ 34,524 $ 38,503 $73,237 ========== ==== ======= ======= =======
See notes to consolidated financial statements. F-5 62 MEGO FINANCIAL CORP. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS (thousands of dollars)
FOR THE YEARS ENDED AUGUST 31, ---------------------------------- 1997 1996 1995 -------- -------- -------- CASH FLOWS FROM OPERATING ACTIVITIES Net income................................................................................. $ 19,340 $ 4,851 $ 1,767 -------- -------- -------- Adjustments to reconcile net income to net cash provided by (used in) operating activities: Amortization of negative goodwill........................................................ (29) (49) (50) Charges to allowance for cancellations................................................... (10,470) (6,918) (6,611) Provision for cancellations.............................................................. 10,219 9,778 9,495 Gain on sale of notes receivable......................................................... (2,013) (1,116) (1,586) Provision for uncollectible owners' association advances................................. 275 12 1,050 Cost of sales............................................................................ 7,493 5,842 5,406 Depreciation............................................................................. 1,964 1,526 1,131 Gain on prior discontinued operations.................................................... -- -- (1,323) Gain on sale of stock of subsidiary...................................................... 13,085 -- -- Additions to interest only receivables................................................... (1,543) (781) (1,238) Amortization of interest only receivables................................................ 394 716 398 Repayments on notes receivable, net...................................................... 34,243 26,596 22,728 Additions to notes receivable............................................................ (55,469) (51,535) (45,396) Proceeds from sale of notes receivable................................................... 30,117 16,003 32,517 Purchase of land and timeshare interests................................................. (8,911) (20,883) (13,905) Changes in operating assets and liabilities: Decrease (increase) in restricted cash................................................. 134 1,752 (3,183) Increase in other assets............................................................... (1,328) (957) (2,645) Decrease (increase) in deferred selling costs.......................................... (252) 431 (277) Increase in accounts payable and accrued liabilities................................... 1,606 3,837 5,928 Increase (decrease) in deposits........................................................ 12 (648) 1,399 Increase (decrease) in payable to assignors............................................ (2,579) -- 5,448 Increase (decrease) in income taxes payable............................................ (3,836) 2,232 2,425 Decrease in excess of liabilities over net assets of prior discontinued operations..... -- -- (2,899) -------- -------- -------- Total adjustments.................................................................... 13,112 (14,162) 8,812 -------- -------- -------- Net cash provided by (used in) operating activities................................ 32,452 (9,311) 10,579 -------- -------- -------- NET CASH USED IN DISCONTINUED OPERATIONS..................................................... (19,762) (11,280) (15,095) -------- -------- -------- CASH FLOWS FROM INVESTING ACTIVITIES Purchase of property and equipment......................................................... (6,811) (8,690) (3,523) Proceeds from sale of property and equipment............................................... 24 19 3 Additions to other investments............................................................. (769) (1,381) (262) Decreases in other investments............................................................. 592 940 350 -------- -------- -------- Net cash used in investing activities.............................................. (6,964) (9,112) (3,432) -------- -------- -------- CASH FLOWS FROM FINANCING ACTIVITIES Proceeds from borrowings................................................................... 38,568 54,551 43,588 Reduction of debt.......................................................................... (43,251) (27,801) (39,504) Preferred stock dividends.................................................................. -- (240) (360) Redemption of preferred stock.............................................................. -- (1,000) -- Increase in additional paid-in capital due to exercise of warrants......................... 7,472 -- -- Increase in additional paid-in capital due to exercise of stock options.................... 223 9 -- Increase in common stock due to exercise of stock options.................................. 3 1 -- Increase in common stock due to exercise of warrants....................................... 13 -- -- Payments on subordinated debt.............................................................. (2,429) (1,000) -- Increase in subordinated debt.............................................................. 1,309 1,339 652 -------- -------- -------- Net cash provided by financing activities.......................................... 1,908 25,859 4,376 -------- -------- -------- NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS......................................... 7,634 (3,844) (3,572) CASH AND CASH EQUIVALENTS -- BEGINNING OF YEAR............................................... 2,742 6,586 10,158 -------- -------- -------- CASH AND CASH EQUIVALENTS -- END OF YEAR..................................................... $ 10,376 $ 2,742 $ 6,586 ======== ======== ======== SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION Cash paid during the year for: Interest, net of amounts capitalized..................................................... $ 8,193 $ 9,136 $ 5,567 ======== ======== ======== Income taxes............................................................................. $ -- $ 25 $ 3 ======== ======== ======== SUPPLEMENTAL DISCLOSURE OF NON-CASH ACTIVITIES Issuance of subordinated debt to assignors................................................. $ -- $ -- $ 10,000 ======== ======== ======== In connection with the issuance of subordinated debt the Company issued 1,000,000 common stock warrants to the assignors.......................................................... $ -- $ -- $ 1,300 ======== ======== ======== In connection with the securitization of loans and creation of mortgage related securities, the Company retained interest only securities and residual interest securities (included in net assets of discontinued operations)................................................ $ -- $ 20,096 $ -- ======== ======== ======== Redemption of preferred stock through issuance of common stock............................. $ -- $ 2,000 $ -- ======== ======== ======== In connection with the acquisition of certain timeshare interests held for sale............ $ -- $ 245 $ -- ======== ======== ======== Issuance of warrants for 1,000,000 shares of common stock in connection with commitment received................................................................................. $ 3,000 $ -- $ -- ======== ======== ======== Reduction of subordinated debt to assignors in connection with the exercise of 1,000,000 common stock warrants.................................................................... $ 4,250 $ -- $ -- ======== ======== ========
See notes to consolidated financial statements. F-6 63 MEGO FINANCIAL CORP. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS FOR THE YEARS ENDED AUGUST 31, 1997, 1996 AND 1995 1. NATURE OF OPERATIONS Mego Financial Corp. (Mego Financial) is a specialty financial services company that, through its subsidiary, Preferred Equities Corporation (PEC), is engaged primarily in originating, selling, servicing and financing consumer receivables generated through timeshare and land sales. Mego Financial and its subsidiaries are herein individually or collectively referred to as the Company as the context requires. PEC markets and finances timeshare interests and land in select resort areas. By providing financing to virtually all of its customers, PEC also originates consumer receivables that it sells and generally services. Mego Financial was incorporated under the laws of the state of New York in 1954 under the name Mego Corp. and, in 1992, changed its name to Mego Financial Corp. In February 1988, Mego Financial acquired PEC, pursuant to an assignment by the Assignors, as defined below, of their contract right to purchase PEC. See Note 2 for further discussion. To facilitate its sales of timeshare interests, the Company has entered into several trust agreements. The trustees administer the collection of the related notes receivable. The Company has assigned title to certain of its resort properties in Nevada and its interest in certain related notes receivable to the trustees. In 1992, Mego Financial organized a subsidiary, Mego Mortgage Corporation (MMC), which is a specialized consumer finance company that originates, purchases, sells, securitizes and services consumer loans consisting primarily of conventional uninsured home improvement and debt consolidation loans. After an initial public offering (the IPO) of MMC common stock in November 1996, Mego Financial held 81.3% of the outstanding stock of MMC. On September 2, 1997, Mego Financial distributed all of its remaining 10,000,000 shares of MMC's common stock to Mego Financial's shareholders in a tax-free spin-off (the Spin-off). See Note 3. 2. ACQUISITION OF PREFERRED EQUITIES CORPORATION The acquisition of PEC on February 1, 1988, was effected pursuant to an Assignment Agreement, dated October 25, 1987, between Mego Financial and several corporations (Assignors) and a related Assignment and Assumption Agreement (Assignment and Assumption Agreement), dated February 1, 1988, and amended on July 29, 1988, between Mego Financial and the Assignors (collectively, such agreements constitute the Assignment). The acquisition of PEC was accomplished by PEC's issuing 2 shares of its common stock to Mego Financial for a purchase price of approximately $50,000. Immediately prior to that time, the previously outstanding shares held by others were surrendered and redeemed by PEC at a cost to PEC of approximately $10,463,000 plus fees and expenses, leaving Mego Financial with all of the outstanding shares of PEC. The right to purchase shares from PEC was obtained by Mego Financial pursuant to the Assignment, which assigned to Mego Financial the right to purchase shares from PEC pursuant to the Stock Purchase and Redemption Agreement, dated October 6, 1987, between PEC and the Assignors, as amended on October 25, 1987. Consideration for the Assignment consisted of promissory notes (Purchase Notes) from Mego Financial to the Assignors in the aggregate amount of $2,000,000 and additional payments to the Assignors as described below. The Purchase Notes were paid in full prior to August 31, 1988. After the payment of the Purchase Notes, the Assignors were entitled to receive from Mego Financial on a quarterly basis, as determined as of the end of each quarter, additional payments equal in the aggregate to 63% of PEC's consolidated unrestricted cash balances, for a period ending on January 31, 1995. The additional payments are collateralized by a pledge of PEC stock to the Assignors. On March 2, 1995, Mego Financial entered into the Second Amendment to Assignment and Assumption Agreement (Amendment) whereby the Assignors agreed to defer payment of $10,000,000 of the amount payable to Assignors and to subordinate such amount constituting (Subordinated Debt), in right of payment F-7 64 MEGO FINANCIAL CORP. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) FOR THE YEARS ENDED AUGUST 31, 1997, 1996 AND 1995 to debt for money borrowed by Mego Financial or obligations of subsidiaries guaranteed by Mego Financial. Warrants (Warrants) for 1,000,000 shares of Mego Financial common stock, at an exercise price of $4.25 per share (the closing market price per share on March 2, 1995) were granted to the Assignors in consideration of the payment deferral and subordination. The Warrants were exercised in August 1997, in a non-cash transaction, whereby the Subordinated Debt was reduced by $4,250,000. The Amendment calls for interest to be paid semiannually at the rate of 10% per annum starting September 1, 1995, and 7 equal semi-annual payments of $1,429,000 plus interest, which commenced March 1, 1997. However, in connection with the reduction of the Subordinated Debt, payments aggregating $4,250,000 have been deemed paid and the semiannual payments will resume in March 1999 with a partial payment in September 1998, pursuant to the Third Amendment to the Assignment and Assumption Agreement. The Subordinated Debt is collateralized by a pledge of PEC's outstanding stock. See Notes 15 and 20 for further discussion. 3. DISCONTINUED OPERATIONS On September 2, 1997, Mego Financial distributed all of its 81.3% interest in MMC comprised of 10,000,000 shares of MMC's common stock to Mego Financial's shareholders in the Spin-off. MMC's financial results have been accounted for as discontinued operations and, accordingly, the Company reclassified its Consolidated Financial Statements for all periods presented prior to that date The net effect of the Spin-off will result in the Company recording a distribution in the amount of $43,176,000 for financial statement purposes in fiscal 1998. The summarized components of the net assets of discontinued operations at August 31, 1997 were as follows (thousands of dollars): Cash and cash equivalents, including restricted cash.............. $ 12,994 Loans held for sale, net.......................................... 9,523 Mortgage related securities....................................... 106,299 Mortgage servicing rights......................................... 9,507 Other receivables................................................. 7,945 Property and equipment, net....................................... 2,153 Other............................................................. 5,779 -------- Total assets............................................ 154,200 -------- Notes and contracts payable....................................... 35,572 Accounts payable and accrued liabilities.......................... 7,759 Other liabilities and obligations................................. 57,762 -------- Total liabilities....................................... 101,093 -------- Due to Mego Financial............................................. 10,100 Undistributed minority interest in discontinued operations........ (9,931) -------- Net assets of discontinued operations............................. $ 53,276 ========
F-8 65 MEGO FINANCIAL CORP. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) FOR THE YEARS ENDED AUGUST 31, 1997, 1996 AND 1995 Operating results of the discontinued operations were as follows (thousands of dollars):
FOR THE YEARS ENDED AUGUST 31, ------------------------------- 1997 1996 1995 ------- ------- ------- REVENUES Gain on sale of loans and mortgage related securities......... $48,641 $19,236 $12,233 Interest income, net.......................................... 3,133 988 473 Financial income and other.................................... 3,036 3,348 873 ------- ------- ------- Total revenues...................................... 54,810 23,572 13,579 ------- ------- ------- EXPENSES Operating expenses............................................ 25,511 12,845 6,817 Net provision for credit losses............................... 6,300 55 864 Interest expense.............................................. 245 167 187 ------- ------- ------- Total expenses...................................... 32,056 13,067 7,868 ------- ------- ------- Income before income taxes.................................... 22,754 10,505 5,711 Income taxes.................................................. 9,062 4,235 2,277 Minority interest in discontinued operations.................. 2,358 -- -- ------- ------- ------- Net income from discontinued operations....................... $11,334 $ 6,270 $ 3,434 ======= ======= =======
For fiscal 1995, a gain on prior discontinued operations not related to MMC, occurred as a result of an order for judgment against PEC in the matter of the PEC Apartment Subsidiaries in the amount of $3,356,000, which amount was settled for $2,900,000 on May 15, 1995, and paid on June 15, 1995. Excess of liability over assets of discontinued operations (a provision for loss) had been provided in the amount of $4,222,000 resulting in a gain on discontinued operations of $873,000 after deducting $450,000 of taxes to be reflected on the Statements of Operations. 4. EXCESS OF BOOK VALUE OF NET ASSETS ACQUIRED OVER ACQUISITION COST On February 1, 1988, the underlying book value of the net assets of PEC exceeded Mego Financial's acquisition cost by the amount of $42,315,000. Management allocated the excess book value to assets existing at the acquisition date (primarily notes receivable which mature over approximately seven to ten years), as a revaluation adjustment. As collections are made on the receivables (either through installment payments or upon sale of receivables), a portion of the revaluation adjustment is recorded to income as amortization. For the fiscal years ended August 31, 1997, 1996 and 1995, such amortization amounted to $0, $0 and $166,000, respectively. The Company previously determined that $20,000,000 of the revaluation adjustment should not be amortized. Payments to assignors aggregated $47,401,000 through January 31, 1995 at which time the accrual of payments to Assignors ceased. Amounts in excess of $20,000,000 have been expensed and $0, $0 and $7,252,000 have been included in costs and expenses for the fiscal years ended August 31, 1997, 1996 and 1995, respectively. See Notes 2 and 20 for further discussion. 5. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES Principles of Consolidation and Basis of Presentation -- The accompanying consolidated financial statements include the accounts of Mego Financial and its subsidiaries. All significant intercompany accounts and transactions have been eliminated in consolidation. See Note 1 for further discussion. The accompanying Consolidated Statements of Operations reflect the operating results of MMC as discontinued operations in accordance with Accounting Principles Board (APB) Opinion No. 30. Prior period operating results have been restated to reflect continuous operations. The footnote information presented herein applies only to the continuing operations of Mego Financial unless otherwise stated. See Note 3 for further discussion. F-9 66 MEGO FINANCIAL CORP. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) FOR THE YEARS ENDED AUGUST 31, 1997, 1996 AND 1995 Parent Company Only Basis -- At August 31, 1997 and 1996, Mego Financial, on a "parent company only" basis, reflected total assets of $98,157,000 and $58,708,000, respectively, which were comprised principally of its equity investment in subsidiaries of $79,723,000 and $46,082,000, respectively, and liabilities of $10,669,000 and $23,166,000, respectively, excluding subordinated debt. At August 31, 1997, liabilities were comprised principally of income taxes payable of $6,235,000 and payable to PEC of $3,072,000, excluding subordinated debt. At August 31, 1996, liabilities were comprised principally of income taxes payable of $11,669,000, payable to Assignors of $2,579,000, and payable to PEC of $7,445,000, excluding subordinated debt. At August 31, 1997 and 1996, subordinated debt of $4,321,000 and $9,691,000, respectively, was outstanding. At August 31, 1997 and 1996, Mego Financial had no outstanding redeemable preferred stock. See Notes 2 and 20 for further discussion. Cash Equivalents -- Cash equivalents consist primarily of certificates of deposit, repurchase agreements and commercial paper with original maturities of 90 days or less. Restricted Cash -- Restricted cash represents cash on deposit which relates to utility subsidiary customer deposits and betterment fees; cash on deposit in accordance with notes receivable sale agreements; and untransmitted funds received from collection of notes receivable which have not as yet been disbursed to the purchasers of such notes receivable in accordance with the related sale agreements. Notes Receivable -- The basis is the outstanding principal balance of the notes reduced by the allowance for cancellations and discounts. Substantially all of the notes receivable generated by PEC are carried at the lower of cost or market on an aggregate basis by type of receivable. Allowance for Cancellations -- Provision for cancellations relating to notes receivable is recorded as expense in amounts sufficient to maintain the allowance at a level considered adequate to provide for anticipated losses resulting from customers' failure to fulfill their obligations under the terms of their notes receivable. The Company records provision for cancellations at the time revenue is recognized, based upon periodic analysis of the portfolio, collateral values, historical credit loss experience, borrowers' ability to repay and current economic factors. The allowance for cancellations represents the Company's estimate of the future credit losses to be incurred over the lives of the notes receivable. The allowance for cancellations is reduced by actual cancellations experienced, including cancellations related to previously sold notes receivable which were reacquired pursuant to the recourse obligations discussed herein. Such allowance is also reduced to establish the separate liability for the reserve for notes receivable sold with recourse. Recourse to the Company on sales of notes receivable is governed by the agreements between the purchasers and the Company. The Company's judgment in determining the adequacy of this allowance is based upon a periodic review of its portfolio of notes receivable. These reviews take into consideration changes in the nature and level of the portfolio, current economic conditions which may affect the purchasers' ability to pay, the estimated value of inventory that may be reacquired and overall portfolio quality. Changes in the allowance as a result of such reviews are reflected in the provision for cancellations. Interest Only Receivables -- Interest only receivables were formerly excess servicing rights which were renamed in accordance with Statement of Financial Accounting Standards (SFAS) No. 125 (as hereinafter defined) and are carried at fair market value. Timeshare Interests Held for Sale -- Costs incurred in connection with preparing timeshare interests for sale are capitalized and include all costs of acquisition, renovation and furnishings. Timeshare interests held for sale are valued at the lower of cost or net realizable value. Land and Improvements Inventory -- Land and improvements inventory include carrying costs capitalized during the development period and costs of improvements incurred to date and are stated at cost, not in excess of market value. F-10 67 MEGO FINANCIAL CORP. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) FOR THE YEARS ENDED AUGUST 31, 1997, 1996 AND 1995 Property and Equipment -- Property and equipment is stated at cost and is depreciated over its estimated useful life (generally 3 - 40 years) using the straight-line method. Costs of maintenance and repairs that do not improve or extend the life of the respective assets are recorded as expense. Utility Accounting Policies -- The Company, through a wholly-owned subsidiary, provides water and sewer services to customers in the Pahrump valley of Nevada. This subsidiary is subject to regulation by the Public Utilities Commission of Nevada and the Company's accounting policies conform to generally accepted accounting principles as applied in the case of regulated public utilities in accordance with the accounting requirements of the regulatory authority having jurisdiction. Contributions in aid of construction (CIAC) received by the Company from its customers are included as a separate liability and amortized over the period of 9 - 25 years, which represents the estimated remaining useful life of the corresponding improvements. Amortization of CIAC reduces depreciation expense. CIAC is included in accounts payable and accrued liabilities in the amounts of $6,409,000 and $4,494,000 at August 31, 1997 and 1996, respectively. The Company excludes from the CIAC liability a sum equal to the income taxes related to the receipt of CIAC funds. Reserve for Notes Receivable Sold with Recourse -- Recourse to the Company on sales of notes receivable is governed by the agreements between the purchasers and the Company. The reserve for notes receivable sold with recourse represents the Company's estimate of the fair value of future credit losses to be incurred over the lives of the notes receivable. Proceeds from the sale of notes receivable sold with recourse were $30,117,000, $16,003,000 and $32,517,000 for the years ended August 31, 1997, 1996 and 1995, respectively. A liability for reserve for notes receivable sold with recourse is established at the time of each sale based upon the Company's estimate of future recourse obligations under each agreement of sale. For notes receivable sold between September 30, 1992 and December 31, 1996, the liability was determined in accordance with Emerging Issues Task Force (EITF) Issue No. 92-2, on a "discounted to present value" basis using an interest rate equivalent to the risk-free market rate for securities with a duration similar to that estimated for the underlying notes receivable. Effective January 1, 1997, the estimated liability is recorded at its fair value as a result of the adoption of SFAS 125. Income Taxes -- The Company utilizes the provisions of SFAS No. 109, "Accounting for Income Taxes" (SFAS 109). SFAS 109 requires the Company to adhere to an asset/liability approach for financial accounting and reporting for income taxes. Income tax expense is provided for the tax effects of transactions reported in the financial statements and consists of taxes currently due plus deferred taxes related primarily to differences between the bases of the balance sheet for financial and income tax reporting. The deferred tax assets and liabilities represent the future tax return consequences of those differences, which will either be taxable or deductible when they are recovered or settled. Deferred taxes also are recognized for operating losses that are available to offset future taxable income and tax credits that are available to offset future income taxes. See Note 17. Revenue and Profit Recognition -- Timeshare Interests and Land Sales -- Sales of timeshare interests and land are recognized and included in revenues after certain "down payment" and other "continuing investment" criteria are met. Land sale revenues are recognized using the deposit method in accordance with the provisions of SFAS No. 66, "Accounting for Sales of Real Estate." The agreement for sale generally provides for a down payment and a note secured by a deed of trust or mortgage payable to the Company in monthly installments, including interest, over a period of up to ten years. Revenue is recognized after the requisite rescission period has expired and at such time as the purchaser has paid at least 10% of the sales price for sales of timeshare interests and 20% of the sales price for land sales. Land sales usually meet these requirements within eight to ten months from closing, and sales of timeshare interests usually meet these requirements at the time of sale. The sales price, less provision for cancellations, is recorded as revenue and the allocated cost related to such net revenue of the timeshare interest or land is recorded as expense in the F-11 68 MEGO FINANCIAL CORP. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) FOR THE YEARS ENDED AUGUST 31, 1997, 1996 AND 1995 year that revenue is recognized. When revenue related to land sales is recognized, the portion of the sales price attributable to uncompleted required improvements, if any, is deferred. All payments received prior to the recognition of the sale as revenue are accounted for as deposits. Selling costs directly attributable to unrecognized sales are accounted for as deferred selling costs until the sale is recognized. For land sales made at a location other than at the property, the purchaser may cancel the contract within a specified inspection period, usually five months from the date of purchase, provided that the purchaser is not in default under the terms of the contract. At August 31, 1997, $308,000 of recognized sales remain subject to such cancellation. If a purchaser defaults under the terms of the contract, after all rescission and inspection periods have expired, all payments are generally retained by the Company. If the underlying note receivable is at a "below market" interest rate, a discount is applied to the note receivable balance and amortized over its term so that the effective yield is 8% - 10% depending on the year of sale. Notes receivable with payment delinquencies of 90 days or more have been considered in determining the allowance for cancellations. Cancellations occur when the note receivable is determined to be uncollectible and the related collateral, if any, has been recovered. Cancellation of a sale in the year the revenue is recognized is deemed to not represent a sale and is accounted for as a reversal of the revenue with an adjustment to cost of sales. Cancellation of a note receivable subsequent to the year the revenue was recognized is charged to the allowance for cancellations. Revenue Recognition -- Gain on Sale of Notes Receivable -- Gain on sale of notes receivable includes the present value of the differential between contractual interest rates charged to borrowers on notes receivable sold by the Company and the interest rates to be received by the purchasers of such notes receivable, after considering the effects of estimated prepayments and a normal servicing fee. The Company retains certain participations in cash flows from the sold notes receivable and generally retains the associated servicing rights. The Company generally sells its notes receivable at par value. The present values of expected net cash flows from the sale of notes receivable are recorded at the time of sale as interest only receivables. Interest only receivables are amortized as a charge to income, as payments are received on the retained interest differential over the estimated life of the underlying notes receivable. Interest only receivables are recorded at the lower of unamortized cost or estimated fair value. Reserve for notes receivable sold with recourse represents the Company's estimate of losses to be incurred in connection with the recourse provisions of the sales agreements and is shown separately as a liability in the Company's Consolidated Statements of Financial Condition. In discounting cash flows related to notes receivable sales, the Company defers servicing income at an annual rate of 1% and discounts cash flows on its sales at the rate it believes a purchaser would require as a rate of return. Earned servicing income is included under the caption of financial income. The cash flows were discounted to present value using a discount rate which averaged 15% in each of fiscal years 1997, 1996 and 1995. The Company has developed its assumptions based on experience with its own portfolio, available market data and ongoing consultation with its investment bankers. In determining expected cash flows, management considers economic conditions at the date of sale. In subsequent periods, these estimates may be revised as necessary using the original discount rate, and any losses arising from prepayment and loss experience will be recognized as realized. Interest Income -- Interest income is recorded as earned. Interest income represents the interest earned on notes receivable and short term investments. F-12 69 MEGO FINANCIAL CORP. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) FOR THE YEARS ENDED AUGUST 31, 1997, 1996 AND 1995 Financial Income -- Fees for servicing notes receivable originated or acquired by the Company and sold with servicing rights retained are generally based on a stipulated percentage of the outstanding principal balance of such notes receivable and are recognized when earned. Interest received on notes receivable sold, less amounts paid to investors, is reported as financial income. Capitalized interest only receivables are amortized systematically to reduce income to an amount representing normal servicing income and the present value discount. Late charges and other miscellaneous income are recognized when collected. Costs to service notes receivable are recorded as expense when incurred. Timeshare Owners' Associations -- The Company incurs a portion of operating expenses of the timeshare owners' associations based on ownership of the unsold timeshare interests at each of the respective timeshare properties. These costs are referred to as Association Assessments and are included in the Consolidated Statements of Operations in general and administrative expense. Management fees and costs received from the associations are included in other revenues. See Note 20. Income (Loss) Per Common Share -- Income (loss) per common share is based on the net income (loss) applicable to common stock for each period divided by the weighted-average number of common shares and common share equivalents outstanding during the period. Income per common share assuming full dilution is computed by dividing net income applicable to common stock by the weighted-average number of common shares plus common share equivalents using the treasury stock method. Income (loss) from continuing operations per share, income (loss) from discontinued operations per share and gain on prior discontinued operations per share, are also disclosed due to the Spin-off of MMC. See Note 3. In loss periods, anti-dilutive common share equivalents are excluded. Recently Issued Accounting Standards -- The Financial Accounting Standards Board (the FASB) issued Statement No. 121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed Of" (SFAS 121). SFAS 121 requires that long-lived assets and certain identifiable intangibles be reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. SFAS 121 was effective for fiscal years beginning after December 15, 1995. The adoption of SFAS 121 did not have a material adverse effect on the Company's results of operations or financial condition. The FASB issued SFAS No. 123, "Accounting for Stock-Based Compensation," (SFAS 123), which established financial accounting and reporting standards for stock-based employee compensation plans and for transactions in which an entity issues its equity instruments to acquire goods or services from nonemployees. Those transactions must be accounted for based on the fair value of the consideration received or the fair value of the equity instruments issued, whichever is more reliably measurable. SFAS 123 is effective for fiscal years beginning after December 15, 1995. The Company elected to continue to apply the provisions of APB Opinion No. 25, "Accounting for Stock Issued to Employees," as permitted by SFAS 123, and accordingly provides pro forma disclosure in Note 18. SFAS No. 125, "Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities" (SFAS 125) was issued by the FASB in June 1996. SFAS 125 provides accounting and reporting standards for transfers and servicing of financial assets and extinguishments of liabilities. This statement also provides consistent standards for distinguishing transfers of financial assets that are sales from transfers that are secured borrowings. It requires that liabilities and derivatives incurred or obtained by transferors as part of a transfer of financial assets be initially measured at fair value. SFAS 125 also requires that servicing assets be measured by allocating the carrying amount between the assets sold and retained interests based on their relative fair values at the date of transfer. Additionally, this statement requires that the servicing assets and liabilities be subsequently measured by (a) amortization in proportion to and over the period of estimated net servicing income or loss and (b) assessment for asset impairment or increased obligation based on their fair values. SFAS 125 requires the Company's excess servicing rights be measured at fair market value and F-13 70 MEGO FINANCIAL CORP. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) FOR THE YEARS ENDED AUGUST 31, 1997, 1996 AND 1995 reclassified as interest only receivables and accounted for in accordance with SFAS No. 115, "Accounting for Certain Investments in Debt and Equity Securities" (SFAS 115). As required by SFAS 125, the Company adopted the new requirements effective January 1, 1997. Implementation of SFAS 125 did not have any material impact on the financial statements of the Company, as the book value of the Company's interest only receivables approximated fair value. SFAS No. 128, "Earnings per Share," (SFAS 128) was issued by the FASB in March 1997, effective for financial statements issued after December 15, 1997. SFAS 128 provides simplified standards for the computation and presentation of earnings per share (EPS), making EPS comparable to international standards. SFAS 128 requires dual presentation of "Basic" and "Diluted" EPS, by entities with complex capital structures, replacing "Primary" and "Fully-diluted" EPS under APB Opinion No. 15. Basic EPS excludes dilution from common stock equivalents and is computed by dividing income available to common stockholders by the weighted-average number of common shares outstanding for the period. Diluted EPS reflects the potential dilution from common stock equivalents, similar to fully diluted EPS, but uses only the average stock price during the period as part of the computation. An entity that reports discontinued operations is required to present Basic and Diluted EPS for each of the income related line items. Data utilized in calculating pro forma earnings per share under SFAS 128 are as follows (thousands of dollars, except share amounts):
FOR THE YEARS ENDED AUGUST 31, ------------------------------------------- 1997 1996 1995 ----------- ----------- ----------- BASIC: Income (loss) from continuing operations............ $ 8,006 $ (1,419) $ (2,540) Income from discontinued operations................. 11,334 6,270 3,434 Gain on prior discontinued operations............... -- -- 873 Preferred stock dividends........................... -- (240) (360) ----------- ----------- ----------- Net income.......................................... $ 19,340 $ 4,611 $ 1,407 =========== =========== =========== Weighted-average number of common shares outstanding....................................... 18,657,224 18,117,122 18,087,121 =========== =========== =========== DILUTED: Income (loss) from continuing operations.......... $ 8,006 $ (1,419) $ (2,540) Income from discontinued operations................. 11,334 6,270 3,434 Gain on prior discontinued operations............... -- -- 873 Preferred stock dividends........................... -- (240) (360) ----------- ----------- ----------- Net income.......................................... $ 19,340 $ 4,611 $ 1,407 =========== =========== =========== Weighted-average number of common shares and common share equivalents outstanding..................... 19,528,470 19,114,888 18,646,616 =========== =========== ===========
F-14 71 MEGO FINANCIAL CORP. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) FOR THE YEARS ENDED AUGUST 31, 1997, 1996 AND 1995 The following table reconciles income (loss) from continuing operations, basic and diluted shares and EPS for the following periods (thousands of dollars, except per share amounts):
FOR THE YEARS ENDED AUGUST 31, ------------------------------------------------------------------------------------------------ 1997 1996 1995 ---------------------------- ----------------------------- ----------------------------- PER- PER- PER- SHARE SHARE SHARE INCOME SHARES AMOUNT INCOME SHARES AMOUNT INCOME SHARES AMOUNT ------ ---------- ------ ------- ---------- ------ ------- ---------- ------ Income (loss) from continuing operations.... $8,006 $(1,419) $(2,540) BASIC EPS Income (loss) from continuing operations.... 8,006 18,657,224 $0.43 (1,419) 18,117,122 $(0.08) (2,540) 18,087,121 $(0.14) ------ ---------- ===== ------- ---------- ====== ------- ---------- ====== Effect of dilutive securities: Warrants...... -- 620,133 -- 735,870 -- 350,202 Stock options..... -- 251,113 -- 261,896 -- 209,293 ------ ---------- ------- ---------- ------- ---------- DILUTED EPS Income (loss) from continuing operations and assumed conversions... $8,006 19,528,470 $0.41 $(1,419) 19,114,888 $(0.08) $(2,540) 18,646,616 $(0.14) ====== ========== ===== ======= ========== ====== ======= ========== ======
F-15 72 MEGO FINANCIAL CORP. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) FOR THE YEARS ENDED AUGUST 31, 1997, 1996 AND 1995 The following table reconciles income from discontinued operations, net of tax and minority interest, basic and diluted shares, and EPS for the following periods (thousands of dollars, except per share amounts):
FOR THE YEARS ENDED AUGUST 31, ----------------------------------------------------------------------------------------------- 1997 1996 1995 ----------------------------- ---------------------------- ---------------------------- PER- PER- PER- SHARE SHARE SHARE INCOME SHARES AMOUNT INCOME SHARES AMOUNT INCOME SHARES AMOUNT ------- ---------- ------ ------ ---------- ------ ------ ---------- ------ Income from discontinued operations(1)... $13,692 $6,270 $3,434 Less: Minority interest in discontinued operations..... 2,358 -- -- ------ ------- ------- BASIC EPS Income from discontinued operations..... 11,334 18,657,224 $0.61 6,270 18,117,122 $0.34 3,434 18,087,121 $0.19 ------ ---------- ===== ------- ---------- ====== ------- ---------- ====== Effect of dilutive securities: Warrants....... -- 620,133 -- 735,870 -- 350,202 Stock options...... -- 251,113 -- 261,896 -- 209,293 ------ ---------- ------- ---------- ------- ---------- DILUTED EPS Income from discontinued operations and assumed conversions.... $11,334 19,528,470 $0.58 $6,270 19,114,888 $0.33 $3,434 18,646,616 $0.19 ====== ========== ===== ======= ========== ====== ======= ========== ======
- --------------- (1) Net of income taxes of $9,062, $4,235 and $2,277 for 1997, 1996 and 1995, respectively. The following table reconciles gain on prior discontinued operations, basic and diluted shares and EPS for the following periods (thousands of dollars, except per share amounts):
FOR THE YEAR ENDED AUGUST 31, 1995 ------------------------------------ PER-SHARE INCOME SHARES AMOUNT ------- ----------- --------- Gain on prior discontinued operations(1).................... $ 873 BASIC EPS Income from prior discontinued operations................... 873 18,087,121 $0.05 ---- ---------- ===== Effect of dilutive securities: Warrants.................................................. -- 350,202 Stock options............................................. -- 209,293 ---- ---------- DILUTED EPS Income from prior discontinued operations and assumed conversions............................................... $ 873 18,646,616 $0.05 ==== ========== =====
- --------------- (1) Net of income taxes of $450. F-16 73 MEGO FINANCIAL CORP. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) FOR THE YEARS ENDED AUGUST 31, 1997, 1996 AND 1995 The following table reconciles the net income applicable to common shareholders, basic and diluted shares and EPS for the following periods (thousands of dollars, except per share amounts):
FOR THE YEARS ENDED AUGUST 31, ------------------------------------------------------------------------------------------- 1997 1996 1995 ----------------------------- ---------------------------- ---------------------------- PER PER PER SHARE SHARE SHARE INCOME SHARES AMOUNT INCOME SHARES AMOUNT INCOME SHARES AMOUNT ------- ----------- ------ ------ ----------- ------ ------ ----------- ------ Net income................ $19,340 $4,851 $1,767 Less: Preferred stock dividends............... -- 240 360 ------- ------- ------- BASIC EPS Income applicable to common stockholders..... 19,340 18,657,224 $1.04 4,611 18,117,122 $0.25 1,407 18,087,121 $0.08 ------- ---------- ===== ------- ---------- ===== ------- ---------- ===== Effect of dilutive securities: Warrants................ -- 620,133 -- 735,870 -- 350,202 Stock options........... -- 251,113 -- 261,896 -- 209,293 ------- ---------- ------- ---------- ------- ---------- DILUTED EPS Income applicable to common stockholders and assumed conversions..... $19,340 19,528,470 $0.99 $4,611 19,114,888 $0.24 $1,407 18,646,616 $0.08 ======= ========== ===== ======= ========== ===== ======= ========== =====
Reclassification and Recasting -- Certain reclassifications and recasting relating to discontinued operations have been made to conform prior years with the current year presentation. Use of Estimates -- The preparation of financial statements in conformity with generally accepted accounting principles (GAAP) requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosures of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. 6. FAIR VALUES OF FINANCIAL INSTRUMENTS SFAS No. 107, "Disclosure about Fair Value of Financial Instruments" (SFAS 107), requires disclosure of estimated fair value information for financial instruments, whether or not recognized in the Statements of Financial Condition. Fair values are based upon estimates using present value or other valuation techniques in cases where quoted market prices are not available. Those techniques are significantly affected by the assumptions used, including the discount rate and estimates of future cash flows. In that regard, the derived fair value estimates cannot be substantiated by comparison to independent markets and, in many cases, could not be realized in immediate settlement of the instrument. SFAS 107 excludes certain financial instruments and all nonfinancial instruments from its disclosure requirements. Accordingly, the aggregate fair value amounts presented do not represent the underlying value of the Company. F-17 74 MEGO FINANCIAL CORP. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) FOR THE YEARS ENDED AUGUST 31, 1997, 1996 AND 1995 Estimated fair values, carrying values and various methods and assumptions used in valuing the Company's financial instruments at August 31, 1997 and 1996 are set forth below (thousands of dollars):
AUGUST 31, 1997 AUGUST 31, 1996 --------------------- --------------------- CARRYING ESTIMATED CARRYING ESTIMATED VALUE FAIR VALUE VALUE FAIR VALUE -------- ---------- -------- ---------- FINANCIAL ASSETS: Cash and cash equivalents(a).......................... $ 10,376 $ 10,376 $ 2,742 $ 2,742 Notes receivable, net(b).............................. 34,274 34,753 40,610 41,337 Interest only receivables(c).......................... 3,296 3,296 2,147 2,147 FINANCIAL LIABILITIES: Notes and contracts payable(d)........................ 65,569 65,569 70,252 70,252 Deposits(e)........................................... 2,983 2,983 2,971 2,971 Subordinated debt(a).................................. 4,321 4,321 9,691 9,691
- --------------- (a) Carrying value was used as the estimate of fair value. (b) The fair value was estimated by using outstanding commitments from investors adjusted for non-qualified receivables and the collateral securing such receivables. (c) The fair value was estimated by discounting future cash flows of the instruments using discount rates, default, loss and prepayment assumptions based upon available market data, opinions from investment bankers and portfolio experience. (d) Notes payable generally are adjustable rate, indexed to the prime rate, or to the 90 day London Interbank Offering Rate (LIBOR); therefore, carrying value approximates fair value. (e) Deposits represent down payments received from customers prior to the recognition of a sale under GAAP. The carrying value approximates the estimated fair value for these deposits. The fair value estimates made at August 31, 1997 were based upon pertinent market data and relevant information on the financial instruments at that time. Because no market exists for a certain portion of the financial instruments, fair value estimates may be based upon judgments regarding future expected loss experience, current economic conditions, risk characteristics of various financial instruments and other factors. Changes in assumptions could significantly affect the estimates and do not reflect any premium or discount that could result from the bulk sale of the entire portion of the financial instruments. These estimates are subjective in nature and involve uncertainties and matters of significant judgment and therefore cannot be determined with precision. Fair value estimates are based upon existing on- and off-balance sheet financial instruments without attempting to estimate the value of anticipated future business and the value of assets and liabilities that are not considered financial instruments. For instance, the Company has certain fee-generating business lines (e.g., its loan servicing operations) that were not considered in these estimates since these activities are not financial instruments. In addition, the tax implications related to the realization of the unrealized gains and losses can have an effect on fair value estimates and have not been considered in any of the estimates. 7. CONCENTRATIONS OF RISK Availability of Funding Sources -- The Company funds substantially all of the notes receivable, timeshare inventory and land inventory with borrowings through its financing facilities and internally generated funds. These borrowings are in turn repaid with the proceeds received by the Company from such notes receivable through loan sales and payments. Any failure to renew or obtain adequate financing under its F-18 75 MEGO FINANCIAL CORP. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) FOR THE YEARS ENDED AUGUST 31, 1997, 1996 AND 1995 financing facilities, or other borrowings, or any substantial reduction in the size of or pricing in the markets for the Company's notes receivable, could have a material adverse effect on the Company's operations. Geographic Concentrations -- The Company services notes receivable in all 50 states, the District of Columbia and Canada. At August 31, 1997, 30% of the dollar value of notes receivable serviced had been originated in California. No other state accounted for more than 10% of the servicing portfolio of the Company's receivables. The risk inherent in such concentrations is dependent upon regional and general economic stability which affects property values and the financial stability of the borrowers. The Company's timeshare and land inventories are concentrated in Nevada, New Jersey, Colorado, and Florida. The risk inherent in such concentrations is in the continued popularity of these resort destinations, which affects the marketability of the Company's products. Credit Risk -- The Company is exposed to on-balance sheet credit risk related to its notes receivable. The Company is exposed to off-balance sheet credit risk related to notes receivable sold under recourse provisions. The outstanding balance of notes receivable sold with recourse provisions totaled $77,061,000 and $59,322,000 at August 31, 1997 and 1996, respectively. Interest Rate Risk -- The Company's profitability is in part determined by the difference, or "spread," between the effective rate of interest received on the notes receivable originated by the Company and the interest rates payable under its financing facilities to fund the Company's notes receivable and inventory held for sale and the yield required by investors on notes receivable sales. The spread can be adversely affected after a note is originated or purchased and while it is held during the warehousing period by increases in the interest rate demanded by investors. In addition, because the notes receivable originated by the Company have fixed rates, the Company bears the risk of narrowing spreads because of interest rate increases during the period from the date the notes receivable are originated or purchased until the closing of the sale. Additionally, the fair value of interest only receivables owned by the Company may be adversely affected by changes in the interest rate environment which could affect the discount rate and prepayment assumptions used to value the assets. 8. NOTES RECEIVABLE Notes receivable consist of the following (thousands of dollars):
AUGUST 31, --------------------- 1997 1996 -------- -------- Related to timeshare sales............................. $ 21,947 $ 24,973 Related to land sales.................................. 23,668 27,601 -------- -------- Total........................................ 45,615 52,574 -------- -------- Less: Allowance for cancellations...................... (10,824) (11,512) Discounts........................................ (517) (452) -------- -------- (11,341) (11,964) -------- -------- Total........................................ $ 34,274 $ 40,610 ======== ========
The Company provides financing to the purchasers of its timeshare interests and land. This financing is generally evidenced by notes secured by deeds of trust or mortgages as well as non-recourse installment sales contracts. These notes receivable are generally payable over a period of up to 10 years, bear interest at rates ranging from 0% to 16% and require equal monthly installments of principal and interest. The Company has entered into financing arrangements with certain purchasers of timeshare interests and land whereby no stated interest rate is charged if the aggregate down payment is at least 50% of the purchase price and the balance is payable in 24 or fewer monthly payments. Notes receivable of $7,023,000 and F-19 76 MEGO FINANCIAL CORP. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) FOR THE YEARS ENDED AUGUST 31, 1997, 1996 AND 1995 $5,991,000 at August 31, 1997 and 1996, respectively, made under this arrangement are included in the table above. A discount is established to provide for an effective interest rate (currently 10%) on notes receivable bearing no stated interest rate at the time of sale, and is applied to the principal balance and amortized over the terms of the notes receivable. The effective interest rate is based upon the economic interest rate environment and similar industry data. The Company is obligated under certain agreements for the sale of notes receivable and certain loan agreements to maintain various minimum net worth requirements. The most restrictive of these agreements requires PEC to maintain a minimum net worth of $25,000,000. At August 31, 1997 and 1996, receivables aggregating $41,063,000 and $49,637,000, respectively, were pledged to lenders to collateralize certain of the Company's indebtedness. Receivables which qualify for the lenders' criteria may be pledged as collateral whether or not such receivables have been recognized for accounting purposes. See Note 14 for further discussion. Allowance for Cancellations -- The Company provides an allowance for cancellations, in an amount which in the Company's judgment will be adequate to absorb losses on notes receivable that may become uncollectible. The Company's judgment in determining the adequacy of this allowance is based on its continual review of its portfolio which utilizes historical experience and current economic factors. These reviews take into consideration changes in the nature and level of the portfolio, historical rates, collateral values, current and future economic conditions which may affect the obligors' ability to pay and overall portfolio quality. Changes in both the allowance for cancellations and the reserve for notes receivable sold with recourse consist of the following (thousands of dollars):
FOR THE YEARS ENDED AUGUST 31, -------------------------------- 1997 1996 1995 -------- ------- ------- Balance at beginning of year................................. $ 19,924 $18,821 $16,875 Provision for cancellations.................................. 10,219 9,778 9,495 Amounts charged to allowance for cancellations and reserve for notes receivable sold with recourse.................... (10,616) (8,675) (7,549) -------- ------- ------- Balance at end of year....................................... $ 19,527 $19,924 $18,821 ======== ======= ======= Allowance for cancellations.................................. $ 10,824 $11,512 $11,677 Reserve for notes receivable sold with recourse.............. 8,703 8,412 7,144 -------- ------- ------- Total.............................................. $ 19,527 $19,924 $18,821 ======== ======= =======
Number of Notes Receivable Accounts Serviced -- The number of notes receivable accounts serviced at August 31, 1997 and 1996, was 18,136 and 18,424, respectively. At August 31, 1997 and 1996, the amount of notes receivable with payment delinquencies of 90 days or more was $4,029,000 and $4,860,000, respectively, on serviced accounts other than accounts serviced for MMC. Notes Receivable Serviced and Originated -- At August 31, 1997 and 1996, notes receivable serviced were $118,641,000 and $120,709,000, respectively. Notes receivable originated were $51,086,000 and $48,463,000 for the years ended August 31, 1997 and 1996, respectively. F-20 77 MEGO FINANCIAL CORP. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) FOR THE YEARS ENDED AUGUST 31, 1997, 1996 AND 1995 9. INTEREST ONLY RECEIVABLES With the implementation of SFAS 125 on January 1, 1997, the Company's future and existing excess servicing rights were renamed interest only receivables. Activity in interest only receivables is as follows (thousands of dollars):
FOR THE YEARS ENDED AUGUST 31, ---------------------------- 1997 1996 1995 ------ ------ ------ Balance at beginning of year..................................... $2,147 $2,082 $1,242 Plus: Additions.................................................. 1,543 781 1,238 Less: Amortization............................................... (394) (716) (398) ------ ------ ------ Balance at end of year........................................... $3,296 $2,147 $2,082 ====== ====== ======
As of August 31, 1997 and 1996, interest only receivables consisted of excess cash flows on sold loans totaling $77,061,000 and $59,322,000, respectively, yielding weighted-average interest rates of 12.3% for both years, net of normal servicing fees and had weighted-average pass-through yields to the investor of 9.2% and 9.3%, respectively. These loans were sold under recourse provisions as described in Note 5. The principal balance of notes receivable as shown below, represents a series of sales, providing a range of yields to purchasers at fixed rates for the periods indicated as follows (thousands of dollars):
1997 1996 - ------------------------------------ ------------------------------------- PRINCIPAL BALANCE OF PRINCIPAL BALANCE OF NOTES RECEIVABLE SOLD YIELD NOTES RECEIVABLE SOLD YIELD - --------------------- ---------- --------------------- ----------- $19,741 9% -- 9.13% $12,329 8.3% -- 9.35% 10,376(a) 9% -- 9.75% 3,674(a) 9.5% -- 10.55%
- --------------- (a) These series of sales were to the same purchaser, while the other series of sales were to different purchasers. 10. INVENTORIES Timeshare interests held for sale consist of the following (thousands of dollars):
AUGUST 31, ------------------- 1997 1996 ------- ------- Timeshare interests (including capitalized interest of $473 and $486 in 1997 and 1996, respectively)........................................... $17,624 $14,353 Timeshare interests under construction (including capitalized interest of $1,043 and $389 in 1997 and 1996, respectively)........................ 17,464 19,338 ------- ------- Total.......................................................... $35,088 $33,691 ======= =======
At August 31, 1997 and 1996, 9,124 and 7,637 timeshare interests, respectively, were available for sale. Apartment units amounting to 176 and 254 at August 31, 1997 and 1996, respectively, were under construction and awaiting completion of remodeling, renovation, furnishing, conversion and registration, representing 8,976 and 12,954 timeshare interests, respectively. Land and improvements inventory consist of $2,206,000 at August 31, 1997 and $2,185,000 at August 31, 1996. F-21 78 MEGO FINANCIAL CORP. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) FOR THE YEARS ENDED AUGUST 31, 1997, 1996 AND 1995 11. OTHER INVESTMENTS Other investments in the following locations, at lower of cost or market, consist of the following (thousands of dollars):
AUGUST 31, ----------------- 1997 1996 ------ ------ Water rights: Huerfano County, Colorado................................ $ 532 $ 524 Nye County, Nevada....................................... 413 98 Land: Nye County, Nevada....................................... 602 863 Park County, Colorado.................................... -- 13 Clark County, Nevada..................................... 51 51 Other...................................................... 551 423 ------ ------ Total............................................ $2,149 $1,972 ====== ======
12. PROPERTY AND EQUIPMENT Property and equipment and related accumulated depreciation, consist of the following (thousands of dollars):
AUGUST 31, --------------------- 1997 1996 -------- -------- Water and sewer systems................................ $ 16,209 $ 13,752 Furniture and equipment................................ 7,065 5,312 Buildings.............................................. 10,643 8,451 Vehicles............................................... 2,531 2,270 Recreational facilities and equipment.................. 1,323 1,192 Land................................................... 1,342 1,342 Leasehold improvements................................. 399 349 -------- -------- 39,512 32,668 Less: Accumulated depreciation......................... (15,292) (13,271) -------- -------- Total........................................ $ 24,220 $ 19,397 ======== ========
F-22 79 MEGO FINANCIAL CORP. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) FOR THE YEARS ENDED AUGUST 31, 1997, 1996 AND 1995 13. OTHER ASSETS Other assets consist of the following (thousands of dollars):
AUGUST 31, ----------------- 1997 1996 ------ ------ Other receivables.......................................... $3,574 $2,102 Miscellaneous assets....................................... 843 1,318 Deposits and impounds...................................... 511 461 Licenses................................................... 967 1,067 Other receivables collateralized by trust deeds and second mortgages................................................ 86 222 Receivable from owners' associations (Notes 5 and 20)...... -- 623 Prepaid expenses and other................................. 949 583 ------ ------ Total............................................ $6,930 $6,376 ====== ======
14. NOTES AND CONTRACTS PAYABLE The Company's debt including lines of credit consists of the following (thousands of dollars):
AUGUST 31, ------------------- 1997 1996 ------- ------- Notes collateralized by receivables(a)................... $31,489 $38,178 Mortgages collateralized by real estate properties(b).... 32,311 31,078 Installment contracts and other notes payable............ 1,769 996 ------- ------- Total.......................................... $65,569 $70,252 ======= =======
The details of the notes payable are summarized as follows (thousands of dollars):
AUGUST 31, ------------------- 1997 1996 ------- ------- (a) NOTES COLLATERALIZED BY RECEIVABLES Borrowings bearing interest at prime plus: 2% in 1997 and 2.25% to 2.5% in 1996 including "lines of credit" (see below)....................................... $31,489 $38,178 ======= ======= (b) MORTGAGES COLLATERALIZED BY REAL ESTATE PROPERTIES Mortgages collateralized by the respective underlying assets with various repayment terms and fixed interest rates of 8% in 1997 and variable rates of prime plus: 2% to 3% and 90 day LIBOR plus 4.25% in 1997 and 1.75% to 3% and 90 day LIBOR plus 4.25% in 1996............ $32,311 $31,078 ======= =======
The prime rate of interest was 8.50% and the 90 day LIBOR was 5.72% at August 31, 1997. Maturities -- Scheduled maturities of the Company's contracts payable, excluding lines of credit and mortgages are as follows (thousands of dollars):
FOR THE YEARS ENDING AUGUST 31, ---------------------------------------- BALANCE 1998 1999 2000 2001 2002 - ------- ---- ---- ---- ---- ---- $ 1,769 $776 $502 $321 $134 $ 36
F-23 80 MEGO FINANCIAL CORP. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) FOR THE YEARS ENDED AUGUST 31, 1997, 1996 AND 1995 Lines of Credit -- PEC is the borrower under 6 agreements for lines of credit with 5 lenders not to exceed $137,500,000 which are collateralized by security interests in timeshare and land receivables and are guaranteed by the Company. At August 31, 1997 and 1996, an aggregate of $62,089,000 and $65,875,000 had been borrowed under these lines, respectively. Under the terms of such lines of credit, PEC may borrow 70% to 85% of the balances of the pledged timeshare and land receivables. Summarized line of credit information relating to these six lines of credit outstanding at August 31, 1997, consist of the following (thousands of dollars):
BORROWING MAXIMUM AMOUNT AT BORROWING REVOLVING AUGUST 31, 1997 AMOUNT EXPIRATION DATE(f) MATURITY DATE INTEREST RATE - --------------- --------- ------------------ -------------- -------------------- $39,113 $75,000 (a) May 15, 2000 Various Prime + 2.0 - 2.25% 4,599 15,000 (b) May 30, 1998 Various Prime + 2.0% 6,365 15,000 (c) March 29, 1998 March 29, 1999 LIBOR + 4.25% 4,140 15,000 (c) February 6, 1998 August 6, 1999 LIBOR + 4.25% 4,500 10,000 (d) August 1, 2000 August 1, 2003 Prime + 2.25% 3,372 7,500 (e) April 30, 1998 May 31, 2002 Prime + 2.0%
- --------------- (a) Restrictions include PEC's requirement to maintain a minimum tangible net worth of $20,000,000 with such amount increasing each fiscal quarter after August 31, 1997 by an amount equal to 50% of PEC's consolidated net income for each quarter up to a maximum requirement of $25,000,000. The maximum borrowing amount was increased from $57,000,000 to $75,000,000 as of May 15, 1997. At August 31, 1997, $24,597,000 was outstanding related to financings at prime +2%, of which $18,008,000 of loans secured by land receivables mature May 15, 2010 and $6,589,000 of loans secured by timeshare receivables mature May 15, 2007. The outstanding borrowing amount includes $2,997,000 in acquisition and development (A&D) financing maturing May 20, 1998 and $5,868,000 maturing July 1, 2003 for the financing of corporate office buildings; both loans are amortizing loans and bear interest at prime +2.25%. The remaining A&D and receivables loans and a resort lobby loan outstanding of $5,651,000 are at prime +2% and mature between January 31, 1998 and May 15, 2000. (b) Restrictions include PEC's requirement to maintain a minimum tangible net worth of $25,000,000 during the life of the loan. These credit lines include available financings for A&D and receivables. At August 31, 1997, $1,079,000 was outstanding under the A&D loan which matured in November 1997 and is currently being extended to May 1999 and $3,520,000, maturing June 1, 2002, was outstanding under the receivables loan. (c) Restrictions include PEC's requirement to maintain a minimum tangible net worth of $17,000,000 during the life of the loan. These credit lines include available financings for A&D and receivables, however only the A&D lines are currently outstanding and bear interest at 90 day LIBOR +4.25%. The available receivable financings would be at 90 day LIBOR +4% and have maturity dates of June 2005 and August 2005. (d) Restrictions include PEC's requirement to maintain a minimum tangible net worth of $25,000,000. This credit line is for the purpose of financing receivables and costs of remodeling. (e) Restrictions include PEC's requirement to maintain a minimum tangible net worth of $15,000,000. This credit line is for the purpose of financing receivables. (f) Revolving expiration dates represent the expiration of the revolving features of the lines of credit, at which time the credit lines become loans with fixed maturities. F-24 81 MEGO FINANCIAL CORP. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) FOR THE YEARS ENDED AUGUST 31, 1997, 1996 AND 1995 15. SUBORDINATED DEBT On March 2, 1995, Mego Financial entered into the Amendment whereby the Assignors agreed to defer payment of $10,000,000 of the amount payable to Assignors and to subordinate such amount, constituting Subordinated Debt, in right of payment to debt for money borrowed by Mego Financial or obligations of subsidiaries guaranteed by Mego Financial. Warrants for 1,000,000 shares of Mego Financial common stock, at an exercise price of $4.25 per share (the closing market price per share on March 2, 1995) were granted to the Assignors in consideration of the payment deferral and subordination. The Warrants were exercised in August 1997 in a non-cash transaction whereby the Subordinated Debt was reduced by $4,250,000. The Amendment calls for interest to be paid semi-annually at the rate of 10% per annum starting September 1, 1995, and 7 equal semi-annual payments of $1,429,000 plus interest, which commenced March 1, 1997. However, in connection with the reduction of the Subordinated Debt, payments aggregating $4,250,000 were deemed paid and the semiannual payments will resume in March 1999 with a partial payment in September 1998, pursuant to the Third Amendment to the Assignment and Assumption Agreement. The Subordinated Debt is collateralized by a pledge of PEC's outstanding stock. See Note 2 for further discussion. The following tables represents Subordinated Debt activity since inception (thousands of dollars):
1997 1996 ------- ------- Balance at beginning of year............................. $ 9,691 $ 9,352 Accreted interest........................................ 1,309 1,339 Less: Interest payments.................................. (1,000) (1,000) Principal paydowns................................... (1,429) -- Reduction due to exercise of warrants................ (4,250) -- ------- ------- Balance at end of year................................... $ 4,321 $ 9,691 ======= =======
The carrying value of Subordinated Debt approximated fair value at August 31, 1997 and 1996. See Note 6 for further discussion. 16. REDEEMABLE PREFERRED STOCK Mego Financial had designated 300,000 shares of its 5,000,000 authorized preferred shares as Series A, 12% Cumulative Preferred Stock, par value, $.01 per share. The remaining 4,700,000 authorized preferred shares have not been designated. As of August 31, 1993, Mego Financial sold 300,000 shares of its Series A, 12% Cumulative Preferred Stock (Preferred Stock), at a price of $10 per share. The Preferred Stock was stated at its par value of $.01 per share, and redemption value of $10 per share. Mego Financial was obligated to redeem 100,000 shares of Preferred Stock on August 31, 1995, at $10 per share. In August 1995, Mego Financial gave notice of redemption of 100,000 shares. On September 1, 1995, after receipt of the certificates, Mego Financial redeemed 100,000 shares of its Preferred Stock. On August 31, 1996, the holder of Mego Financial's 200,000 shares of outstanding 12% cumulative Preferred Stock with a redemption price of $2,000,000 redeemed their shares for 343,347 shares of Mego Financial's common stock. The number of common shares exchanged was based upon the 10 day average closing stock price of $5.825 for Mego Financial's common stock immediately prior to August 31, 1996. In conjunction with the exchange, the expiration date of the warrants outstanding to purchase 300,000 shares of Mego Financial's common stock at a price of $1.20, issued in conjunction with the Preferred Stock, and due to expire on August 31, 1996, was extended to August 31, 1997. In February 1997, the warrants were exercised and 300,000 shares of Mego Financial common stock were issued. F-25 82 MEGO FINANCIAL CORP. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) FOR THE YEARS ENDED AUGUST 31, 1997, 1996 AND 1995 17. INCOME TAXES Mego Financial files a consolidated federal income tax return with its subsidiaries for its tax year which ends the last day of February. The operations of MMC will no longer be included subsequent to the Spin-off which occurred on September 2, 1997. The benefit from continuing operations recorded for fiscal 1997 is a result of the use of net operating loss (NOL) carryforwards which were previously fully reserved and currently are used to offset income from the discontinued operations on a consolidated basis. In addition, due to changes in facts and circumstances determined in fiscal 1997, certain income tax liability reserves recorded in prior periods were reversed. Deferred income taxes reflect the net tax effects of (a) temporary differences between the carrying amount of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes, (b) temporary differences between the timing of revenue recognition for book purposes and for income tax purposes, and (c) operating loss and tax credit carryforwards. The tax effects of significant items comprising the Company's net deferred tax liability as of August 31, 1997 and 1996 are as follows (thousands of dollars):
AUGUST 31, ------------------- 1997 1996 ------- ------- Deferred tax liabilities: Difference between book and tax carrying value of assets....... $ -- $ 3,065 Timing of revenue recognition.................................. 13,279 8,347 ------- ------- 13,279 11,412 ------- ------- Deferred tax assets: Difference between book and tax carrying value of assets....... 4,821 -- Other.......................................................... 2,223 1,341 ------- ------- 7,044 1,341 ------- ------- Net deferred tax liability............................. $ 6,235 $10,071 ======= =======
The provision for taxes as reported is different from the tax provision computed by applying the statutory federal rate of 34%. The differences are as follows (thousands of dollars):
1997 1996 1995 -------- ------- ------- Loss from continuing operations before income taxes.............................................. $ 4,656 $ 2,487 $ 1,524 ======== ======== ======== Tax at the statutory federal rate.................... (1,583) (846) (518) Increase (decrease) in taxes resulting from: Payments to assignors.............................. -- -- 813 Amortization of negative goodwill.................. -- -- 70 Contributions in aid of construction............... -- 81 929 Preferred stock dividends.......................... -- (82) (122) Application of NOL carryforwards and changes in certain income tax liability reserves........... (11,079) -- -- Other.............................................. -- (221) (156) -------- -------- -------- Total.............................................. $(12,662) $(1,068) $ 1,016 ======== ======== ========
The income tax provision applied to discontinued operations exceeds the statutory federal rate primarily due to state income taxes. F-26 83 MEGO FINANCIAL CORP. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) FOR THE YEARS ENDED AUGUST 31, 1997, 1996 AND 1995 18. STOCKHOLDERS' EQUITY Mego Financial has a stock option plan (Stock Option Plan), adopted November 1993, for officers and key employees which provides for non-qualified and qualified incentive options. The Stock Option Committee of the Board of Directors determines the option price (not to be less than fair market value for qualified incentive options) at the date of grant. The options generally expire ten years from the date of grant and are exercisable over the period stated in each option at the cumulative rate of 20% per year commencing December 22, 1994, for three years and the remaining 40% after December 22, 1997. In August 1997, in connection with the Spin-off of MMC, the Stock Option Committee vested all options previously granted, excluding those granted subsequent to February 26, 1997. The following table sets forth shares reserved and options exercised, granted and forfeited for the following periods:
NUMBER OF PRICE PER RESERVE SHARES OPTIONS SHARE -------------- -------- ------------ At November 17, 1993......................... 525,000 -- $ -- Granted to more than 10% stockholder......... -- 35,000 $ 2.75 Granted to others............................ -- 355,000 $ 2.50 -------- -------- At August 31, 1994........................... 525,000 390,000 $ 2.50/2.75 Exercised.................................... (2,000) (2,000) Forfeited.................................... -- (8,000) Granted...................................... -- 85,000 $ 8.00/8.75 -------- -------- At August 31, 1995........................... 523,000 465,000 Exercised.................................... (4,000) (4,000) Forfeited.................................... -- (6,000) Granted...................................... -- 25,000 $ 5.875 -------- -------- At August 31, 1996........................... 519,000 480,000 $ 2.50/8.75 Exercised.................................... (455,000) (455,000) Forfeited.................................... -- (50,000) Granted...................................... 500,000(1) 70,000 $ 5.625/6.75 -------- -------- At August 31, 1997........................... 564,000 45,000 $ 5.625 ======== ========
- --------------- (1) The Stock Option Plan was increased by 500,000 shares upon shareholder approval which was obtained on September 9, 1997. On September 3, 1997, an additional 873,000 incentive stock options were granted under the Stock Option Plan to employees at fair market value, which was authorized by the Stock Option Committee, of which 15,000 are subject to future shareholder approval of certain amendments to the Stock Option Plan in accordance with applicable law. There were no options exercisable under this plan at August 31, 1997. SFAS 123 establishes financial accounting and reporting standards for stock-based employee compensation plans and for transactions in which an entity issues its equity instruments to acquire goods or services from non employees. Those transactions must be accounted for based on the fair value of the consideration received or the fair value of the entity instruments issued, whichever is more reliably measurable. The Company elected to continue to apply the provisions of APB Opinion No. 25 as permitted by SFAS 123 and, accordingly, provides pro forma disclosure below. F-27 84 MEGO FINANCIAL CORP. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) FOR THE YEARS ENDED AUGUST 31, 1997, 1996 AND 1995 Stock options granted under Mego Financial's Stock Option Plan are qualified stock options that: (1) are generally granted at prices which are equal to the market value of the stock on the date of grant; (2) subject to a grantee's continued employment with the Company, vest at various periods over a four year period; and (3) expire ten years subsequent to the award. A summary of the status of Mego Financial's stock options granted under the Stock Option Plan as of August 31, 1997, 1996 and 1995 and the changes during the year is presented below:
AUGUST 31, 1997 AUGUST 31, 1996 AUGUST 31, 1995 ------------------- ------------------- ------------------- WEIGHTED- WEIGHTED- WEIGHTED- AVERAGE AVERAGE AVERAGE EXERCISE EXERCISE EXERCISE SHARES PRICE SHARES PRICE SHARES PRICE -------- --------- -------- --------- -------- --------- Outstanding at beginning of year....... 480,000 $ 3.746 465,000 $ 3.605 390,000 $ 2.522 Granted................................ 70,000 6.027 25,000 5.875 85,000 8.441 Exercised.............................. 455,000 3.512 4,000 2.500 2,000 2.500 Forfeited.............................. 50,000 7.375 6,000 2.500 8,000 2.500 ------- ------- ------- Outstanding at end of year............. 45,000 5.625 480,000 3.746 465,000 3.605 ======= ======= ======= Options exercisable at end of year..... -- -- 165,000 3.133 76,000 2.523 ======= ======= =======
The fair value of each option granted during fiscal 1997, 1996 and 1995 is estimated on the date of grant using the Black-Scholes option-pricing model with the following weighted-average assumptions: (1) dividend yield of zero; (2) expected volatility of 59.3%; (3) risk-free interest rate of 6% for 1997, 1996 and 1995 and; (4) expected life of 7 years. The weighted-average fair value of options granted during 1997, 1996 and 1995 were $3.93, $3.83, and $5.51, respectively. As of August 31, 1997, there were 45,000 options outstanding which have an exercise price of $5.625 per common share and a weighted-average remaining contractual life of 9.7 years. In August 1997, in connection with the Spin-off of MMC, the Stock Option Committee vested all options granted, excluding those granted subsequent to February 26, 1997. Had compensation cost for Mego Financial's fiscal 1997, 1996 and 1995 grants for stock options been determined consistent with SFAS 123, the Company's pro forma net income and pro forma net income per common share for fiscal 1997, 1996 and 1995 would approximate the pro forma amounts below (thousand of dollars, except per share amounts):
AUGUST 31, 1997 AUGUST 31, 1996 AUGUST 31, 1995 ----------------------- ----------------------- ----------------------- AS REPORTED PRO FORMA AS REPORTED PRO FORMA AS REPORTED PRO FORMA ----------- --------- ----------- --------- ----------- --------- Net income applicable to common stock......................... $19,340 $19,042 $ 4,611 $ 4,431 $ 1,407 $ 1,291 Net income per common share: Primary....................... 0.99 0.98 0.24 0.23 0.08 0.07 Fully-diluted................. 0.99 0.97 0.24 0.23 0.07 0.07
In addition to the 1,000,000 warrants exercised as described in Note 15, an additional 1,300,000 warrants were exercised in August 1997 for $7,485,000. As of August 31, 1997 there were no warrants outstanding. 19. TIMESHARE INTEREST SALES AND LAND SALES Timeshare interest sales, net -- A summary of the components of timeshare interest sales is as follows (thousands of dollars):
FOR THE YEARS ENDED AUGUST 31, ------------------------------- 1997 1996 1995 ------- ------- ------- Timeshare interest sales.............................. $39,850 $33,178 $26,272 Less: Provision for cancellations..................... (7,597) (5,400) (5,590) ------- ------- ------- Total....................................... $32,253 $27,778 $20,682 ======= ======= =======
F-28 85 MEGO FINANCIAL CORP. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) FOR THE YEARS ENDED AUGUST 31, 1997, 1996 AND 1995 Land sales, net -- A summary of the components of land sales is as follows (thousands of dollars):
FOR THE YEARS ENDED AUGUST 31, ------------------------------- 1997 1996 1995 ------- ------- ------- Land sales............................................ $19,248 $22,346 $24,717 Less: Provision for cancellations..................... (2,622) (4,378) (3,905) ------- ------- ------- Total....................................... $16,626 $17,968 $20,812 ======= ======= =======
The following table reflects the maturities of receivables from land sales for each of the five years after August 31, 1997 (thousands of dollars):
1998 1999 2000 2001 2002 ---- ------ ---- ---- ------ Land receivables maturities........................ $516 $1,348 $348 $603 $1,785
The range of interest rates are from 0.0% to 14.5% and the weighted-average interest rate at August 31, 1997 was 11.4%. The delinquency information related to land loans at August 31, 1997 is as follows (thousands of dollars):
PRINCIPAL BALANCE % OF LOANS SERVICED ----------------- ------------------- 30 - 59 days.......................................... $ 1,812 1.5% 60 - 90 days.......................................... 338 0.3% Over 90 days.......................................... 1,895 1.6%
The amount of recorded expenditures for improvements on land was $68,000 during fiscal 1996, and the estimated total costs and expenditures for improvements on these loans for the next five years are deemed immaterial for disclosure purposes at August 31, 1997. No material obligations for future improvements on land existed at August 31, 1997. 20. RELATED PARTY TRANSACTIONS Timeshare Owners' Associations -- Owners' Associations have been incorporated for the Grand Flamingo, Reno Spa, Brigantine, Steamboat Springs, Aloha Bay and Orlando timesharing resorts. The respective Owners' Associations are independent not-for-profit corporations. PEC acts as the managing agent for these Owners' Associations and the White Sands Waikiki Resort Club, which is a division of PEC, (Associations) and has received management fees for its services of $2,198,000, $2,081,000 and $1,988,000 in 1997, 1996 and 1995, respectively. Such fees were recorded under the caption of other revenue. The expenses of PEC for management of each timeshare resort are incurred to preserve the integrity of the property and the portfolio performance on an on-going basis beyond the end of the sales period. PEC does not manage resorts of other developers and would not collect management fees or incur expenses were it not part of the total timeshare sale package and support of the portfolio. The owners of timeshare interests in each Association are responsible for payment to the Associations of assessments, which are intended to fund all of the operating expenses at each of the resort facilities. The Company's share of the Association Assessments, net of room income, was $1,589,000, $983,000 and $56,000 for 1997, 1996 and 1995, respectively, and have been recorded under the caption general and administrative expense. The Company has in the past financed budget deficits of the Associations as is reflected in the receivable from such Associations, but is not obligated to do so in the future. Since January 1988, the Company has agreed to pay to the Associations the assessments of timeshare interest owners who are delinquent with respect to their assessments, but have paid the Company in full for their timeshare interests. In exchange for these payments, the Associations assign their liens for non-payment of assessments on the respective timeshare interests to the Company. In the event the timeshare interest F-29 86 MEGO FINANCIAL CORP. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) FOR THE YEARS ENDED AUGUST 31, 1997, 1996 AND 1995 holder does not satisfy the lien after having an opportunity to do so, the Company acquires the timeshare interest for the amount of the lien and any foreclosure costs. At August 31, 1997 and 1996, $500,000 was due to Owners' Associations and $623,000 was due from Owners' Associations, respectively. The $500,000 is included under the caption accounts payable and accrued liabilities at August 31, 1997 and the $623,000 is included under the caption of other assets at August 31, 1996. Payments to Assignors -- Certain transactions have been entered into with the Assignors, who are affiliates of certain officers and directors of the Company, and these transactions are more fully described in Notes 2 and 15. During the years ended August 31, 1997, 1996 and 1995, approximately $5,225,000, $1,196,000 and $2,301,000, including interest of $1,218,000, $1,196,000 and $473,000, respectively, were paid to the Assignors. In connection with the exercise of warrants for 1,000,000 shares of common stock, a non-cash payment of $4,250,000 was recorded, whereby the Subordinated Debt was reduced by such amount. See Note 15 for further discussion. Transactions with MMC -- In November 1996, MMC consummated the IPO and as a result, the Company's ownership of MMC was reduced to approximately 81.3% of the outstanding common stock. On September 2, 1997, Mego Financial distributed all of its 10,000,000 shares of MMC's common stock to Mego Financial's shareholders in the Spin-off. To fund MMC's past operations and growth and in conjunction with filing consolidated income tax returns, MMC incurred debt to the Company and its subsidiary PEC. The amount of intercompany debt was $10,100,000 at August 31, 1997 and $12,813,000 at August 31, 1996 of which approximately $3,400,000 was paid in October 1997 together with $500,000 advanced by the Company to MMC in September 1997. Prior to the IPO, the Company had guaranteed MMC's obligations under MMC's credit agreements and an office lease. The guarantees of MMC's credit agreements were released upon consummation of the IPO. MMC did not pay any compensation to the Company for such guarantees. On August 29, 1997, MMC and the Company entered into an agreement (the Payment Agreement) with respect to MMC's repayment after the Spin-off of (i) a portion of the debt owed by MMC to the Company as of May 31, 1997 aggregating approximately $3,400,000 (the May Amounts) and (ii) debt owed by MMC to the Company as of August 31, 1997 in addition to the May Amounts (the Excess Amounts). The May Amounts consist of a portion of the debt owed by MMC to the Company as of May 31, 1997 in respect of funds advanced by the Company to MMC through such date, the portion of the Warrant Value (as hereinafter defined) amortized through such date and amounts owed under the tax allocation and indemnification agreement between the Company and MMC as of such date. The Excess Amounts consist of funds advanced by the Company to MMC during the period commencing June 1, 1997 and ended August 31, 1997 (the Excess Period), the portion of the Warrant Value amortized during the Excess Period and amounts accrued under the tax allocation and indemnification agreement during the Excess Period. Warrants valued at $3,000,000 (the Warrant Value) were issued by the Company to a financial institution in connection with MMC's agreement with that financial institution to purchase up to $2 billion of loans from MMC. Pursuant to the Payment Agreement, MMC agreed to repay the May Amounts upon the earlier to occur of (i) the first consummation after the date of the agreement of a public or private debt or equity transaction by MMC of at least $25,000,000 in amount or (ii) August 31, 1998. MMC repaid the May Amounts plus $500,000 advanced by Mego Financial in September 1997 with a portion of the net proceeds of a private placement of MMC's subordinated notes in October 1997. MMC has further agreed to repay the Excess Amounts upon the earlier to occur of (i) the second consummation after the date of the agreement of a public or private debt or equity transaction by MMC of at least $25,000,000 in amount or (ii) August 31, 1998. The amount of the amortization of the Warrant Value for each of the months of September, October, November and December 1997 will be payable January 31, 1998. Commencing in January 1998, the unpaid balance of the F-30 87 MEGO FINANCIAL CORP. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) FOR THE YEARS ENDED AUGUST 31, 1997, 1996 AND 1995 Warrant Value will continue to be amortized on a monthly basis and the amount of such amortization will be due and payable within 30 days from the end of each fiscal quarter. Under the Payment Agreement, the Company may, but is not obligated to, make advances to PEC on behalf of MMC. Advances, if any, by the Company on behalf of MMC to PEC will be due and payable within 30 days after the close of the month in which such advance was made. Under the Payment Agreement, any amount owed by MMC to the Company that is not paid when due will bear interest from such due date until paid at the rate of 10% per annum. Although the Company may provide funds to MMC or guarantee MMC's indebtedness or other obligations in the future, it is not anticipated that it will do so and it has no obligation to do so. Tax Sharing and Indemnity Agreement. For taxable periods up to the date of the Spin-off, the results of operations of MMC are includable in the income tax returns filed by the Company's affiliated group for federal income tax purposes. Following the Spin-off, MMC will remain liable for any amounts payable to the Company pursuant to the tax sharing agreements in effect prior to the date of the Spin-off. From and after the date of the Spin-off, MMC no longer will file consolidated returns with the Company's affiliated group but will file separate consolidated returns with its subsidiaries. PEC is under the same tax sharing arrangement as MMC was prior to the IPO. Management Services Provided by PEC. MMC and PEC were parties to a management services arrangement pursuant to which certain executive, accounting, legal, management information, data processing, human resources, advertising and promotional personnel of PEC provided services to MMC on an as needed basis. For the years ended August 31, 1997, 1996 and 1995, approximately $967,000, $671,000 and $690,000, respectively, of the salaries and expenses of certain employees of PEC were attributable to and paid by MMC in connection with services rendered by such employees to MMC. In addition, during the years ended August 31, 1997, 1996 and 1995, MMC paid PEC for developing certain computer programming, incurring costs of $0, $56,000 and $36,000, respectively. MMC has entered into a formal management services agreement with PEC, effective as of September 1, 1996, pursuant to which PEC has agreed to provide the following services to MMC for an aggregate annual fee of approximately $967,000 payable monthly: strategic planning, management and tax, accounting and finance, legal, management information systems, insurance management, human resources, and purchasing. Servicing Agreement between PEC and MMC. Prior to September 1, 1996, MMC had an arrangement with PEC pursuant to which it paid annual servicing fees at an annual rate of 50 basis points on the principal balance of loans serviced. For the years ended August 31, 1997, 1996 and 1995, MMC paid servicing fees to PEC of approximately $1,874,000, $709,000 and $232,000, respectively. MMC has entered into a servicing agreement with PEC (the Servicing Agreement), providing for the payment of servicing fees at an annual rate of 50 basis points on the principal balance of loans serviced per year. The Servicing Agreement was modified effective September 1, 1997, to provide for the payment of servicing fees at an annual rate of 40 basis points on the principal balance of loans serviced per year, reducing to 35 basis points per year on the later to occur of (i) January 1, 1998 or (ii) the first day of the month following the month in which MMC's loan portfolio serviced by PEC equals or exceeds $1 billion. For the years ended August 31, 1997, 1996 and 1995, MMC incurred interest expense in the amount of $16,000, $29,000 and $85,000, respectively, related to fees payable to PEC for these services. The interest rates were based on PEC's average cost of funds and equaled 10.48% in 1997, 10.68% in 1996 and 11.8% in 1995. 21. COMMITMENTS AND CONTINGENCIES Future Improvements -- Central Nevada Utilities Company (CNUC), a subsidiary, has issued performance bonds of $2,943,000 outstanding at August 31, 1997, to ensure the completion of water, sewer and other F-31 88 MEGO FINANCIAL CORP. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) FOR THE YEARS ENDED AUGUST 31, 1997, 1996 AND 1995 improvements in portions of the Calvada development areas. The cost of the improvements will be offset by the future receipt of betterment fees and connection fees. Leases -- The Company leases certain real estate for sales offices. The Company also leases its Hawaii real estate for timeshare usage. Rental expense for fiscal 1997, 1996 and 1995 was $2,339,000, $2,567,000 and $2,292,000, respectively. Future minimum rental payments under operating leases are set forth below (thousands of dollars):
FOR THE YEARS ENDING AUGUST 31, ------------------------------------------------------------ 1998................................................... $3,118 1999................................................... 869 2000................................................... 654 2001................................................... 642 2002................................................... 415 Thereafter............................................. 228 ------ Total............................................. $5,926 ======
Litigation -- In the matter of the PEC Apartment Subsidiaries litigation previously reported upon, an order for judgment of $3,346,000 was rendered against PEC on its limited guaranty, in connection with the defendants' counterclaim. Pursuant to a stipulation between the parties dated as of May 15, 1995, PEC paid the amount of $2,900,000 on June 15, 1995 in full settlement of this matter. Because the reserve recorded in the financial statements of the Company exceeded the amount of the settlement, the Company recognized a gain on discontinued operations of $873,000, net of taxes of $450,000 in fiscal 1995. Following the Company's November 10, 1995 announcement disclosing certain accounting adjustments, an action was filed on November 13, 1995, in the United States District Court, District of Nevada (Court) by Christopher Dunleavy, as a purported class action against the Company, certain of the Company's officers and directors and the Company's independent auditors. The complaint alleges, among other things, that the defendants violated Section 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5 thereunder in connection with the preparation and issuance of certain of the Company's financial reports issued in 1994 and 1995, including certain financial statements reported on by the Company's independent auditors. The complaint also alleges that one of the director defendants violated the federal securities laws by engaging in "insider trading." The named plaintiff seeks to represent a class consisting of purchasers of Mego Financial's common stock between January 14, 1994 and November 9, 1995, and seeks damages in an unspecified amount, costs, attorney's fees and such other relief as the court may deem just and proper. On November 16, 1995, a second action was filed in the Court by Alan Peyser as a purported class action against the Company and certain of its officers and directors, which was served on the Company on December 20, 1995. The complaint alleges, among other things, that the defendants violated the federal securities laws by making statements and issuing certain financial reports in 1994 and 1995 that overstated the Company's earnings and business prospects. The named plaintiff seeks to represent a class consisting of purchasers of Mego Financial's common stock between November 28, 1994 and November 9, 1995. The complaint seeks damages in an unspecified amount, cost, attorney's fees and such other relief as the Court may deem just and proper. On or about June 10, 1996, the Dunleavy Action and Peyser Action were consolidated under the caption "In re Mego Financial Corp. Securities Litigation," Master File No. CV-9-95-01082-LD (RLJ), pursuant to a stipulation by the parties. F-32 89 MEGO FINANCIAL CORP. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) FOR THE YEARS ENDED AUGUST 31, 1997, 1996 AND 1995 On December 26, 1996, in the above captioned matter, Michael Nadler filed a purported class action complaint against the Company, certain of the Company's officers and directors, and the Company's independent auditors. The complaint alleges that the defendants violated the federal securities laws and common law and contain allegations similar to those contained in the Dunleavy and Peyser complaints. On February 13, 1997, defendants moved to dismiss Nadler's complaint. On March 13, 1997, Nadler filed a "Motion for the Filing of a Consolidated Complaint and a Class Certification Motion, the Holding of a Pretrial Conference and the Suspension of Briefing on Defendants' Motions to Dismiss." The Company opposed that motion. On March 31, 1997, the Court, among other things, denied without prejudice to refiling after either the filing of a consolidated complaint or a ruling on Nadler's motion for the filing of a consolidated complaint, and defendants' motions to dismiss Nadler's complaint. On May 12, 1997, counsel for the plaintiffs in the Dunleavy and Peyser actions, and counsel for the defendants executed a Memorandum of Understanding with respect to a proposed settlement. The proposed settlement, which is subject to a number of conditions, including approval by the Court, calls for certification, for settlement purposes only, of a class consisting of all purchasers of Mego Financial stock (excluding the defendants and their respective directors, executive officers, partners and affiliates and their respective immediate families, heirs, successors and assigns) during the period from January 14, 1994 through November 9, 1995, inclusive, and for creation of a settlement fund of $1,725,000. The portion of this amount to be contributed by the Company, net of anticipated directors and officers insurance proceeds and contribution by another defendant, is not expected to have a material adverse effect on the Company. The parties anticipate submitting papers to the Court in due course seeking approval of the settlement. Final approval of the settlement is expected to dispose of all class claims in the litigation, including those asserted by Nadler. The Company believes that it has substantial defenses to all of the complaints that have been filed against it described above, and that the likelihood of a material liability being incurred by the Company is remote. However, the Company presently cannot predict the outcome of this matter. On November 22, 1996, D. Anthony Pullella filed an action in the Superior Court, Chancery Division, Atlantic County, New Jersey (Case No. ATL-C-175-96) against Brigantine Preferred Properties, Inc. ("BPP") and the Brig, Inc., subsidiaries of PEC. The complaint requests an order requiring the sale to the Plaintiff of the restaurant and bar facility in the Brigantine Inn Resort Club, pursuant to alleged obligations in a lease and management agreement, and also asks for unspecified compensatory and punitive damages. On September 10, 1997, BPP filed an answer and counterclaim in this action. In its counterclaim, BPP requests an order terminating the management agreement for the failure of Pullella to perform all of his obligations under such agreement, the return of Pullella's 1% interest in the Brig, Inc., the subsidiary of the Company holding the liquor license, and overdue rent of approximately $25,500. The Company believes that the defendants have valid defenses to the complaint, valid claims in the counterclaim and does not believe that the matter will have a material adverse effect on the business or financial condition of the Company. In the general course of business the Company, at various times, has been named in other lawsuits. The Company believes that it has meritorious defenses to these lawsuits and that resolution of these matters will not have a material adverse affect on the business or financial condition of the Company. Contingencies -- At August 31, 1997, irrevocable letters of credit in the amount of $2,084,000 were issued and outstanding to secure certain obligations of the Company. These letters are collateralized by notes receivable in the amount of $2,530,000. License Agreement -- In April 1995, PEC entered into a strategic alliance pursuant to which PEC was granted a ten-year (including a renewal option) exclusive license to operate both its existing and future timeshare properties under the name "Ramada Vacation Suites." PEC has renamed its timeshare resorts. The arrangement provides for the payment by PEC of an initial access fee of $1,000,000, which has been paid, and F-33 90 MEGO FINANCIAL CORP. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) FOR THE YEARS ENDED AUGUST 31, 1997, 1996 AND 1995 monthly recurring fees equal to 1% of PEC's Gross Sales (as defined) each month through January 1996 and 1.5% of PEC's Gross Sales each month commencing in February 1996. The initial term of the arrangement is five years and PEC has the option to renew the arrangement for an additional term of five years. 22. QUARTERLY FINANCIAL DATA (UNAUDITED) The following tables reflect consolidated quarterly financial data for the Company for the fiscal years ended August 31, 1997 and 1996 (thousands of dollars, except per share amounts):
FOR THE THREE MONTHS ENDED ----------------------------------------------------- AUGUST 31, MAY 31, FEBRUARY 28, NOVEMBER 30, 1997 1997 1997 1996 ---------- ---------- ------------ ------------ REVENUES: Net timeshare interest and land sales.......... $ 12,774 $ 13,202 $ 11,956 $ 10,947 Gain on sale of receivables.................... 620 503 441 449 Interest income................................ 1,828 1,941 1,762 1,637 Financial income and other..................... 2,219 2,609 2,493 2,115 ---------- ---------- ---------- ---------- Total revenues....................... 17,441 18,255 16,652 15,148 ---------- ---------- ---------- ---------- EXPENSES: Direct costs of timeshare interest and land sales........................................ 2,501 1,746 1,612 1,634 Operating expenses............................. 14,967 14,326 14,014 12,894 Interest expense............................... 2,107 2,084 2,116 2,151 ---------- ---------- ---------- ---------- Total expenses....................... 19,575 18,156 17,742 16,679 ---------- ---------- ---------- ---------- Income (loss) from continuing operations before income taxes................................. (2,134) 99 (1,090) (1,531) Income taxes (benefit)......................... (7,653) (2,084) (2,458) (467) Income (loss) from continuing operations....... 5,519 2,183 1,368 (1,064) Income from discontinued operations, net of taxes and minority interest.................. 3,747 2,944 2,413 2,230 ---------- ---------- ---------- ---------- Net income applicable to common stock.......... $ 9,266 $ 5,127 $ 3,781 $ 1,166 ========== ========== ========== ========== EARNINGS (LOSS) PER COMMON SHARE: Primary: Income (loss) from continuing operations..... $ 0.28 $ 0.12 $ 0.07 $ (0.05) Income from discontinued operations.......... 0.19 0.15 0.12 0.11 Cumulative preferred stock dividends......... -- -- -- -- ---------- ---------- ---------- ---------- Net income applicable to common stock........ $ 0.47 $ 0.27 $ 0.19 $ 0.06 ========== ========== ========== ========== Weighted-average number of common shares and common share equivalents outstanding...... 19,619,687 19,299,365 19,662,582 19,585,940 ========== ========== ========== ========== FULLY-DILUTED: Income (loss) from continuing operations..... $ 0.28 $ 0.12 $ 0.07 $ (0.05) Income from discontinued operations.......... 0.19 0.15 0.12 0.11 Cumulative preferred stock dividends......... -- -- -- -- ---------- ---------- ---------- ---------- Net income applicable to common stock........ $ 0.47 $ 0.27 $ 0.19 $ 0.06 ========== ========== ========== ========== Weighted-average number of common shares and common share equivalents outstanding...... 19,686,805 19,310,198 19,662,582 19,724,579 ========== ========== ========== ==========
F-34 91 MEGO FINANCIAL CORP. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) FOR THE YEARS ENDED AUGUST 31, 1997, 1996 AND 1995
FOR THE THREE MONTHS ENDED ------------------------------------------------------ AUGUST 31, MAY 31, FEBRUARY 29, NOVEMBER 30, 1996 1996 1996 1995 ----------- ---------- ------------ ------------ REVENUES: Net timeshare interest and land sales......... $ 10,345 $ 12,449 $ 11,159 $ 11,793 Gain on sale of receivables................... 251 394 39 432 Interest income............................... 2,361 1,843 1,366 1,024 Financial income and other.................... 2,627 2,374 836 1,359 ---------- ---------- ---------- ---------- Total revenues...................... 15,584 17,060 13,400 14,608 ---------- ---------- ---------- ---------- EXPENSES: Direct costs of timeshare interest and land sales....................................... 1,499 1,447 1,387 1,509 Operating expenses............................ 14,209 13,641 11,007 11,126 Interest expense.............................. 2,278 2,856 1,057 1,123 ---------- ---------- ---------- ---------- Total expenses...................... 17,986 17,944 13,451 13,758 ---------- ---------- ---------- ---------- Income (loss) from continuing operations before income taxes......................... (2,402) (884) (51) 850 Income taxes (benefit)........................ (595) (485) (122) 134 ---------- ---------- ---------- ---------- Income (loss) from continuing operations...... (1,807) (399) 71 716 Income from discontinued operations, net of taxes....................................... 2,076 705 1,407 2,082 ---------- ---------- ---------- ---------- Cumulative preferred stock dividends (1)...... 60 40 60 80 ---------- ---------- ---------- ---------- Net income applicable to common stock......... $ 209 $ 266 $ 1,418 $ 2,718 ========== ========== ========== ========== EARNINGS (LOSS) PER COMMON SHARE: Primary: Income (loss) from continuing operations.... $ (0.10) $ (0.03) $ -- $ 0.04 Income from discontinued operations......... 0.11 0.04 0.08 0.11 Cumulative preferred stock dividends........ -- -- -- -- ---------- ---------- ---------- ---------- Net income applicable to common stock....... $ 0.01 $ 0.01 $ 0.08 $ 0.15 ========== ========== ========== ========== Weighted-average number of common shares and common share equivalents outstanding..... 18,587,472 18,087,556 18,087,556 18,087,556 ========== ========== ========== ========== Fully-diluted: Income (loss) from continuing operations.... $ (0.10) $ (0.02) $ -- $ 0.04 Income from discontinued operations......... 0.11 0.03 0.07 0.11 Cumulative preferred stock dividends........ -- -- -- (0.01) ---------- ---------- ---------- ---------- Net income applicable to common stock....... $ 0.01 $ 0.01 $ 0.07 $ 0.14 ========== ========== ========== ========== Weighted-average number of common shares and common share equivalents outstanding..... 19,286,027 19,484,667 19,463,556 19,463,556 ========== ========== ========== ==========
- --------------- (1) See Note 17 of Notes to Consolidated Financial Statements. F-35 EX-10.128 2 SUB-SERVICING AGREEMENT 1 EXHIBIT 10.128 [PREFERRED EQUITIES CORPORATION LETTERHEAD] September 2, 1997 Mego Mortgage Corporation 1000 Parkwood Circle, 5th Floor Atlanta, GA 30339 Attention: James L. Belter, Executive Vice President Re: Loan Program Sub-Servicing Agreement (the "Agreement") dated as of September 1, 1996 between Preferred Equities Corporation ("PEC") and Mego Mortgage Corporation ("MMC") Gentlemen: This letter serves to confirm our agreement that the present monthly servicing fee of one-twelfth (1/12) of one-half (1/2) of one percent (0.50%) as set forth in Article 4 of the Agreement is hereby modified and amended to be one-twelfth (1/12) of four tenths (4/10) of one percent (0.40%) of the outstanding principal balance of all loans being serviced on the first day of the prior month. This change is effective as of September 1, 1997. It is further agreed that upon the later to occur of (i) January 1, 1998 or (ii) the first day of the month following the month in which the aggregate principal balance of all loans being serviced by PEC for MMC is equal to or exceeds $1,000,000,000, the monthly servicing fee shall thereafter be one-twelfth (1/12) of thirty-five one hundredths (35/100) of one percent (0.35%). Except as modified hereby, all other terms and conditions of the Agreement shall remain in full force and effect. Please sign a copy of this letter in the space indicated below to indicate your acceptance and approval of the foregoing. Very truly yours, PREFERRED EQUITIES CORPORATION By: /s/ FREDERICK H. CONTE -------------------------------------------- Frederick H. Conte, Executive Vice President Accepted and approved as of this 2nd day of September, 1997. MEGO MORTGAGE CORPORATION By: /s/ JAMES L. BELTER ----------------------------------------- James L. Belter, Executive Vice President EX-10.129 3 3RD AMENDMENT TO ASSIGNMENT AND ASSUMPTION AGRMNT 1 EXHIBIT 10.129 THIRD AMENDMENT TO ASSIGNMENT AND ASSUMPTION AGREEMENT This Third Amendment (the "Amendment") to Assignment and Assumption Agreement, by and between RER CORP., COMAY CORP., GROWTH REALTY INC. and H&H FINANCIAL, INC. (the "Assignors"), and MEGO FINANCIAL CORP., formerly named MEGO CORP., (the "Assignee"). WITNESSETH: WHEREAS, the Assignors are parties to the Assignment Agreement dated October 25, 1987, with the Assignee, and the Assignment and Assumption Agreement, dated February 1, 1988, between the Assignors and the Assignee, which two agreements were amended by the Amendment to Assignment and Assumption Agreement dated July 29, 1988, and by the Second Amendment to Assignment and Assumption Agreement dated as of March 2, 1995 between the Assignors and the Assignee (collectively, the described agreements as so amended are hereinafter referred to as the "Assignment"); and WHEREAS, the Assignment fixed the date of January 31, 1995 as the date on which the accrual of amounts due to the Assignors under the Assignment would terminate, except for interest on any of such amounts which remained unpaid; and WHEREAS, the amount due the Assignors, as of January 31, 1995 was $13,328,742.25, plus interest from January 28, 1995 in the amount of $9,322.57, (collectively, and with interest from January 31, 1995 to March 2, 1995 (the Amount Due"); and WHEREAS, $10,000,000 of the Amount Due was agreed to be considered subordinated debt (the "Subordinated Debt"), of which $1,428,571.43 plus accrued interest was paid on March 1, 1997 as scheduled, and the Remaining Balance of $3,328,742.25 which was not subordinated and all accrued interest thereon has been paid prior to the date hereof; and WHEREAS, the balance of the Subordinated Debt in the amount of $8,571,428.57 continues to be secured by a pledge of the stock of Preferred Equities Corporation (and any distributions in respect thereto) pursuant to a Pledge and Security Agreement dated as of February 1, 1988 (the "Pledge Agreement") between the Assignee and the Assignors; and WHEREAS, interest on the balance of the Subordinated Debt has been paid through March 1, 1997; and 1 2 WHEREAS, one of the Assignors, RER Corp. and affiliates of the other Assignors, namely Jerome J. Cohen, Don A. Mayerson, Herbert B. Hirsch, and Growth Realty Holdings LLC (RER Corp. and the above named affiliates of Assignors are collectively referred to herein as the "Warrant Holders"), presently hold warrants (the "Warrants") for the purchase of an aggregate of 1,000,000 shares of common stock of the Assignee for an exercise price of $4.25 per share for an aggregate exercise price of $4,250,000.00; and WHEREAS, the Warrant Holders and the Assignee are desirous that the Warrants be exercised at this time; and WHEREAS, the Assignors other than RER Corp. are prepared to assign a portion of their share of the future principal payments on the Subordinated Debt to the Warrant Holders other than RER Corp. so that the Warrant Holders can exercise their Warrants by applying such portion in payment of the Exercise Price of the Warrants, to which the Assignee has agreed herein; NOW THEREFORE, in consideration of the mutual covenants herein contained it is hereby agreed as follows: 1. The statements in the foregoing preamble are true and correct. 2. That the present balance of the Subordinated Debt in the amount of $8,571,428.57 is hereby agreed to be reduced by $4,250,000 (the "Reduction Amount") which Reduction Amount shall be credited towards the Exercise price of the Warrants on behalf of the Warrant Holders. 3. That the balance of the Subordinated Debt, in the amount of $4,321,428.57, plus interest at the Agreed Rate of 10% per annum, shall be paid by the Assignee to the Assignors as follows: (a) A payment of interest only on September 1, 1997 and March 1, 1998 on the unpaid balance. (b) A payment of principal in the amount of $35,714.28 plus interest on the unpaid balance on September 1, 1998. (c) A payment of principal in the amount of $1,428,571.43 plus interest at the Agreed Rate on the unpaid balance on each of the following dates: March 1, 1999, September 1, 1999 and March 1, 2000, a which time any unpaid principal or interest shall be due and payable. (d) If any of the above amounts are not paid within 15 days of the due date thereof, then until such delinquent amounts are paid, interest on the unpaid balance of the Deferred Amount shall thereafter bear interest at the rate of twelve percent (12%) per annum instead of the Agreed Rate, or if lower, the highest rate permitted by law. (e) If any of the above amounts are not paid within 30 days of the due date thereof, then the entire unpaid balance of the Deferred Amount, and any accrued but unpaid interest thereon, shall be immediately due and payable, unless such payment is 2 3 deferred pursuant to the written agreement of Assignors holding the right to receive at lease 51% of such payments. (f) In the event of (i) the Assignee generally not paying its debts when due, or (ii) the dissolution, termination of existence or insolvency of the Assignee, or (iii) the appointment of a trustee, receiver, custodian, liquidator or other similar official for the Assignee or any substantial part of its property, or (iv) the makings of an assignment for the benefit of creditors by the Assignee, or (v) the commencement of any proceedings under any bankruptcy or insolvency laws by or against the Assignee that, in the case of any such involuntary proceeding, shall continue undismissed or unstayed and in effect for a period of 60 days, then the entire unpaid balance of the Deferred Amount, together than any accrued but unpaid interest thereon, shall be immediately due and payable, unless such payment is deferred pursuant to the written agreement of Assignors holding the right to receive at least 51% of the above payments. 4. The Assignee and Assignors agree that all amounts due to Assignors pursuant to the Assignment as amended by this Amendment shall continue to be secured as set forth in the Pledge Agreement, and that the Pledge Agreement remains in full force and effect. 5. The Assignors agree that the unpaid balance of the Subordinate Debt, and an accrued but unpaid interest due thereon, shall continue to be subordinate in right of payment to any debt of Assignee for money borrowed, and to any obligation of the Assignee under any guaranty of obligations of a subsidiary of Assignee (the "Superior Obligations"), provided however, that unless and until a holder of a Superior Obligation has declared such Superior Obligation to be in default, which default has not been cured and is continuing, Assignee shall pay, and Assignors may accept, scheduled payments on the Subordinated Debt and accrued interest thereon as set forth in paragraph 3 above. Assignors agree to execute such documentation evidencing such subordination as the holder of any Superior Obligation may reasonable request. 6. The Assignee and Assignors agree that this Amendment is an amended to the Assignment and not a novation, and that, except as modified hereby, all terms and conditions of the Assignment remain in full force and effect. 3 4 7. It is agreed that this Amendment may be signed in counterparts, and all such counterparts in the aggregate shall constitute one agreement. IN WITNESS WHEREOF, the parties hereto have duly executed this Amendment as of August 20, 1997. MEGO FINANCIAL CORP. By: /s/ JEROME J. COHEN ------------------------------------- Jerome J. Cohen, President RER CORP. By: [SIG] ------------------------------------ Title: President COMAY CORP. By: [SIG] ------------------------------------ Title: President GROWTH REALTY INC. By: [SIG] ----------------------------------- Title: President H&H FINANCIAL, INC. By: [SIG] ----------------------------------- Title: President 4 5 The undersigned Warrant Holders hereby ratify and consent to the statements included above with respect to the Warrant Holders this 20th day of August, 1997. RER CORP. By: /s/ [SIG] -------------------------------- Title: President By: /s/ JEROME J. COHEN -------------------------------- Jerome J. Cohen By: /s/ DON A. MAYERSON -------------------------------- Don A. Mayerson By: /s/ HERBERT B. HIRSCH -------------------------------- Herbert B. Hirsch GROWTH REALTY HOLDINGS LLC By: /s/ [SIG] -------------------------------- Title: 5 EX-10.130 4 LOAN AND SECURITY AGREEMENT 1 EXHIBIT 10.130 LOAN AND SECURITY AGREEMENT $10,000,000.00 Working Capital and Note Receivable Loan provided by Litchfield Financial Corporation to Preferred Equities Corporation As of July 30, 1997 2 LOAN AND SECURITY AGREEMENT LOAN AND SECURITY AGREEMENT dated as of July 30, 1997 among Preferred Equities Corporation, a Nevada corporation, having an address of and office at 4310 Paradise Road, Las Vegas, Nevada 89109-6597 ("Borrower") and LITCHFIELD FINANCIAL CORPORATION, a Massachusetts corporation, having an office at 789 Main Road, Stamford, Vermont 05352 and having a mailing address of POB 488, Williamstown, Massachusetts 01267 ("Lender"). In consideration of the mutual covenants and agreements contained in this Agreement, and for other good and valuable consideration, the receipt and adequacy of which are acknowledged, the parties to this Agreement, intending to be legally bound, hereby agree as follows: SECTION 1 1. DEFINITION OF TERMS 1.1. TERM DEFINITIONS. Capitalized terms used in this Agreement are defined in this Section 1.1. The definitions include the singular and plural forms of the terms defined. ADA. Defined in Section 6.13 of this Agreement. ADVANCE. A portion of the proceeds of the Loan advanced from time to time by Lender to Borrower in accordance with the terms of this Agreement. AFFILIATE. Any party controlled by, controlling, or under common control with, the Borrower or Guarantor. AGREEMENT. This Loan and Security Agreement among Borrower, Guarantor and Lender (including the exhibits and schedules to it), as it may be amended from time to time. ASSIGNED DEED OF TRUST. A properly recorded, first priority deed of trust executed and delivered by each Purchaser to Borrower, securing a Pledged Note Receivable and encumbering all of the right, title and interest of such Purchaser in the related Encumbered Interval and related or appurtenant easement, access and use rights and benefits. ASSIGNMENT OF NOTES RECEIVABLE AND DEEDS OF TRUST. A recordable assignment made by Borrower in favor of Lender evidencing the assignment to Lender of all of the Pledged Notes Receivable and Assigned Deeds of Trust. ASSIGNMENTS OF INTEREST IN CONTRACTS, PERMITS, LICENSES AND APPROVALS. The properly recorded assignments made by 3 Borrower in favor of Lender evidencing the assignment to Lender of all of Borrower's interest in and to all contracts, permits, licenses and approvals in respect of the Property. BACKGROUND DOCUMENTS. Defined in Section 4.1(e) of this Agreement. BANKRUPTCY CODE. Defined in Section 11.13 of this Agreement. BORROWING BASE. With respect to Eligible Notes Receivable pledged to Lender in connection with each Receivables Loan Advance, an amount equal to the sum of: (1) eighty-five percent (85%) of the remaining principal balance of each such Eligible Note Receivable pursuant to which the Purchaser has made at least six (6) monthly payments; plus (2) eighty percent (80%) of the remaining principal balance of each such Eligible Note Receivable pursuant to which the Purchaser has made less than six (6) monthly payments. BUSINESS DAY. Each day which is not a Saturday or Sunday or a legal holiday under the laws of the State of Vermont, the State of Nevada, the Commonwealth of Massachusetts or the United States. CLOSING DATE. The date of this Agreement. CODE. The Uniform Commercial Code in force in the Commonwealth of Massachusetts as amended from time to time. COLLATERAL. The Real Estate Collateral and the Receivables Collateral. COMMITMENT. The Commitment Letter issued by Lender to Borrower dated June 20, 1997. COMMITMENT FEE. $100,000 payable on the Closing Date. COMMON ELEMENTS. Common elements and limited common elements, as each is defined or provided for in the Timeshare Declaration or other Timeshare Documents. DEBTOR RELIEF LAWS. Any applicable liquidation, conservatorship, bankruptcy, moratorium, rearrangement, insolvency, reorganization or similar law, proceeding or device providing for the relief of debtors from time to time in effect and generally affecting the rights of creditors. DEED OF TRUST. The properly recorded, first priority deed of trust executed and delivered by Borrower in favor of Lender, as beneficiary, securing the Obligations of Borrower to Lender and encumbering all of the right, title and interest 2 4 of Borrower in the Property. Deed of Trust when used in the context of "Assigned Deed of Trust" shall have the meaning ascribed to the term Assigned Deed of Trust. DEFAULT. An event or condition the occurrence of which immediately is or, with a lapse of time or the giving or notice or both, becomes an Event of Default. DEFAULT RATE. Four (4) percentage points in excess of the Mortgage Loan Interest Rate and/or the Receivables Loan Interest Rate as applicable. DIVISION. The division of the Nevada Division of Real Estate having jurisdiction over the enforcement of violations of the Nevada timeshare statutes, regulations and rules. ELIGIBLE NOTES RECEIVABLE. Those Pledged Notes Receivable which satisfy each of the following criteria: (i) the Borrower shall be the sole payee; (ii) it arises from a bona fide installment sale by Borrower of one or more fee simple timeshare Intervals; (iii) the Interval sale from which it arises shall not have been cancelled by the Purchaser, and any statutory or other applicable cancellation or rescission period shall have expired and such Pledged Note Receivable shall otherwise be in compliance with this Agreement; (iv) it is secured by a first lien priority Assigned Deed of Trust on the purchased Interval and there shall have been issued to Lender or for Lender's benefit an American Land Title Association (ALTA) form of title insurance policy acceptable in form, scope and substance to Lender and its counsel which may be a blanket policy covering more than one Interval; (v) it is generated from the sale of a fee simple timeshare Interval at the Property and the principal and interest payments on it are payable to the Borrower in United States Dollars; (vi) payments of principal and, if applicable, interest on it are payable in equal monthly installments; 3 5 (vii) it shall have an original term of no more than one hundred twenty (120) months; (viii) a cash down payment has been received from the Purchaser or the maker in an amount equal to at least ten percent (10%) of the actual Purchase Price, net of all discounts, credits and adjustments in reduction of such Purchase Price, of each Interval and Purchaser shall have received no cash or other rebates of any kind; provided however, that in the case of a Note Receivable representing an upgrade or downgrade either a cash down payment shall have been received and/or the Purchaser shall have paid in principal reduction of the prior Note Receivable an aggregate amount equivalent to at least 10% of the Purchase Price of the present Interval; (ix) no monthly installment is more than thirty (30) days contractually past due at the time of an initial Advance in respect of such Eligible Note Receivable, or more than sixty one (61) days contractually past due at any time subsequent to the initial Advance; (x) the weighted average interest rate on the entire assigned portfolio of Eligible Notes Receivable bearing interest rates greater than 0% against which Receivable Loan Advances are outstanding is at least 12.0% per annum and no greater than fifteen (15%) percent of the entire assigned portfolio of Eligible Notes Receivable against which Receivable Loan Advances are outstanding have interest rates of 0%; (xi) Subject to Borrower's applicable reservation criteria, the Purchaser of an Interval has immediate access, for the timeshare "unit week" related to such purchase, to an Interval at the Property which Interval has been completed, developed, and furnished in accordance with the specifications provided in the Purchaser's purchase contract, public offering statement and other Timeshare Documents; and the Purchaser has, subject 4 6 to the terms of the Timeshare Declaration, purchase contract, public offering statement and other Timeshare Documents, complete and unrestricted access to an Interval; provided however, in connection with any Eligible Note Receivable initially pledged to Lender but as to which subsequent to such pledge Borrower has entered into an upgrade or downgrade of such Eligible Note Receivable such upgrade or downgrade shall continue to be an Eligible Note Receivable so long as such upgrade or downgrade is from or to the Property, or the Grand Flamingo Villas resort located in the metropolitan area of Las Vegas, Nevada which has been dedicated to timeshare ownership by Borrower pursuant to Declaration of Timeshare Ownership Covenants, Conditions and Restrictions recorded in the Official Records of Clark County, Nevada on November 10, 1983 in Book 1832 as Document No. 1791580 and rerecorded on February 6, 1984 in Book 1871 as Document No. 1830906, or the Grand Flamingo Towers resort located in the metropolitan area of Las Vegas, Nevada which has been dedicated to timeshare ownership by Borrower pursuant to Declarations of Timeshare Ownership Covenants, Conditions and Restrictions recorded in the Official Records of Clark County, Nevada on August 23, 1984 in Book 1978 as Document No. 1937487, or the Grand Flamingo Terraces resort located in the metropolitan area of Las Vegas, Nevada which has been dedicated to timeshare ownership by Borrower pursuant to Declaration of Timeshare Plan Ownership Covenants, Conditions and Restrictions recorded in the Official Records of Clark County, Nevada on December 12, 1989 in Book 891212 as Document No. 00188, Amended Declaration of Timeshare Ownership Covenants, Condition and Restrictions recorded in the Official Records of Clark County, Nevada on April 11, 1990 in Book 900411 as Document No. 00406 and Declaration of Annexation recorded in the Official Records of Clark County, Nevada on December 14, 1990 in Book 901214 as 5 7 Document No. 00077, or the Grand Flamingo Winnick resort located in the metropolitan area of Las Vegas, Nevada which has been dedicated to timeshare ownership by Borrower pursuant to Declaration of Timeshare Ownership Covenants, Conditions and Restrictions recorded in the Official Records of Clark County, Nevada on March 19, 1993 in Book 930319 as Document No. 00051, or the Grand Flamingo Fountains resort located in the metropolitan area of Las Vegas, Nevada which has been dedicated to timeshare ownership by Borrower pursuant to Declaration of Timeshare Ownership recorded in the Official Records of Clark County, Nevada on May 26, 1993 in Book 930526 as Document No. 00566, or the Grand Flamingo Terraces Four resort located in the metropolitan area of Las Vegas, Nevada which has been dedicated to timeshare ownership by Borrower pursuant to Declaration of Timeshare Ownership Covenants, Conditions and Restrictions recorded in the Official Records of Clark County,Nevada on August 17, 1995 in Book 950817 as Document No. 01139, or the Grand Flamingo Plaza resort located in the metropolitan area of Las Vegas, Nevada which has been dedicated to timeshare ownership by Borrower pursuant to Declaration of Timeshare Ownership recorded in the Official Records of Clark County, Nevada on May 23, 1997 in Book 970523 as Document No. 01649; (xii) neither the Purchaser of the related Interval or any other maker of the Note Receivable is an Affiliate of, or related to, or employed by the Borrower or Guarantor; (xiii) the Purchaser or other maker has no claim against Borrower and no defense, set-off or counterclaim with respect to the Note Receivable; (xiv) the maximum remaining principal balance of any such Note Receivable shall not exceed $20,000.00 and the total maximum remaining principal balance of the Notes Receivable executed by any one Purchaser 6 8 or other maker shall not exceed $20,000.00 in the aggregate (or such greater amount as may be approved in writing in advance by Lender); (xv) it is executed by a U.S. resident; provided, however, that no more than ten percent (10%) of the outstanding principal balance of all Eligible Notes Receivable shall at any time be comprised of Notes Receivable executed by non U.S. residents, and, to the extent such outstanding principal balance of such Notes Receivable exceeds such ten percent (10%), they shall not be considered Eligible Notes Receivable; (xvi) the original of such Note Receivable has been endorsed to Lender and delivered to Lender as provided in this Agreement, and the terms thereof and all instruments related thereto shall comply in all respects with all applicable federal and state laws and the regulations promulgated thereunder; (xvii) the timeshare Interval being financed or evidenced by such Note Receivable is not subject to any Lien which is not previously consented to in writing by Lender; (xviii) the Purchaser has made at least two (2) scheduled monthly payments under the Note Receivable; and (xix) Lender has been provided with all credit application information furnished by such Purchaser, and Lender has the ability to perform a credit review and underwriting of such Purchaser at the cost of Lender. ENCUMBERED INTERVALS. The Intervals subject to Assigned Deeds of Trust. ENVIRONMENTAL LAWS. The Comprehensive Environmental Response, Compensation and Liability Act of 1980, as amended from time to time ("CERCLA"), the Resource Conservation and Recovery Act of 1976, as amended from time to time ("RCRA"), the Superfund Amendments and Reauthorization Act of 1986, as amended, the federal Clean Air Act, the federal Clean Water 7 9 Act, the federal Safe Drinking Water Act, the federal Toxic Substances Control Act, the federal Hazardous Materials Transportation Act, the federal Emergency Planning and Community Right to Know Act of 1986, the federal Endangered Species Act, the federal Water Pollution Control Act and all applicable Nevada environmental laws, rules and regulations applicable to the Property, as all of the foregoing legislation may be amended from time to time, and any regulations promulgated pursuant to the foregoing; together with any similar local, state or federal laws, rules, ordinances or regulations enacted or promulgated after the date of this Agreement, that concern the management, control, storage, discharge, treatment, containment, removal and/or transport of Hazardous Materials or other substances that are or may become a threat to public health or the environment; together with any common law theory involving Hazardous Materials or substances which are (or alleged to be) hazardous to human health or the environment, based on nuisance, trespass, negligence, strict liability or other tortious conduct, or any other federal, state or local statute, regulation, rule, policy, or determination pertaining to health, hygiene, the environment or environmental conditions. EXCHANGE COMPANY. Resort Condominiums International or another similar company approved by Lender. EVENT OF DEFAULT. Defined in Section 8.1 of this Agreement. FINANCIAL STATEMENTS. The tax returns, on a consolidated basis with Guarantor, statements of financial condition and statements of income and expense of the Borrower, and the related notes and schedules delivered by Borrower prior to the Closing Date and provided for in Section 4.1(l) of this Agreement; and the financial statements and reports of the Guarantor delivered to Lender prior to the Closing Date; and the monthly, quarterly and annual financial statements and reports required to be provided to Lender pursuant to Section 7.1(h) (i), (ii) and (iii) of this Agreement and pursuant to the Guaranty. FISCAL QUARTER. Defined in Section 7.1 (h)(iii) of this Agreement. FISCAL YEAR. Defined in Section 7.1 (h)(ii) of this Agreement. GAAP. Generally accepted accounting principles, applied on a consistent basis, as described in Opinions of the Accounting Principles Board of the American Institute of Certified Public Accountants and/or in statements of the Financial Accounting Standards Board which are applicable in 8 10 the circumstances as of the date in question. GOVERNMENTAL AGENCY. Defined in Section 7.1(w) of this Agreement. GUARANTY. The Guaranty Agreement executed and delivered to Lender concurrently with this Agreement by the Guarantor. GUARANTOR. Mego Financial Corp., a New York corporation, which owns all of the issued and outstanding capital stock of Borrower. HAZARDOUS MATERIALS. "Hazardous substances," "hazardous waste" or "hazardous constituents," "toxic substances", or "solid waste", as defined in the Environmental Laws, and any other contaminant or any material, waste or substance which is petroleum or petroleum based, asbestos, polychlorinated biphenyls, flammable explosives, or radioactive materials. ILSA. Defined in Section 6.13 of this Agreement. IMPROVEMENTS. All buildings, structures, recreational facilities and appurtenances now or hereafter located on the Property. INDEMNIFIED LENDER PARTIES. Defined in Section 7.1(w) of this Agreement. INITIAL RECEIVABLES LOAN ADVANCE. The first Receivables Loan Advance made by Lender to Borrower of proceeds of the Receivables Loan in accordance with the terms of this Agreement. INTERVAL. A "time share" as defined in Chapter 119A of the Nevada Revised Statutes sold to a Purchaser by delivery of a deed, being comprised of (i) an undivided fee title interest in the Grand Flamingo Suites or in the event of an upgrade or downgrade of an existing Eligible Note Receivable, the name of the relevant project resort shall be substituted for Grand Flamingo Suites in this definition for purposes of determining if such upgrade or downgrade qualifies as an Eligible Note Receivable; and (ii) the exclusive right to use and occupy an assigned Unit of a particular type and the common furnishings in such assigned Unit together with the nonexclusive right to use the common area, all for a specified use period as defined in the Timeshare Declaration and subject to the covenants, conditions and restrictions set forth in the Timeshare Declaration and any rules and regulations pursuant thereto. LIEN. Any interest in property securing an obligation owed to, or claim by, a Person other than the owner of such property, whether such interest arises in equity or is based 9 11 on common law, statute, or contract. LOAN. The Mortgage Loan and Receivables Loan to be advanced on the terms set forth in this Agreement and with an aggregate outstanding principal balance which may not exceed the Maximum Loan Amount. LOAN COSTS. All costs incurred by Lender in connection with the Loan, including without limitation, all taxes and assessments, exclusive of income, franchise and similar taxes, recording fees, title insurance premiums and other title charges, lock box and Lockbox Agent fees, custodial fees due to Lender under Section 3.8, Borrower's and lender's attorney's fees, document binding costs, appraisal fees, lien, judgment and litigation search costs, fees of architects, engineers, surveyors and any special consultants, brokers fees (except as otherwise specified herein), escrow fees, all travel and out-of-pocket expenses of Lender to conduct audits or inspections and wire transfer fees. LOAN DOCUMENTS. Collectively, this Agreement and the following documents and instruments listed below, as such agreements, documents, instruments or certificates may be amended, renewed, extended, restated or supplemented from time to time. (i) This Agreement; (ii) The Deed of Trust; (iii) The Guaranty; (vi) The Assignment of Notes Receivable and Deeds of Trust; (v) UCC financing statements covering the Collateral, to be filed in all offices necessary to perfect the Lender's Liens in the Collateral; and (vi) Such other agreements, documents, instruments, certificates and materials as Lender may request to evidence the Obligations, to evidence and perfect the rights and Liens and security interests of Lender contemplated by the Loan Documents and to effectuate the transactions contemplated herein and to appoint the Lockbox Agent and implement the Lockbox Agreement. LOAN YEAR. The period from the Closing Date through the last day of the twelfth (12th) calendar month thereafter 10 12 and each twelve (12) month period thereafter. LOCKBOX AGENT. Bank of America or such other Person as is approved by Lender in writing to act as Lockbox Agent for the receipt of collections under the Pledged Notes Receivable. LOCKBOX AGREEMENT. A Lockbox Agreement between Borrower and Lender pursuant to which Lockbox Agent is to provide for the receipt of collections on the Pledged Notes Receivable and disbursement of such collections as directed by Lender and Borrower. MANDATORY PREPAYMENT. Any prepayment required by Section 2.6 of this Agreement. MATERIAL PARTY. Defined in Section 4.1(h) of this Agreement. MAXIMUM LOAN AMOUNT. $10,000,000.00. MORTGAGE LOAN. An advance of $4,500,000 to be used for general working capital purposes and to pay for marketing and administrative expenses incurred in the marketing and sale of timeshare Intervals at the Property as is more particularly set forth in this Agreement. MORTGAGE LOAN INTEREST RATE. A variable rate, adjusted as of the first Business Day of each calendar month, equal to the sum of the Prime Rate as of the first Business Day of each calendar month, plus two and one quarter percent (2.25%) per annum calculated on the average daily balance outstanding during the month, on an actual days elapsed over a 360 day year basis. MORTGAGE LOAN MATURITY DATE. The last day of the third (3rd) Loan Year or if earlier, at such time, as one thousand five hundred (1500) Intervals have been sold to Purchasers after the Closing Date. NON UTILIZATION FEE. The fee referenced in Section 2.4(b). NOTE RECEIVABLE. A promissory note executed in favor of Borrower in connection with a Purchaser's acquisition of an Interval. OBLIGATIONS. All amounts due or becoming due to Lender in respect of the Loan or any of the Loan Documents, including principal, interest, prepayment premiums, Commitment Fee, Release Payments, Release Fees, Non-Utilization Fees, indemnity obligations, contributions, taxes, insurance, loan charges, custodial fees, attorneys' and paralegals' fees and 11 13 expenses and other fees or expenses incurred by Lender or advanced to or on behalf of Borrower by Lender pursuant to any of the Loan Documents, and the prompt and complete payment and performance by the Borrower, and by the Guarantor, jointly and severally, of all obligations, indebtedness and liabilities pursuant to this Agreement, any of the Loan Documents or otherwise, or any future loan agreements, notes or other agreements between Borrower or Guarantor and Lender, or by Borrower or Guarantor in favor of Lender. The term Obligations shall also include any damages incurred by Lender and any costs, fees and expenses of enforcement incurred by Lender in connection with the covenant contained in Section 7.1(y). OPERATING CONTRACTS. All contracts, agreements and arrangements relating to the operation of the Property, including without limitation, those related to utilities, maintenance, management, services, marketing and sales. PAYMENT AUTHORIZATION AGREEMENT. Pre-authorized electronic debit agreement by Purchaser for payment of a Note Receivable. PENSION REFORM ACT. Defined in Section 6.16 of this Agreement. PERSON. An individual, partnership, corporation, limited liability company, trust, unincorporated organization, other entity, or a government or agency or political subdivision thereof. PERMITTED EXCEPTIONS. Defined in Section 4.1(e)(vii) of this Agreement. PLEDGED NOTE RECEIVABLE. Any Note Receivable which at any time has been pledged to Lender by Borrower pursuant to this Agreement or any of the Loan Documents. PREPARER. Defined in Section 13.15 of this Agreement. PRIME RATE. The highest prime rate of interest from time to time published in the eastern edition of the Wall Street Journal under the Money Rates Section. PROPERTY. The Borrower's interest in the real property more particularly described in Exhibit A hereto comprising the Grand Flamingo Suites, together with the Borrower's interest in all amenities, improvements and fixtures now or hereafter located thereon and all easements and other rights appurtenant thereto. PROPERTY CONTRACTS. Defined in Section 3.1(c) of this 12 14 Agreement. PURCHASE PRICE. The total purchase price of an Interval, as set forth in the Timeshare Documents relating to the purchase of such Interval. PURCHASER. Any Person who purchases one or more Intervals. REAL ESTATE COLLATERAL. Defined in Section 3.1 of this Agreement. RECEIVABLES COLLATERAL. Collectively, all now owned or hereafter acquired right, title and interest of the Borrower, in all of the following: (i) Pledged Notes Receivable and all proceeds of or from them; (ii) Assigned Deeds of Trust and all proceeds of or from them; (iii) All Encumbered Intervals together with all appurtenant rights and interests and easement, license and use rights in and to all Property facilities and amenities, as described and provided for in the Timeshare Declaration or other Timeshare Documents; (iv) Documents, instruments, accounts, chattel paper, and general intangibles relating to the Pledged Notes Receivable, the Assigned Deed of Trusts and the other Receivables Collateral; (v) Furniture, furnishings and fixtures of every kind and description (and all improvements and accessions thereto) located in or on or used in connection with the Units and any Encumbered Interval; (vi) Easements, leasehold interests (whether as lessor or lessee), franchises, permits, approvals, licenses, facilities and amenities on, affecting or appurtenant to the Pledged Notes Receivable; and rights to occupy, use and enjoy any such facilities or amenities, and any such appurtenant Units or 13 15 Encumbered Intervals; (vii) Purchaser's interest, if any, in any management, maintenance, marketing, sales, service, utility, security and other agreements or arrangements relating to the Pledged Notes Receivable, and any agreements guaranteeing the performance of any of them, and all related accounts and proceeds; (viii) All rights in, to and under all Payment Authorization Agreements signed and delivered by or on behalf of each Purchaser, and all accounts and proceeds relating thereto or deriving therefrom; (ix) Extensions, additions, improvements, betterments, renewals, substitutions and replacements of, for or to any of the Receivables Collateral, wherever located, together with the products, proceeds, issues, rents and profits thereof, and any replacements, additions or accessions thereto or substitutions thereof, and all rights in or under insurance policies and to the proceeds of any insurance policies covering any of the other Receivables Collateral, all rights to unearned or refunded insurance premiums, and the proceeds of any condemnation awards or any claims regarding any of the other Receivables Collateral to the extent that any of the foregoing relate to the Receivables Collateral; and (x) All books, records, reports, computer tapes, disks and software relating to the Receivables Collateral. RECEIVABLES LOAN. A revolving loan facility in an amount not to exceed an aggregate outstanding balance of the lesser of (i) $10,000,000.00 less the principal balance of the Mortgage Loan, or (ii) the Borrowing Base, to be used to finance Note Receivables on the terms set forth in this Agreement. RECEIVABLES LOAN ADVANCE. A portion of the proceeds of the Receivables Loan advanced from time to time by Lender to Borrower in accordance with the terms of this Agreement. 14 16 RECEIVABLES LOAN INTEREST RATE. A variable rate, adjusted as of the first Business Day of each calendar month, equal to the sum of the Prime Rate as of the first Business Day of each calendar month, plus two percent (2.00%) per annum calculated on the average daily balance outstanding during the month, on an actual days elapsed over a 360 day year basis. RECEIVABLES LOAN MATURITY DATE. The last day of the sixth (6th) Loan Year. RECEIVABLES LOAN REVOLVING CREDIT PERIOD. A period of three calendar years from the Closing Date. RELEASE FEE. Defined in Section 2.5 of this Agreement. RELEASE PAYMENT. Defined in Section 2.5 of this Agreement. RESORT. The real property described on Exhibit C. SECURITY. Shall have the same meaning as in Section 2(1) of the Securities Act of 1933, as amended. STATE. The State of Nevada. SUBMISSIONS. Defined in Section 13.15 of this Agreement. TANGIBLE NET WORTH. The Tangible Net Worth of any Person shall mean, as of any date, (a) the amount of any capital stock, paid in capital and similar equity accounts plus (or minus in the case of a deficit) the capital surplus and retained earnings of such Person and the amount of any foreign currency translation adjustment account shown as a capital account of such Person, less (b) the net book value of all items of the following character which are included in the assets of such Person: (i) good will, including without limitation, the excess of cost over book value of any asset, (ii) organization or experimental expenses, (iii) unamortized debt discount and expense, (iv) patents, trademarks, trade names and copyrights, (v) treasury stock, (vi) deferred taxes and deferred charges, (vii) franchises, licenses and permits, and (viii) other assets which are deemed intangible assets under generally accepted accounting principles, provided, however, that, notwithstanding the foregoing, no deduction shall be made pursuant to clause (b) in respect of any asset presently shown on the statement of financial condition of Borrower as "Deferred Selling Expense" as determined in accordance with generally accepted accounting principles. Tenant Leases. Defined in Section 3.1(b) of this Agreement. 15 17 TIMESHARE ACT. The Nevada Timeshare Act (Nevada Revised Statutes Chapter 119 A) or any successor thereto or replacement thereof, as the same may be amended from time to time and any rules and regulations promulgated thereunder. TIMESHARE DECLARATION. With respect to the Property, the Declaration of Covenants, Conditions and Restrictions for the Grand Flamingo Suites resort located in the metropolitan area of Las Vegas, Nevada which has been dedicated to timeshare ownership by Borrower pursuant to Declaration of Timeshare Ownership Covenants, Conditions and Restrictions recorded in the Official Records of Clark County, Nevada on November 8, 1991 in Book 911108 as Document No. 00235. TIMESHARE DOCUMENTS. Defined in Section 5.2(c)(xv) of this Agreement. TIMESHARE OWNERS' ASSOCIATION. With respect to the Property, The Grand Flamingo Suites Owners Association, a Nevada non profit corporation. TITLE COMPANY. Defined in Section 4.1(e)(vii) of this Agreement. TITLE POLICY. Defined in Section 4.1(e)(vii) of this Agreement. RESPA. Defined in Section 6.13 of this Agreement. UNIT. One individual air space living unit in a building incorporated into the Property pursuant to the Timeshare Declaration. VOLUNTARY PREPAYMENT. Any voluntary prepayment of the Loan permitted to be made by the Borrower under the terms of this Agreement. SECTION 2 2. LOAN 2.1. LOAN. (a) GENERAL. Subject to the terms and conditions hereinafter set forth, Lender agrees to extend the Loan to Borrower. (b) MORTGAGE LOAN. Upon and subject to the conditions set forth in this Agreement, Lender shall advance to Borrower and Borrower shall borrow from Lender the Mortgage Loan in an amount of $4,500,000.00. The Mortgage Loan shall be disbursed to Borrower for general working capital purposes and to pay for marketing and administrative expenses incurred in the marketing and 16 18 sale of timeshare Intervals at the Property as is more particularly set forth in this Agreement. (c) RECEIVABLES LOAN. Upon the terms and subject to the conditions set forth in this Agreement, Lender shall advance to Borrower, and Borrower may borrow, repay and reborrow, principal under the Receivables Loan in an amount not to exceed at any time the lesser of (i) the amount of the Borrowing Base, or (ii) $10,000,000.00 less the amount outstanding under the Mortgage Loan. Lender shall have no obligation to make any further Receivables Loan Advances after the expiration of the Receivables Loan Revolving Credit Period. (d) TOTAL LOAN. Notwithstanding anything herein or elsewhere to the contrary, Borrower shall not be entitled to and Lender shall have no obligation to make any Advance which would cause the aggregate outstanding principal balance of the Loan (including the Mortgage Loan and the Receivable Loan) to exceed the Maximum Loan Amount. 2.2. LOAN DOCUMENTS. The Loan Documents shall be satisfactory in form and substance to Lender and Lender's counsel. The Mortgage Loan and the Receivables Loan shall be evidenced by this Agreement and shall be governed by the terms contained herein. The Deed of Trust shall be a first and prior lien upon the Property, subject only to the Permitted Exceptions. The Guaranty shall be the absolute and unconditional guaranty of payment and performance of the Loan and all sums secured by or under the Loan Documents in favor of Lender, subject only to the limitations set forth therein. 2.3. COMMITMENT FEE. Borrower agrees to pay the Commitment Fee on the Closing Date. 2.4. INTEREST RATE AND NON-UTILIZATION FEE. (a) MORTGAGE LOAN. The average daily outstanding principal balance of the Mortgage Loan, will bear interest in arrears at a rate equal to the Mortgage Loan Interest Rate. The outstanding principal balance of the Mortgage Loan shall bear interest as of Lender's wiring of funds through its receipt of repayment of the Mortgage Loan (if received by Lender later than 12 noon, Eastern Time, then interest accrual shall be through, but not including, the next Business Day following such receipt). Immediately upon the occurrence of an Event of Default and after the Mortgage Loan Maturity Date (if the Mortgage Loan is not paid in full on or before the Mortgage Loan Maturity Date), at Lender's election in its discretion, the Mortgage Loan will bear interest at the Default Rate. (b) RECEIVABLES LOAN. The average daily outstanding principal balance of the Receivable Loan will bear interest in 17 19 arrears at a rate equal to the Receivables Loan Interest Rate. The outstanding principal balance of the Receivables Loan shall bear interest as of Lender's wiring of funds through its receipt of repayment of the Receivables Loan (if received by Lender later than 12 noon, Eastern Time, then interest accrual shall be through, but not including, the next Business Day following such receipt). Immediately upon the occurrence of an Event of Default and after the Receivables Loan Maturity Date (if the Receivables Loan is not paid in full on or before the Receivables Loan Maturity Date), at Lender's election in its discretion, the Receivables Loan will bear interest at the Default Rate. In addition to interest, commencing on the ninetieth (90th) day after the Closing Date, Borrower shall pay to Lender, in arrears, a Non-Utilization Fee in an amount equal to 0.25% per annum multiplied by the difference between $5,500,000 and the average outstanding balance of the Receivables Loan during the prior calendar month. 2.5. PAYMENTS. (a) MORTGAGE LOAN. The Borrower agrees punctually to pay or cause to be paid to the Lender all principal and interest due under the Mortgage Loan or in respect of the Mortgage Loan. The Borrower shall make the following payments on the Mortgage Loan: (i) INTEREST. Interest only on the outstanding principal balance of the Mortgage Loan for the preceding calendar month shall be payable monthly on the fifth day of each calendar month, commencing on the fifth day of September, 1997 (which payment shall also include any interest due for July, 1997) at the Mortgage Loan Interest Rate. (ii) PRINCIPAL. (A) The entire outstanding principal balance of the Mortgage Loan, all accrued and unpaid interest thereon and all other sums due in connection therewith shall be payable in full, if not earlier paid pursuant to the terms hereof and of the Loan Documents, on the Mortgage Loan Maturity Date. (B) In addition to all other payments required herein, during such time as there is any outstanding principal balance due under the Mortgage Loan, upon the sale of each Interval, Borrower must make a principal reduction payment on the Mortgage Loan in an amount equal to the greater of (i) 25% of the Interval sales price or (ii) $3,000 (each, a "RELEASE PAYMENT", and collectively, the "RELEASE PAYMENTS"). In addition to paying to Lender such Release Payments, upon the sale of each Interval, during such time as there is any outstanding principal balance due under the Mortgage Loan, Borrower shall also pay to Lender, as a 18 20 fee and not in reduction of principal on the Mortgage Loan, a release fee ("RELEASE FEE") in the amount of $25.00. (C) In addition to the Release Payments, Borrower shall, on November 1, 1997, make a principal payment to Lender in an amount equal to the difference between (w) Three Hundred Seventy Five Thousand ($375,000) Dollars less (x) the sum of all Release Payments made to Lender during the period from the Closing Date through October 31, 1997; and on the first day of each third month thereafter (each February 1, May 1, August 1 and November 1) make a payment in the amount of the difference between (y) Three Hundred Seventy Five Thousand ($375,000) Dollars multiplied by the number of quarterly periods having expired since October 31, 1997 plus one less (z) the sum of all Release Payments made to Lender since the Closing Date, if such differences are positive numbers. (iii) FINAL PAYMENT. The entire outstanding principal amount of the Mortgage Loan together with any and all other Obligations related to the Mortgage Loan (exclusive of the Receivables Loan and any Obligations related solely thereto) shall be paid in full by not later than the Mortgage Loan Maturity Date. (iv) LATE FEE. The Borrower agrees that a late fee, in the amount of 5% of the amount unpaid, may be charged by Lender should Borrower fail to punctually pay or cause to be paid to the Lender any principal or interest due under the Mortgage Loan within five (5) days of the date that any such sum is due. Any unpaid amount representing late fees shall become part of the Obligations. (b) RECEIVABLES LOAN. The Borrower agrees punctually to pay or cause to be paid to the Lender all principal and interest due under the Receivables Loan together with any Non-Utilization Fee due. The Borrower shall make the following payments on the Receivables Loan: (i) MONTHLY PAYMENTS. The Borrower shall direct or otherwise cause all makers of all Pledged Notes Receivable to pay all monies due thereunder to a post office box agreed to between Borrower and Lender and as to which Lockbox Agent shall have the exclusive right to withdraw funds and distribute same in accordance with the Lockbox Agreement. One hundred percent (100%) of the cleared funds collected from the Pledged Notes Receivable received by Lender will be applied by Lender in the following order: (A) to the payment of costs or expenses incurred by Lender pursuant to this Agreement in creating, maintaining, protecting or enforcing its Liens in and to the Collateral, in acting as custodian of the Collateral and in collecting any other fees (including late fees including but not limited to the custodial fees set forth in Section 3.8 hereof), expenses or amounts due to Lender in connection with the Loan; (B) to any 19 21 interest accrued on the Receivables Loan at the Default Rate, if applicable and to any Non-Utilization Fee due; (C) to the payment of accrued and unpaid interest at the Receivables Loan Interest Rate; (D) to the reduction of the principal balance of the Receivables Loan and (E) to the payment of interest and principal on the Mortgage Loan. If the amount of the funds received by Lender from collections under the Pledged Notes Receivable in any month is insufficient to pay in full the amounts provided for in clauses (A), (B), and (C) of the preceding sentence for such month, without notice or demand after receipt by Borrower of the monthly accounting provided for in (ii) below, Borrower shall pay the difference to Lender on or before the last day of the month following the interest accrual. In the event Borrower receives any payments on any of the Pledged Notes Receivable directly from or on behalf of the maker or makers thereof, Borrower shall receive all such payments in trust for the sole and exclusive benefit of Lender; and Borrower shall deliver to Lender all such payments (in the form so received by Borrower) as and when received by Borrower. (ii) MONTHLY ACCOUNTING. Lender agrees to render to Borrower an accounting during each month showing the accrual of interest and charges to the Obligations and showing the payments of interest and principal received and further indicating if any deficiency exists which is to be paid by Borrower. (iii) FINAL PAYMENT. The entire outstanding principal amount of the Receivables Loan together with all other Obligations then outstanding shall be paid in full by not later than the Receivables Loan Maturity Date. 2.6. PREPAYMENTS. (a) MORTGAGE LOAN. Except as set forth in Section 2.5(a) above, Borrower may not prepay the Mortgage Loan, in whole or in part, at any time without the payment of the difference between (i) $30,240 and (ii) the amount of Release Fees paid by Borrower to Lender through the date of such prepayment without the prior written approval of Lender. (b) RECEIVABLES LOAN. (i) VOLUNTARY PREPAYMENTS. Subject to the terms of this Agreement, and to the payment of the applicable premium set forth in Subsection (iii) below, Borrower may prepay the Receivables Loan, in whole but not in part (except that partial prepayments shall be allowed in connection with bulk sales of Eligible Notes Receivable after the first Loan Year), at any time, after first providing Lender with thirty (30) days prior written notice. Any such prepayment must include the principal amount being prepaid, accrued but unpaid interest and all other then due Obligations, including any applicable prepayment premium provided 20 22 in Subsection (iii) below. (ii) MANDATORY PREPAYMENTS. If at any time and for any reason, the outstanding unpaid principal balance of the Receivables Loan shall exceed the aggregate amount of the Borrowing Base, then, within two (2) Business Days following Borrower's receipt of telecopied notice from Lender of the occurrence of such excess over the Borrowing Base or, absent such telecopied notice, within five (5) days after the end of the calendar month in which such excess occurred, Borrower shall either (A) prepay the principal balance of the Receivables Loan in an amount equal to the difference between the aggregate principal amount of the Receivables Loan and the amount of the Borrowing Base, or (B) increase the aggregate principal amount of Eligible Note Receivables pledged to Lender so that the amount of Borrowing Base equals or exceeds the aggregate outstanding principal amount of the Receivables Loan. The pledge and delivery to Lender of additional Eligible Notes Receivable shall comply with the document delivery and recordation requirements set forth in Section 5.2(b) of this Agreement and shall be accompanied by a written certification of the Borrower to the effect that such additional Pledged Notes Receivable are Eligible Notes Receivable, and that, giving effect to the pledge to Lender of such Eligible Note Receivable, the outstanding unpaid principal balance of the Receivables Loan is equal to or less than the aggregate amount of the Borrowing Base. If Borrower elects to prepay the excess principal balance of the Receivables Loan pursuant to this Section 2.6(b)(ii)(A) above, no prepayment premium shall be payable in connection with such prepayment. (iii) PREMIUMS. Any prepayment of the Receivables Loan pursuant to Section 2.6(b)(i) above must be accompanied by a prepayment premium calculated, as of immediately prior to such prepayment, as follows:
Date of Prepayment Premium ------------------ ------- Within the First Three percent (3%) of the then outstanding balance Loan Year of the Receivables Loan. Within the Second Two percent (2%) of the then outstanding balance Loan Year of the Receivables Loan; provided however, in the event of a prepayment resulting from a bulk sale of Eligible Notes Receivable no prepayment premium shall be due, but, in lieu of such premium, an exit fee of one (1%) percent of the amount of such prepayment shall be due with respect to the principal
21 23 amount of the Eligible Notes Receivable subject to such bulk sale provided that Lender has been given the first right of refusal to effect such purchase for a period of twenty (20) days after written notification from Borrower to Lender and Lender has not agreed to purchase such Eligible Notes Receivable within such twenty (20) day period or has failed to consummate such purchase within sixty (60) days of the expiration of the initial notification period. Within the Third One percent (1%) of the then outstanding balance Loan Year of the Receivables Loan; provided however, in the event of a prepayment resulting from a bulk sale of Eligible Notes Receivable no prepayment premium shall be due, but, in lieu of such premium, an exit fee of one (1%) percent of the amount of such prepayment shall be due with respect to the principal amount of the Eligible Notes Receivable subject to such bulk sale provided that Lender has been given the first right of refusal to effect such purchase for a period of twenty (20) days after written notification from Borrower to Lender and Lender has not agreed to purchase such Eligible Notes Receivable within such twenty (20) day period or has failed to consummate such purchase within sixty (60) days of the expiration of the initial notification period. After the Third Zero (0). Loan Year No prepayment premium shall be payable in connection with any prepayment of the principal balance of the Receivables Loan which arises from the normal monthly payments, made in the ordinary course by Purchasers or the prepayment of one or more Eligible Notes Receivable by its maker or makers in full or in part. No prepayment premium or exit fee shall be payable in the event that Lender engages in a bulk purchase of Eligible Notes Receivable from 22 24 Borrower. In the event that Lender shall initially agree to purchase, in bulk, Eligible Notes Receivable within the twenty (20) day period described above and Lender fails to consummate such purchase within sixty (60) days of the expiration of the initial notification by Lender of its agreement to purchase such bulk Eligible Notes Receivables, due solely to and wholly as a result of the fault of Lender, Borrower may then sell such Eligible Notes Receivables in bulk on the same or better terms to another party without the obligation to pay an exit fee. SECTION 3 3. COLLATERAL 3.1. REAL ESTATE COLLATERAL. To secure the payment and performance of the Obligations for value received, Borrower unconditionally and irrevocably assigns, pledges and grants to Lender a continuing first priority lien and security interest in the following collateral (collectively, the "Real Estate Collateral"): (a) The Deed of Trust constituting a first lien in and to Borrower's fee simple interest in the Property. (b) An absolute and unconditional primary assignment of all: (i) leases, subleases, licenses, concessions, entry fees or other agreements which grant a possessory interest in and to, or the right to use the Property or any portion thereof now in existence or which may come into existence hereafter (the "Tenant Leases"); and (ii) rents, revenues, income, proceeds, royalties, profits, deposits and other benefits payable for using, leasing, licensing, possessing, operating from or in or otherwise enjoying the Property pursuant to any of the Tenant Leases together with any damages and insurance and condemnation proceeds in respect thereof. Tenant Leases shall not include any contracts for sale of the Intervals or any receivables arising therefrom. (c) An assignment of all of Borrower's rights in and to all licenses, permits, approvals, authorizations, consents and other agreements and orders pertaining to the Property or the use, occupancy, maintenance or enjoyment of the Property, including, but not limited to, utility contracts, maintenance agreements, management agreements, marketing, sales and service contracts, and any agreements or arrangements guaranteeing the performance of the obligations contained in any of the foregoing agreements or relating to the Property (collectively, the "Property Contracts"), and in and to all related accounts and proceeds and all deposits, letters of 23 25 credit or other property pledged or delivered pursuant thereto. (d) A first lien priority security interest in all of Borrower's interest in all inventory, supplies, accounts, chattel paper and general intangibles (except for receivables arising from the sale of Intervals) at any time located at, arising out of the use of and/or used or useful in connection with the operation of any of the Property, subject to appropriate non-disturbance language acceptable to Lender relating to common area equipment, fixtures and furniture. (e) A first priority security interest in all of Borrower's interest in all furniture, appliances, furnishings, machinery, plumbing, heating, ventilating, air conditioning systems, fixtures and equipment, owned or hereafter acquired by Borrower, used or useful in connection with, and/or placed or to be placed on or under the Property. (f) All proceeds of the Real Estate Collateral. 3.2. RECEIVABLES COLLATERAL. To secure the payment and performance of the Obligations, for value received, Borrower unconditionally and irrevocably assigns, pledges and grants to Lender a continuing first priority security interest in and to the Receivables Collateral. 3.3. SECURITY INTEREST IN ALL PLEDGED NOTES RECEIVABLE. Notwithstanding that the Lender may be obligated, subject to the conditions of the Loan Documents, to make Receivables Loan Advances only in respect of Eligible Notes Receivable, Lender shall have a continuing security interest in all of the Pledged Notes Receivable, and may collect all payments made under or in respect of all Pledged Notes Receivable, including Eligible Notes Receivable that may become ineligible, until any of the same may be released by Lender, if at all, pursuant to Section 13.11 below. 3.4. GUARANTY. As further security for the Obligations, Borrower shall cause to be executed and delivered to Lender the unconditional Guaranty of the Guarantor. The liability of the Guarantor under its Guaranty shall be limited as set forth in the Guaranty. 3.5. FINANCING STATEMENTS. Borrower agrees, at its own expense, to execute the financing statements provided for by the Code together with any and all other instruments or documents and take such other action as may be required to perfect and to continue the perfection of Lender's liens and security interests in the Collateral and, unless prohibited by law, Borrower hereby authorizes Lender to execute and file any such financing statements as other instruments or documents on the Borrower's behalf. 24 26 3.6. LOCATION OF COLLATERAL. All tangible Collateral (other than Collateral delivered to Lender) which is personal property is to remain, at all times, on or at the Resort and the Borrower may not transfer the Collateral from the Resort without the prior written approval of Lender. Notwithstanding anything to the contrary contained in this Section 3.6, Borrower or the Timeshare Owners' Association may remove or replace any tangible Collateral if any item thereof is no longer needed for the operation of the Resort and is of no material value to Borrower or to the Resort or if such Collateral is replaced by or with Collateral of equivalent value. 3.7. INSURANCE AND PROTECTION OF COLLATERAL. Borrower agrees to maintain and pay for insurance upon all Collateral wherever located (whether in storage or in transit) covering risks in such amounts and with such insurance companies as is provided in Section 7.1(d) hereof. To the extent any casualty insurance coverage required under this Agreement with respect to the Property is provided by the Timeshare Owners' Association, and to the extent any portion of the Collateral is covered by such insurance, with respect to such portion of the Collateral only, the Borrower's obligation under this Section 3.7 to maintain casualty insurance coverage shall be deemed satisfied. 3.8. PROTECTION OF COLLATERAL; REIMBURSEMENT. The portion of the Collateral consisting of (i) the original Pledged Notes Receivable, (ii) the original Assigned Deeds of Trusts, (iii) the original purchase contracts (including addendum) related to such Pledged Notes Receivable and Assigned Deeds of Trusts, and (iv) originals or true copies of the related truth-in-lending disclosure, loan application, grant, bargain and sale deed, and if required by Lender, the related Purchaser's acknowledgement, receipt, payment authorization agreement and the Exchange Company application and disclosures, shall, unless directed otherwise be delivered at Borrower's expense to the Lender at its Stamford, Vermont office, and held in Lender's possession and control until the Obligations are fully satisfied. The portion of the Collateral delivered to Lender as described above shall be segregated by Lender and stored in a fire-resistant filing cabinet. Borrower and the Guarantor agree that such storage is and shall be deemed to constitute reasonable care by Lender with respect to such Collateral, provided that Lender uses the same type of storage and undertakes the same degree of care with respect to the Collateral as it uses and undertakes with respect to its own notes and property and the notes, property and collateral of other borrowers which it retains in its possession. All insurance expenses and all expenses of protecting the Collateral, including without limitation, storing, warehousing, insuring, handling, maintaining and shipping the Collateral, and any and all excise, property, intangibles, sales and use taxes imposed by any state, federal or local authority on any of the Collateral or in respect of the sale thereof shall be borne and paid by the Borrower. If the Borrower 25 27 fails to promptly pay any portion thereof when due, Lender may, at its option, but shall not be required to, pay the same and charge the Borrower's account therefor, and the Borrower agrees promptly to reimburse Lender therefor with interest accruing thereon daily at the Default Rate. All sums so paid or incurred by Lender for any of the foregoing and any and all other sums for which the Borrower may become liable hereunder and all costs and expenses (including attorneys' and paralegals' fees, legal expenses and court costs) which the Lender may incur in enforcing or protecting its Lien on, or rights and interest in, the Collateral or any of its rights or remedies under this Agreement or any other Loan Document or in respect to any of the transactions to be had hereunder or thereunder, until paid by the Borrower to Lender with interest at the Default Rate, shall be included among the Obligations, and, as such, shall be secured by all of the Collateral. Provided that Lender retains the original Pledged Notes Receivable and Assigned Deeds of Trust, and originals or copies of the related Timeshare Documents delivered to it as listed above, in a fire-resistant filing cabinet and otherwise as provided above, Lender shall not be liable or responsible in any way for the safekeeping of any of the Collateral or for any loss or damage thereto or for any diminution in the value thereof, or for any act or default of any warehouseman, carrier, forwarding agency, Lockbox Agent or any other Person whomsoever. Lender represents to Borrower that at the present time, neither the Commonwealth of Massachusetts nor the State of Vermont impose an intangibles tax or similar tax on assets or property held by a lender as collateral but that in the event that either state enacts legislation or imposes such a levy, which would have the impact of charging Borrower a fee, tax or levy as a result of Lender's retention of the Collateral in the State of Vermont, Lender will, upon Borrower's written request, remove the Collateral from the State of Vermont to another jurisdiction to avoid the charging or imposition of such fee, tax or levy upon Borrower and the Collateral. Borrower agrees, in consideration of Lender agreeing to hold the Collateral, to pay to Lender as a custodial fee, at the time initial pledge of each Note Receivable (whether at the time of an Advance, replacement for a Note which fails to remain an Eligible Note Receivable, or a Note Receivable resulting from an upgrade or a downgrade) a fee of $10.00 for each Note Receivable pledged to Lender. All of the above custodial fees shall be Loan Costs and Lender is authorized to deduct same from any cash proceeds received from the Lockbox Agent in accordance with Section 2.5(b)(i)(A) above. 26 28 3.9. Cross-Collateral. The Collateral shall secure all of the Obligations, including those related to the Mortgage Loan and those related to the Receivables Loan. SECTION 4 4. CONDITIONS PRECEDENT TO THE CLOSING 4.1. CONDITIONS PRECEDENT. The obligation of Lender to enter into this Agreement and to fund any Advance hereunder, shall be subject to the satisfaction of each of the conditions precedent set forth in the Commitment or in any other communications from Lender, in addition to all of the conditions precedent set forth elsewhere in the Loan Documents and to all of the following conditions: (a) OPINIONS OF COUNSEL. Lender shall have received from counsel for the Borrower and Guarantor licensed in the States of Nevada and New York and reasonably acceptable to Lender, closing opinions in form and substance satisfactory to Lender dated as of the Closing Date, covering such items as may be required by Lender, including without limitation, that the Loan Documents are valid, binding and enforceable in accordance with their terms and that they do not violate any applicable usury laws or other laws, that, to the best of their knowledge, the Property and its intended use comply with all timeshare and other applicable laws and that, to the best of their knowledge, the Borrower, the Guarantor and the Property are in compliance with all applicable laws and that the Notes Receivable and all documentation related to such Notes Receivable comply in all material respects with all applicable consumer and disclosure laws, rules and regulations of any applicable local, state or federal authority including but not limited to Truth in Lending and Regulation Z of the Federal Reserve Board. (b) REPRESENTATIONS, WARRANTIES, COVENANTS AND AGREEMENTS. The representations and warranties contained in the Loan Documents and in any certificates delivered to Lender in connection with the closing shall be true and correct in all material respects, and all covenants and agreements to have been complied with and performed by Borrower and Guarantor shall have been fully complied with and performed to the satisfaction of Lender. (c) NO PROHIBITIONS. Neither Borrower nor Guarantor shall have taken any action or permitted any condition to exist which would have been prohibited by any provision of this Agreement, the Loan Documents or the Commitment. (d) CLOSING CERTIFICATES. Lender shall have received certificates, in form satisfactory to it, dated as of the Closing Date and signed by the Borrower and Guarantor respectively, 27 29 certifying that the conditions specified in Sections 4.1(b) and (c) have been fulfilled. (e) BACKGROUND DOCUMENTS. Borrower shall have delivered to Lender and Lender shall have approved each of the following (collectively, the "Background Documents"): (i) CORPORATE DOCUMENTS. Copies of the Articles of Incorporation stamped by the Secretary of State of Nevada and New York, and the By-Laws of the Borrower and Guarantor and any amendments thereto, all certified to be true and complete by the Secretary of each of Borrower and Guarantor. (ii) GOOD STANDING CERTIFICATES. Current good standing certificates issued by the Secretary of State of Nevada in respect of Borrower, and New York in respect of Guarantor. (iii) RESOLUTIONS. The resolutions of the board of directors of the Borrower and the Guarantor and all other necessary resolutions and consents of Borrower or Guarantor, authorizing the execution of all Loan Documents to which they are a party and authorizing performance of all obligations thereunder. (iv) BORROWER'S AFFIDAVIT. If required by the Title Company (as hereafter defined), Borrower's Affidavit, in form and content sufficient to permit the Title Company to delete any exception for parties in possession, matters of survey, mechanics' or materialmen's liens, the gap period, and taxes and assessments which are due and payable. (v) SURVEY. One (1) original copy of a perimeter survey dated, satisfactory to Lender and prepared by a licensed surveyor satisfactory to Lender and the Title Company in accordance with Lender's requirements, of the Property, showing the location and dimensions of all Improvements thereon and indicating the routes of ingress and egress for public access to the Property, all utility lines, walks, drives, recorded or visible easements and rights-of-way on the Property, and showing that there are no encroachments, improvements, projections or unacceptable easements (recorded or unrecorded) on the property lines. The survey shall certify the acreage of the Property and shall indicate whether the Property is located within any flood hazard area. The survey must be prepared in accordance with the standards set forth by ALTA, any and all Nevada state surveyors' bureaus or associations and any and all regulations or applicable local, state and federal law and must be certified to Lender and the Title Company. The surveyor's certificate placed on the survey shall include a statement that said survey locates any 28 30 and all items set forth as exceptions in the Title Policy as Lender may require, shall satisfy all of the survey requirements in the Commitment, and shall include any other requirements of Lender and the Title Company. (vi) ENVIRONMENTAL REPORT. A phase I environmental survey covering the Property satisfactory to Lender. (vii) DEED OF TRUST TITLE INSURANCE COMMITMENT AND POLICY. A commitment to issue a 1992 ALTA extended coverage mortgagee's policy of title insurance (the "Title Policy") underwritten by a title company acceptable to Lender (the "Title Company"), in an amount at least equal to $4,500,000.00 and insuring that the Deed of Trust creates a first lien in and to the Property without exception for filed and unfiled mechanics liens and claims or for matters which an accurate survey would disclose, subject to Liens being contested as permitted by this Agreement, immaterial easements, taxes not yet due and payable and such exceptions and conditions to title as Lender shall approve in writing (the foregoing taxes, Liens, easements, exceptions and conditions being referred to as the "Permitted Exceptions"). Such Title Policy shall contain such affirmative coverage as Lender deems necessary, including but not limited to an affirmative statement that the Title Policy insures Lender against all mechanics' and materialmen's liens and shall contain endorsements in form and content acceptable to Lender: (A) insuring against matters which would be disclosed on an accurate survey; (B) insuring that no building restriction or similar exception to title disclosed on the Title Policy has been violated and that any violation thereof would not create or result in any reversion, reverter or forfeiture of title; (C) a zoning endorsement in the form typically issued in the State of Nevada. (f) EVIDENCE OF INSURANCE. Lender shall have received evidence satisfactory to Lender that Borrower has obtained and is maintaining all policies of insurance required by and in accordance with Section 7.1(d). (g) APPLICABLE LAWS AND APPROVALS. Lender shall have received evidence satisfactory to Lender that all existing and contemplated improvements are and will be in compliance with all applicable zoning, building and other laws in connection with the existence and operation of the Property and the sale, use, marketing and occupancy of the Intervals and that Borrower has obtained and maintains all necessary approvals, for its operation of the Property including but not limited to all necessary timeshare operating and sales approvals and registrations. (h) LITIGATION. Other than those particular matters 29 31 described in Exhibit B, there shall be no bankruptcy, foreclosure action or other material litigation or judgments pending or outstanding against the Property, the Units, any portion of the Collateral, the Borrower, Guarantor or the managing agent for the Property (each a "Material Party"). The term "other material litigation" as used herein shall not include matters in which (i) a Material Party is plaintiff and no counterclaim is pending or (ii) Lender determines, in its reasonable discretion, that such litigation is immaterial due to settlement, insurance coverage, frivolity, or amount or nature of claim. Lender shall have obtained an independent search, at Borrower's expense, confirming that no such bankruptcy, foreclosure action or other material litigation or judgment exists. (i) LOAN DOCUMENTS. On or prior to the Closing Date, Borrower shall execute and deliver (or cause to be executed and delivered, as the case may be) to Lender, all of the Loan Documents. (j) UCC/OTHER SEARCHES. Lender shall have obtained such searches of the applicable public records as it deems necessary under Nevada and other applicable law to verify that it has a first and prior perfected Lien and security interest covering all of the Collateral, except as otherwise provided herein. Lender shall not be obligated to fund any Advance if Lender determines that it does not have a first and prior perfected lien and security interest covering any portion of the Collateral, except as otherwise provided herein. (k) TAXES AND ASSESSMENTS. Lender shall have received evidence satisfactory to it that, except as noted on Exhibit D, all taxes and assessments owed by or for which Borrower or the Timeshare Owners' Association are responsible for collection have been paid, or will be paid out of closing proceeds, which taxes and assessments include, without limitation, sales taxes, room occupancy taxes, payroll taxes, personal property taxes, excise taxes, intangibles taxes, real property taxes, income taxes, and any assessments related to the Property. Lender shall have also received information satisfactory to Lender disclosing the tax identification numbers, tax rates, estimated tax values, assessment ratios and estimated assessment values or amounts with respect to the Property and as to the identities of the taxing authorities having jurisdiction over the Property and the instrumentalities and entities having the power and jurisdiction to impose assessments against the Property. (l) FINANCIAL STATEMENTS. Lender shall have received and approved the Financial Statements required pursuant to the Commitment to be delivered to Lender, or otherwise required by Lender, for Borrower and Guarantor, all in form and substance satisfactory to Lender. 30 32 (m) PRECLOSING INSPECTIONS. Lender shall have conducted and approved due diligence investigations satisfactory to Lender, of the Borrower, the Guarantor and the Property. (n) PROCEEDINGS SATISFACTORY. All actions taken in connection with the execution or delivery of the Loan Documents, and compliance with closing conditions and all documents and papers relating thereto, shall be reasonably satisfactory to Lender and its counsel. Lender and its counsel shall have received copies of such documents and papers as Lender or such counsel may reasonably request in connection therewith, all in form and substance satisfactory to Lender and its counsel. (o) EXPENSES. The Borrower shall have paid all fees and expenses required to be paid prior to or at closing pursuant to this Agreement. (p) OPERATING BUDGETS AND MISCELLANEOUS. The Borrower shall have furnished an annual detailed operating budget for the Resort in form satisfactory to Lender and Borrower shall furnish and comply with such other matters, insurance or documents as Lender shall require. SECTION 5 5. FUNDING PROCEDURES 5.1. FUNDING PROCEDURE-MORTGAGE LOAN. Upon compliance by Borrower with all of the conditions contained in this Agreement applicable to the Mortgage Loan, Lender shall on the Closing Date fund the Mortgage Loan. 5.2. FUNDING PROCEDURE-RECEIVABLES LOAN. The obligation of Lender to make any Receivables Loan Advance, including the Initial Receivables Loan Advance, shall be subject to the satisfaction of all of the following conditions precedent: (a) REQUESTS FOR ADVANCES. Each request for a Receivables Loan Advance shall: (i) be in writing and shall certify the amount of the then-current Borrowing Base, specify the principal amount of the Receivables Loan Advance requested and designate the account to which the proceeds of such Receivables Loan Advance are to be transferred; (ii) state that, except as noted in such request, the representations and warranties of the Borrower contained in this Agreement and any closing or funding related certifications are true and correct as of the date of the 31 33 request, and after giving effect to the making of such requested Receivables Loan Advance, will be true and correct as of the date on which the requested Receivables Loan Advance is to be made; provided that Lender shall have no obligation to fund any request for an advance if Lender determines, in its reasonable discretion, that such changes as noted in the request for advance are material and affect adversely Lender's credit underwriting of Borrower. (iii) state that no Default or Event of Default exists as of the date of the request and, after giving effect to the making of such requested Receivables Loan Advance, no Default or Event of Default would exist as of the date on which the requested Receivables Loan Advance is to be made; (iv) be delivered to the office of Lender at least five (5) Business Days prior to the date of the requested Receivables Loan Advance and contain a schedule setting forth all Notes Receivable intended to be pledged and delivered to Lender with the actual delivery of such Notes Receivable with all applicable endorsements and assignments being delivered not less than three (3) Business Days prior to the date of the Receivables Loan Advance; (v) be signed by a principal financial officer of the Borrower; (vi) certify that the Borrower has no knowledge of any asserted or threatened defense, offset, counterclaim, discount or allowance in respect of each Note Receivable to be pledged in connection with such requested Receivables Loan Advance, or in respect of any of the Pledged Notes Receivable; (vii) contain an aging report of the Pledged Notes Receivable; identifying, among other things, which among them are Eligible Notes Receivable; and (viii) contain a delinquency report which shall be in form and substance satisfactory to the Lender and shall show which of such Notes Receivable is delinquent and the duration of such delinquency, and which of such Pledged Notes Receivable is not an Eligible Note Receivable; (b) LOAN DOCUMENTS/COLLATERAL. Not less than three (3) Business Days prior to the date of any Receivables Loan Advance, the Borrower shall have: (i) delivered to Lender a current aging report for all Pledged Notes Receivable and a list of all Eligible Notes Receivable and related Assigned Deeds of Trust which are to be the subject of such requested Receivables Loan Advance, 32 34 indicating the unpaid principal balance owing on each of the Pledged Notes Receivable deemed to be an Eligible Note Receivable, together with such additional information as Lender may reasonably require; (ii) delivered to Lender (or, if Lender shall so instruct, a designee appointed by Lender in writing) (A) the original of each Pledged Note Receivable (duly endorsed with the words "Pay to the order of Litchfield Financial Corporation with recourse"), (B) the original of each Assigned Deed of Trust securing such Pledged Notes Receivable, (C) the original of each purchase contract (including addenda) relating to the Pledged Notes Receivable and Assigned Deeds of Trust, and (D) originals or true copies of the related truth-in-lending disclosures, loan application, grant, bargain and sale deed, Payment Authorization Agreement, if one exists, and, if required by Lender, the related Purchaser's acknowledgement, receipt by Purchaser of the Public Offering Statement and Exchange Company application, disclosures and materials; (iii) delivered to Lender a recorded Assignment of Notes Receivable and Deed of Trusts assigning to Lender all of the Borrower's right, title and interest in and to each such Pledged Note Receivable and the related Assigned Deed of Trust; and (iv) delivered to Lender, with respect to each Encumbered Interval, a mortgagee's title insurance policy showing that the Assigned Deed of Trust in respect of such Interval has been assigned to Lender and insuring in favor of Lender the first priority lien of such Assigned Deed of Trust in the original principal amount of the Pledged Note Receivable secured thereby and containing such other affirmative insurance endorsements as Lender may reasonably require. The condition of title must be satisfactory to Lender in all respects. The Assigned Deed of Trust and the applicable Assignment of Notes Receivable and Deed of Trusts shall each have been duly recorded in the land records of Clark County, Nevada. The mortgagee's title insurance policies shall be in form and substance reasonably satisfactory to Lender and shall be issued by the Title Company, and name Lender as the insured party therein. The funding of the requested Receivables Loan Advance, delivery of the documentation related to the Pledged Notes Receivable and issuance of the title insurance policy, and recording of the applicable Assignment of Notes Receivable and Assigned Deeds of Trust or any releases may, in Lender's discretion, be effected by way of an escrow or other arrangement with the Title Company or other fiduciary, the form and substance of which shall be satisfactory to Lender. 33 35 If the Title Company fails to deliver the documentation related to the Pledged Notes Receivable or issue the title insurance policies within the time periods required by Lender. Lender shall have no obligation to make further Receivables Loan Advances hereunder unless such failure has been cured to Lender's satisfaction. (c) OTHER CONDITIONS. In addition to the other conditions set forth in this Agreement, the making of the Initial Receivables Loan Advance or any requested Receivables Loan Advance shall be subject to the satisfaction of the following conditions: (i) no Default or Event of Default shall exist immediately prior to the making of such requested Advance or, after giving effect thereto, immediately after the making of such requested Receivables Loan Advance. (ii) each agreement required to have been executed and delivered in connection with any prior Receivables Loan Advance shall be consistent with the terms of this Agreement and shall be in full force and effect. (iii) the date on which such requested Receivables Loan Advance is to be made shall be a Business Day. (iv) Borrower shall have delivered to Lender a certification showing the dollar amount of the requested Receivables Loan Advance based on the Eligible Notes Receivable pledged to Lender, and the Notes Receivable being pledged contemporaneously with each requested Advance. (v) not more than two (2) Receivables Loan Advances shall have previously been made in the same calendar month in which such requested Receivables Loan Advance is to be made, unless Lender, in its discretion, agrees to make additional Receivables Loan Advances during such calendar month. (vi) such requested Receivables Loan Advance shall be in a principal amount of not less than $50,000.00, unless Lender, in its discretion, agrees to make a Receivables Loan Advance in an amount less than $50,000.00. (vii) Lender shall have determined that the requested Receivables Loan Advance, when added to the aggregate outstanding principal amount of all previous Receivables Loan Advances, if any, does not exceed the total amount of the Borrowing Base, based on the Eligible Notes Receivable that have been duly pledged in favor of Lender or any other restriction set forth in this Agreement. 34 36 (viii) If Lender shall so require, Lender shall have received an executed closing protection letter issued by the Title Company, which shall be reasonably acceptable to Lender. (ix) The representations and warranties contained in the Loan Documents and in any certificates delivered to Lender in connection with the closing shall be true and correct in all material respects except as disclosed in Section 5.2(a)(ii) and all covenants and agreements to have been complied with and performed by Borrower shall have been fully complied with and performed to the satisfaction of Lender. (x) Borrower shall have delivered to Lender and Lender shall have approved the pro forma title commitment with respect to the Encumbered Intervals, and a title commitment with respect to the Assignment of Notes Receivable and Deeds of Trust, all in form and content reasonably satisfactory to Lender. (xi) Lender shall have received evidence reasonably satisfactory to Lender that the Property, the Collateral, and the Borrower are in compliance with all applicable laws in connection with the establishment and operation of the Property, and the marketing and sales of Intervals, including without limitation, the Timeshare Act. (xii) There shall be no bankruptcy, foreclosure action or other material litigation or judgments pending or outstanding against the Property, any portion of the Collateral, the Borrower, Guarantor, or any Material Party, which in Lender's reasonable judgment, would have a material adverse effect on the Property or the Collateral or would materially and adversely affect the likelihood of repayment of the Loan or the performance by the Borrower and Guarantor of their obligations under the Loan Documents. (xiii) Lender shall have received such other agreements, documents, instruments, certificates and materials as Lender may reasonably request to evidence the Obligations; to evidence and perfect the rights, liens and security interests of Lender contemplated by the Loan Documents, and to effectuate the transactions contemplated herein. (xiv) Lender shall have received and approved true, correct and complete copies of all applicable governmental permits, approvals, consents, licenses, and certificates for the establishment of the Property as an interval ownership timeshare project in accordance with Nevada law, and for the occupancy and intended use and operation of the Property, including the Units and Intervals, and, letters 35 37 from utility companies, governmental entities or other Persons, or certification by the Borrower or other confirmation acceptable to Lender. (xv) Lender shall have received and approved true, correct and complete copies of the documents relating to the Property and the creation, marketing and sale of Intervals (collectively, the "Timeshare Documents"), all of which must be in form and substance satisfactory to Lender, consisting of: (A) the public offering statements, final subdivision public report (timeshare project) and other registrations with approvals from the Division related to the establishment and operation of the Property; (B) other registrations, approvals and permits for creation and sale of Intervals and operation of the Property, including, without limitation, the Borrower's occupational and other business licenses relating to the Borrower or the Property, samples of all advertising, gift, prize and promotional materials and evidence of Division and other required approvals thereof, as well as copies of any agreements with all Exchange Companies and, upon request by Lender, a list of all salespeople in connection with the Property, together with evidence that each is properly licensed in accordance with applicable law. (C) the Timeshare Owners' Association's certificate of good standing, and certified articles of incorporation, bylaws and all amendments; (D) the exchange agreement for the Property with the Exchange Company, and all other agreements entered into by or on behalf of the Timeshare Owners' Association or the Borrower, including agreements with any Affiliate, related to management, operations and maintenance of the Property; (E) the form of all documents used to market and sell Intervals or that govern the rights of Purchasers, including without limitation, purchase contracts, advertising and solicitation materials, Notes Receivable, truth-in-lending statements, disclosures, acknowledgments, deeds, deeds of trust, exchange club agreements, reservation agreements, and management agreements; and (F) A proforma commitment to issue lender's title insurance policies from the Title Company for Intervals to be encumbered by Assigned Deeds of Trust, in an amount at least equal to the amount of the Pledged Note Receivable, naming Lender as insured lender and containing such affirmative coverage as Lender may reasonably require. 36 38 (xvi) with respect to the marketing and sales of Intervals in jurisdictions other than Nevada, Borrower shall deliver to Lender (A) a copy of any permit or approval from any jurisdiction where Borrower has obtained the necessary registrations to effect such sales or a letter from the applicable authorities in such jurisdiction or (B) for those jurisdictions where no registration has occurred, an opinion of counsel, acceptable to Lender, in form acceptable to Lender stating that no such registration is necessary, or (C) such other evidence of compliance with applicable laws as Lender may require. (xvii) With respect to the Timeshare Documents, Borrower shall deliver to Lender an opinion of counsel in form acceptable to Lender regarding compliance by all Timeshare Documents with all applicable laws, rules and regulations. (xviii) Lender shall have received evidence satisfactory to it that, except as noted on Exhibit D, taxes and assessments owed by or for which Borrower or the Timeshare Owners' Association are responsible for collection have been paid, or will be paid out of closing proceeds, which taxes and assessments include, without limitation, sales taxes, room occupancy taxes, payroll taxes, personal property taxes, excise taxes, intangibles taxes, real property taxes, and income taxes, and any assessments related to the Property. (xix) Lender shall have conducted and approved due diligence investigations reasonably satisfactory to Lender, of the Borrower, the Guarantor, the Property, the Notes Receivable and other Collateral. (xx) Lender shall have received evidence that the Units have been accepted into the exchange program managed by the Exchange Company. (d) Fees and Expenses. The Borrower shall have paid all fees and expenses required to be paid pursuant to this Agreement in connection with such requested Receivables Loan Advance or any conditions related thereto. (e) Proceedings Satisfactory. All actions taken in connection with such requested Receivables Loan Advance and all documents and papers relating thereto shall be reasonably satisfactory to Lender and its counsel. Lender and its counsel shall have received copies of such documents and papers as the Lender or such counsel may reasonably request in connection with such requested Receivables Loan Advance, all in form and substance reasonably satisfactory to the Lender and its counsel. Upon compliance by Borrower with all of the conditions contained in 37 39 this Section 5.2 applicable to a Receivables Loan Advance, Lender shall fund the Receivables Loan Advance. SECTION 6 6. REPRESENTATIONS AND WARRANTIES Borrower and Guarantor, jointly and severally, hereby represent and warrant to Lender as follows: 6.1. ORGANIZATION, STANDING, QUALIFICATION. Borrower: (a) is a corporation duly organized, validly existing and in good standing under the laws of the State of Nevada; and (b) has all requisite power to conduct its business and to execute, deliver and perform its obligations under the Loan Documents. Guarantor (a) is a corporation duly organized, validly existing and in good standing under the laws of New York; and (b) has all requisite power to conduct its business and to execute, deliver and perform its obligations under the Loan Documents. 6.2. AUTHORIZATION, ENFORCEABILITY, ETC. (a) The execution, delivery and performance by Borrower of the Loan Documents has been duly authorized by all necessary action by Borrower and Guarantor and does not and will not: (i) violate any provision of the articles of incorporation, or bylaws of Borrower or Guarantor, or any agreement, law, rule, regulation, order, writ, judgment, injunction, decree, determination or award presently in effect to which Borrower or Guarantor is a party or is subject; (ii) result in, or require the creation or imposition of, any Lien upon or with respect to any asset of Borrower or Guarantor other than Liens in favor of Lender; or (iii) result in a breach of, or constitute a default by Borrower or Guarantor under, any indenture, loan or credit agreement or any other agreement, document, instrument or certificate to which Borrower or Guarantor is a party or by which it or any of its assets are bound or affected. (b) No approval, authorization, order, license, permit, franchise or consent of, or registration, declaration, qualification or filing with, any governmental authority or other Person, including without limitation, the Division or the Timeshare Owners' Association is required in connection with the execution, delivery and performance by Borrower or Guarantor of any of the Loan Documents. (c) The Loan Documents constitute legal, valid and binding obligations of Borrower and Guarantor, enforceable against Borrower and Guarantor in accordance with their respective terms, subject to the effect of any applicable Debtor Relief Law and with respect to the enforcement of any specific provision to the 38 40 application of principles of equity. (d) Borrower has and will have good and marketable title to the Collateral, free and clear of any Lien, security interest, charge or encumbrance except for the security interests created by this Agreement or any Loan Document or otherwise created in favor of Lender or those specifically consented to in writing by the Lender. No currently effective financing statement or other instrument similar in effect covering all or any part of the Collateral is or will be on file in any recording office, except such as may have been filed in favor of Lender. (e) The execution and delivery of the Loan Documents, the endorsement to Lender of the Pledged Notes Receivable, the filing of the UCC-1's with the Nevada Secretary of State and the Official Records of Clark County, Nevada, and recording of the Deed of Trust and the Assignments of Notes Receivable and Deeds of Trust in the Official Records of Clark County, Nevada, create in favor of Lender a valid and perfected continuing first priority security interest in the Collateral, except as otherwise provided herein. The Collateral shall secure the full payment and performance of the Obligations. (f) To the best of the knowledge of Borrower, none of the Pledged Notes Receivable will be forged or will have affixed thereto any unauthorized signatures or will be entered into by any Person without the required legal capacity; (g) There will be, no modifications or amendments to the Pledged Notes Receivable or Assigned Deeds of Trust, except in connection with a modification resulting in an upgrade or downgrade not involving a delinquent Pledged Note Receivable or except as otherwise permitted herein. (h) To the best of the knowledge of Borrower, the makers of the Eligible Notes Receivable have and during the term of this Agreement will have no defenses, offsets, counterclaims or claims relating to the Eligible Notes Receivable or the Assigned Deeds of Trust. (i) The Pledged Notes Receivable and the Assigned Deeds of Trust will be executed and delivered by Purchasers in favor of Borrower in connection with the purchase of the related Encumbered Intervals. (j) To the best of the knowledge of Borrower, the Assigned Deeds of Trust will constitute valid and enforceable first and prior liens and security interests on the Encumbered Intervals. (k) The Pledged Notes Receivable and the Assigned Deeds of Trust will remain in full force and effect, will be, to the best of the knowledge of Borrower, valid and binding obligations of the 39 41 respective makers in favor of Lender, as holder; and the Borrower further warrants and guarantees the value, quantity and sound condition of the Encumbered Intervals and rights, properties, easements and interests appurtenant or related thereto. (l) The grant of the security interests described herein has not affected and will not affect the validity or enforceability of the obligations of the respective makers of the Pledged Notes Receivable under such Notes Receivable or the respective Assigned Deeds of Trust. (m) The Lender is not and shall not be required to take, and the Borrower has taken any and all required steps to protect Lender's security interests in the Collateral; and Lender is not and shall not be required to collect or realize upon the Collateral or any distribution of interest or principal, nor shall loss of, or damage to, the Collateral release the Borrower or Guarantor from any of the Obligations. 6.3. FINANCIAL STATEMENTS AND BUSINESS CONDITION. The financial statements fairly present the respective financial conditions and results of operations of Borrower and Guarantor as of the date or dates thereof and for the periods covered thereby. The Financial Statements delivered to Lender are true and correct. There were no material liabilities, direct or indirect, fixed or contingent, of Borrower or Guarantor as of the dates of such Financial Statements which were not reflected therein or in the notes thereto, which have not otherwise been disclosed to Lender in writing. Except for any such changes heretofore expressly disclosed in writing to Lender, there has been no material adverse change in the respective financial conditions of Borrower or Guarantor from the financial conditions shown in their respective Financial Statements, nor have Borrower or Guarantor incurred any material liabilities, direct or indirect, fixed or contingent, which are not shown in their respective Financial Statements. Borrower and Guarantor, respectively, is able to pay all of its or their respective debts as they become due, Borrower and Guarantor, as the case may be, shall maintain such solvent financial condition, giving effect to the Obligations, as long as the Borrower or Guarantor, is obligated to Lender under the Agreement, or with respect to the Guarantor, the Guaranty, or in any other manner whatsoever. Borrower's and Guarantor's obligations under this Agreement and under the Loan Documents will not render Borrower or Guarantor unable to pay its or their debts as they become due. The present fair market value of Borrower's and Guarantor' assets is greater than the amount required to pay its or their respective total liabilities. 6.4. TAXES. Except as set forth on Exhibit D, Borrower represents and warrants that Borrower has paid, or caused to be paid, in full all ad valorem taxes and other taxes and assessments against the Collateral, to the extent due and payable. Borrower 40 42 knows of no basis for any additional taxes or assessments against the Property or the Collateral. Borrower has filed all tax returns required to have been filed by it and has caused the Timeshare Owners' Association to file all tax returns required to have been filed by it, and has paid or caused the Timeshare Owners' Association to pay all taxes shown to be due and payable on such returns, including interest and penalties, and all other taxes which are payable by it or the Timeshare Owners' Association, as the case may be, to the extent the same have become due and payable. 6.5. TITLE TO PROPERTIES: PRIOR LIENS. Borrower has good and marketable title to all of the Collateral. Borrower is not in default under any of the documents evidencing or securing any indebtedness which is secured, wholly or in part, by any portion or all of the Collateral and no event has occurred which with the giving of notice, the passage of time or both, would constitute a default under any of the documents evidencing or securing any such indebtedness. Other than the Liens granted in favor of Lender and the Permitted Exceptions, or as otherwise permitted hereunder, there are no liens or encumbrances against the Collateral. 6.6. SUBSIDIARIES, AFFILIATES AND CAPITAL STRUCTURE. Borrower has no subsidiaries which have any involvement or interest in the Property in any way. Guarantor owns all of the capital stock of Borrower. Guarantor derives substantial financial benefit from the Borrower. For so long as Borrower is obligated to Lender under any of the Loan Documents, there shall be no change in the ownership of Borrower without the prior written consent of Lender. 6.7. LITIGATION, PROCEEDINGS, ETC. There are no actions, suits, proceedings, orders or injunctions pending or threatened against or affecting Borrower, Guarantor, the Collateral or the Timeshare Owners' Association at law or in equity, or before or by any governmental authority or other tribunal, which: (a) could have a material adverse effect on Borrower, or Guarantor; or (b) relate to the Loan or which could have a material effect on the Collateral. Borrower has received no notice from any court, governmental authority or other tribunal alleging that Borrower or the Property have violated the Timeshare Act, any of the rules or regulations thereunder, the Timeshare Declaration or any other applicable laws, agreements or arrangements that could have any material effect on the Loan or the Collateral. 6.8. LICENSES, PERMITS, ETC. The Borrower, the Property, the Timeshare Owners' Association, Borrower's Affiliates involved in the operations of the Property, and, to the best of Borrower's knowledge after diligent inquiry, other Persons involved in the operations of the Property, possess and will at all times continue to possess, all requisite franchises, certificates of convenience and necessity, operating rights, approvals, licenses, permits, consents, authorizations, exemptions and orders as are necessary to 41 43 carry on its or their business without any known conflict with the rights of others and, with respect to the Borrower, the Property and the Timeshare Owners' Association, in each case subject to no mortgage, pledge, Lien, lease, encumbrance, charge, security interest, title retention agreement or option other than as provided for by this Agreement. 6.9. Environmental Matters. The Property does not and will not contain any Hazardous Materials in violation of law. No Hazardous Materials are or will be used or stored at or transported to or from the Property in violation of law. Neither Borrower nor the Property nor any manager thereof or to Borrower's knowledge, the Timeshare Owners' Association, have ever used the Property as a facility for the storage, treatment or disposition of any Hazardous Materials in violation of law or have received notice from any governmental agency, entity or other Person with regard to Hazardous Materials on, under or affecting the Property. Neither Borrower nor the Property, nor any portion thereof, nor to Borrower's knowledge after diligent inquiry, the Timeshare Owners' Association, are in violation of any Environmental Laws. 6.10. Full Disclosure. No information, exhibit or written report or the content of any schedule furnished by or on behalf of Borrower or Guarantor to Lender in connection with the Loan, the Collateral or the Property, and no representation or statement made by Borrower or Guarantor in any Loan Document contains any material misstatement of fact or omits the statement of a material fact necessary to make the statement contained herein or therein not misleading. Borrower and Guarantor know of no fact or condition which will prevent the sale of Intervals to Purchasers or prevent the operation of the Property in accordance with the Timeshare Declaration and related public offering statement, and in accordance with applicable law, or prevent Borrower or Guarantor from performing its Obligations pursuant to the Loan Documents. 6.11. Use of Proceeds/Margin Stock. None of the proceeds of the Loan will be used to purchase or carry any "margin stock" (as defined under Regulation G or U of the Board of Governors of the Federal Reserve System, as in effect from time to time), and no portion of the proceeds of the Loan will be extended to others for the purpose of purchasing or carrying margin stock. None of the transactions contemplated in the Agreement (including, without limitation, the use of the proceeds from the Loan) will violate or result in the violation of Section 7 of the Securities Exchange Act of 1934, as amended, or any regulations issued pursuant thereto, including, without limitation, Regulations G, T, U and X of the Board of Governors of the Federal Reserve System, 12 C.F.R., Chapter 11. Borrower is not an investment company as defined by the Investment Company Act of 1940, as amended, and is not required to register under said Act. 6.12. No Defaults. No Default or Event of Default exists, 42 44 and there is no violation in any material respect of any term of any agreement, charter instrument, bylaw or other instrument to which the Borrower or Guarantor is a party or by which it may be bound. 6.13. COMPLIANCE WITH LAW. THE BORROWER (a) is not in violation, nor is the Property, or the business operations in respect of the Property, or to the Borrower's knowledge after diligent inquiry, the Timeshare Owners' Association, in violation, of the Timeshare Act or any laws, ordinances, governmental rules or regulations of Nevada, any political subdivision of Nevada or any other jurisdiction to which the Borrower or the Property, or the business operations conducted in respect of the Property, or the Timeshare Owners' Association, are subject; and (b) has not failed, nor has the Property or, to Borrower's knowledge, the Timeshare Owners' Association failed, to obtain any consents or joinders, or any approvals, licenses, permits, franchises or other governmental authorizations, or to make or cause to be made any filings, submissions, registrations or declarations with any government or agency or department thereof, necessary to the establishment, ownership or operation of the Property or any of Borrower's other assets, or to the conduct of Borrower's business, which violation or failure to obtain or register materially adversely affects the Borrower, the Property or the business, prospects, profits, properties or condition (financial or otherwise) of the Borrower or Guarantor or the Property. The Borrower has, to the extent required by its activities and businesses, and the operations of the Property has, fully complied with (1) all of the applicable provisions of: (a) the Consumer Credit Protection Act; (b) Regulation Z of the Federal Reserve Board; (c) the Equal Credit Opportunity Act; (d) Regulation B of the Federal Reserve Board; (e) the Federal Trade Commissions 3-day cooling off rule for Door-to Door Sales (f) Section 5 of the Federal Trade Commission Act; (g) the Interstate Land Sales Full Disclosure Act ("ILSA"); (h) federal postal laws; (i) applicable state and federal securities laws; (j) applicable usury laws; (k) applicable trade practices, home and telephone solicitation, sweepstakes, anti-lottery and consumer credit and protection laws; (l) applicable real estate sales licensing, disclosure, reporting and escrow laws; (m) the Americans With Disabilities Act and related accessibility guidelines ("ADA"); (n) the Real Estate Settlement Procedures Act ("RESPA"); (o) all amendments to and rules and regulations promulgated under the foregoing acts or laws; and (p) other applicable federal statutes and the rules and regulations promulgated thereunder; and (2) all of the applicable provisions of the Timeshare Act, any Nevada law or law of any state (and the rules and regulations promulgated thereunder) relating to ownership, establishment or operation of the Property, or the sale, offering for sale, or financing of Intervals. 43 45 6.14. RESTRICTIONS OF BORROWER OR GUARANTOR. Neither the Borrower, the Guarantor nor the Property, nor to the Borrower's knowledge, the Timeshare Owners' Association, is a party to any contract or agreement, or subject to any Lien, charge or corporate or partnership restriction, which materially and adversely affects its or their business. The Borrower will not be, on or after the Closing Date, a party to any contract or agreement which prohibits the Borrower's execution of, or compliance with the terms of this Agreement or the other Loan Documents. The Borrower has not agreed or consented to cause or permit in the future (upon the happening of a contingency or otherwise) any of the Collateral, whether now owned or hereafter acquired, to be subject to a Lien except in favor of Lender as provided hereunder. 6.15. BROKER'S FEES. Lender and Borrower represent to each other that neither of them has made any commitment or taken any action which will result in a claim for any brokers', finders' or other similar fees or commitments with respect to the transactions described in the Agreement. 6.16. DEFERRED COMPENSATION PLANS. The Borrower has no pension, profit sharing or other compensatory or similar plan (herein called a "Plan") providing for a program of deferred compensation for any employee or officer except for Borrower's 401-K Plan. No fact or situation, including but not limited to, any "Reportable Event," as that term is defined in Section 4043 of the Employee Retirement Income Security Act of 1974 as the same may be amended from time to time ("Pension Reform Act"), exists or will exist in connection with any Plan of the Borrower which might constitute grounds for termination of any Plan by the Pension Benefit Guaranty Corporation or cause the appointment by the appropriate United States District Court of a Trustee to administer any such Plan. No "Prohibited Transaction" within the meaning of Section 406 of the Pension Reform Act exists or will exist upon the execution and delivery of the Agreement or the performance by the parties hereto of their respective duties and obligations hereunder. The Borrower will (a) at all times make prompt payment of contributions required to meet the minimum funding standards set forth in Sections 302 through 305 of the Pension Reform Act with respect to each of its Plans; (b) promptly, after the filing thereof, furnish to the Lender copies of each annual report required to be filed pursuant to Section 103 of the Pension Reform Act in connection with each Plan for each Plan Year, including any certified financial statements or actuarial statements required pursuant to said Section 103; (c) notify the Lender immediately of any fact, including, but not limited to, any Reportable Event arising in connection with any Plan which might constitute grounds for termination thereof by the Pension Benefit Guaranty Corporation or for the appointment by the appropriate United States District Court of a Trustee to administer the Plan; and (d) notify the Lender of any "Prohibited Transaction" as that term is defined in Section 406 of the Pension Reform Act. The Borrower will not (i) 44 46 engage in any Prohibited Transaction, or (ii) terminate any such Plan in a manner which could result in the imposition of a Lien on any property of the Borrower pursuant to Section 4068 of the Pension Reform Act. 6.17. LABOR RELATIONS. The employees of the Borrower are not a party to any collective bargaining agreement with the Borrower, and, to the best knowledge of the Borrower and its officers, there are no material grievances, disputes or controversies with any union or any other organization of the Borrower's employees, or threats of strikes, work stoppages or any asserted pending demands for collective bargaining by any union or organization with respect to the Borrower. 6.18. ZONING ORDINANCES AND SIMILAR LAWS. The Property complies with all appropriate governmental and quasi-governmental authorities laws, rules and regulations and will continue to comply with all applicable governmental and quasi-governmental laws, regulations, and standard requirements, including but not limited to the Fair Housing Act of 1968 as amended, and the ADA. 6.19 AVAILABILITY OF UTILITIES. All utility services necessary for the operation of the Property for its intended purposes are available to the Property, including water supply, storm and sanitary sewer facilities, electric and telephone facilities. 6.20 ACCESS. The rights-of-way for all roads necessary for the full utilization of the Property for its intended purposes, have either been acquired by the appropriate governmental authority and have been dedicated to public use and accepted by such governmental authority, and all such roads are completed. All curb cuts and traffic signals necessary in accordance with applicable laws, rules and regulations are existing. 6.21. CONTINUATION AND INVESTIGATION. The warranties and representations contained herein shall be and remain true and correct so long as any of the Obligations have not been satisfied, or so long as part of the Loan shall remain outstanding, and, except as noted in such request, each request by Borrower for an Advance shall constitute an affirmation that the foregoing representations and warranties remain true and correct as of the date thereof. All representations, warranties, covenants and agreements made herein or in any certificate or other document delivered to Lender by or on behalf of Borrower pursuant to or in connection with this Agreement shall be deemed to have been relied upon by Lender notwithstanding any investigation heretofore or hereafter made by Lender or on its behalf, and shall survive the making of any or all of the disbursements contemplated hereby. 45 47 SECTION 7 7. COVENANTS 7.1. AFFIRMATIVE COVENANTS. So long as any portion of the Obligations remains unsatisfied, Borrower hereby covenants and agrees with Lender as follows: (a) Payment and Performance of Obligations. Borrower shall pay all of the Obligations, Loan Costs and related expenses when and as the same become due and payable, and Borrower shall strictly observe and perform all of the Obligations including without limitation, all covenants, agreements, terms, conditions and limitations contained in the Loan Documents, and all documents collateral thereto and will do all things necessary which are not prohibited by law to prevent the occurrence of any Event of Default hereunder or thereunder. Borrower will maintain an office or agency in the State of Nevada where notices, presentations and demands in respect of the Loan Documents may be made upon the Borrower. Such office or agency and the books and records of the Borrower shall be maintained at 4310 Paradise Road, Las Vegas, Nevada 89109-6597 until such time as the Borrower shall so notify the Lender, in writing, of any change of location of such office or agency. (b) Maintenance of Existence, Qualification and Assets. Borrower shall at all times (i) maintain its legal existence, (ii) maintain its qualification to transact business and good standing in the State and in any jurisdiction where it conducts business in connection with the Property, and (iii) comply or cause compliance with all governmental laws, rules, regulations and ordinances applicable to the Property, the Borrower, the Collateral or Borrower's business, including without limitation the Timeshare Act, if non-compliance would have a material adverse effect on Borrower or the Property. (c) Consolidation and Merger. Unless Guarantor shall have first obtained Lender's prior written approval, which may be granted, withheld or conditioned in Lender's discretion, or Borrower has prepaid the Obligations as provided in Section 7.2(b), Guarantor will not consolidate with or merge into any other Person or permit any other Person to consolidate with or merge into it. (d) Maintenance of Insurance. The Borrower, or if required pursuant to the Timeshare Declaration, the Timeshare Owners' Association, shall maintain (or the Borrower shall cause to be maintained) at all times during the term of this Agreement, policies of insurance with premiums being paid when due, and shall deliver to Lender certificates evidencing such insurance issued by insurance companies in amounts, in form and in substance, and with expiration dates, all reasonably acceptable to Lender and containing a waiver of subrogation rights by the insuring company, 46 48 a non-contributory standard mortgage benefit clause, or their equivalents, and a mortgagee loss payable endorsement in favor of and satisfactory to Lender, and breach of warranty coverage, providing the following types of insurance on and with respect to the Borrower (or, as appropriate, the Timeshare Owners' Association) and the Property: (i) Public liability and property damage insurance covering the Property in amounts and on terms satisfactory to Lender. (ii) Such other insurance on the Property or any replacements or substitutions therefor including, without limitation, flood insurance (if the Property is or becomes located in an area which is considered a flood risk by the U.S. Emergency Management Agency or pursuant to the National Flood Insurance program), in such amounts and upon terms as may from time to time be reasonably required by Lender. The Borrower shall submit to Lender evidence satisfactory to Lender as to whether or not any of the Property or any part thereof is located within an area identified pursuant to the Flood Disaster Protection Act of 1973 as being in a flood hazard area. If any of the Property is located in a flood hazard area, flood insurance shall be obtained for the maximum amount of coverage available through the federal flood insurance program for any improvements located on any of the Property from time to time or 100% of the highest insurance value of the improvements on a replacement cost basis, whichever is less. The National Flood Insurance Program flood policy shall cover the same parties covered under the builder's risk policy, other insurance policies with coverage for flood, collapse, rain damage and such other usual coverage as may be obtained thereunder, and such policy will be written with an insurance company and with cancellation provisions as hereinabove provided. In the event of any insured loss or claim in respect of the Property, Borrower shall apply (or cause to be applied), and Borrower covenants that the Timeshare Owners' Association shall apply (or cause to be applied), all proceeds of such insurance policies in a manner consistent with the Timeshare Documents and the Timeshare Act. All insurance policies required pursuant to this Agreement (or the Timeshare Documents or Timeshare Act) shall provide that the coverage afforded thereby shall not expire or be amended, canceled, modified or terminated without at least thirty (30) days prior written notice to Lender. At least thirty (30) days prior to the expiration date of each policy maintained pursuant to this Section 7.1(d), a certificate evidencing the renewal or replacement thereof satisfactory to 47 49 Lender shall be delivered to Lender. Borrower shall deliver or cause to be delivered to Lender receipts evidencing the payment for all such insurance policies and renewals or replacements. The delivery of any certificates of insurance hereunder shall constitute an assignment of all unearned premiums, payable to the Borrower with respect to the Collateral, as further security for the Obligations. In the event of the foreclosure of any Deed of Trust or any other transfer of title to any of the Property in extinguishment of any of the Obligations, all right, title and interest of Borrower in and to all insurance policies then in force, with respect thereto, shall pass to the purchaser or grantee. In the event of any fire or other casualty to or with respect to the Improvements or the Property, Borrower covenants that Borrower or the Timeshare Owners' Association, as the case may be, will promptly restore or repair (or cause to be restored, repaired or replaced) the damaged Improvements and repair or replace any other personal property to the same condition as immediately prior to such fire or other casualty and, with respect to the Improvements and personal property on the Property, in accordance with the terms of the Timeshare Documents or Timeshare Act. All insurance proceeds payable to Borrower and received by Lender will be turned over to Borrower or directly disbursed for repair, restoration or replacement in accordance with the provisions contained herein at such times and as necessary to effect such repairs or restoration. The insufficiency of any net insurance proceeds shall in no way relieve the Borrower or, as applicable, Borrower and Timeshare Owners' Association, of its obligation to restore, repair or replace Improvements and other personal property in accordance with the terms hereof, of the Timeshare Declaration or other Timeshare Documents or of the Timeshare Act, and Borrower covenants that Borrower or, as the case may be, the Timeshare Owners' Association, shall promptly comply and cause compliance with the provisions of the Timeshare Declaration and other Timeshare Documents, or of the Timeshare Act relating to such restoration, repair or replacement. To the extent that such proceeds are not necessary for or are not used for any repair or restoration, such proceeds, payable to Borrower, in Lender's discretion, may be applied to the payment of the Obligations, whether or not due and in whatever order Lender elects. Subject to the provisions of the Timeshare Declaration and the Timeshare Documents, Lender is hereby authorized and empowered, at its option, to adjust or compromise any loss under any insurance policy payable to Borrower. Each insurance company is hereby authorized and directed to make payment for all such losses directly to Lender instead of to Borrower and Lender jointly. After deducting from the insurance proceeds any expense incurred by it in the 48 50 collection or handling of said funds, Lender shall apply the proceeds payable to Borrower and received by Lender, toward the repair and restoration of the Improvements or personal property or if no such repair or restoration is necessary or is to occur to the reduction of the Obligations. Lender shall not be held responsible for any failure to collect any insurance proceeds due under the terms of any policy, regardless of the cause of such failure. Borrower shall not take out separate insurance concurrent in form or contributing in the event of loss with that required to be maintained hereunder, unless Lender is included thereon under a standard, non-contributory mortgagee endorsement making losses payable to Lender. Borrower shall immediately notify Lender whenever any such separate insurance is taken out and shall promptly deliver to Lender a certificate of such insurance. If required by Lender following the occurrence of an Event of Default, Borrower will pay to Lender on the first (1st) day of each month, together with and in addition to all other payments due on the Obligations, an amount equal to one-twelfth (1/12) of the yearly premiums for insurance, to enable Lender to pay such insurance premiums when due. The Borrower shall promptly furnish Lender with the insurance premium statements. Such added payments shall not be nor be deemed to be trust funds, but may be commingled with the general funds of Lender and Lender shall not pay interest on them. At the option of Lender, such added payments may be carried as a debit item on Lender's books and accounts. Upon demand of Lender, Borrower agrees to deliver to Lender such additional sums as are necessary to make up any deficiencies in the amounts necessary to enable Lender to pay such insurance premiums. Lender shall have no responsibility for payment of any premium for insurance hereunder, except to the extent that funds are deposited by Borrower with Lender hereunder. Upon the occurrence of a Default or Event of Default, Lender may, at its option, apply any amount then held by Lender under this paragraph to payment of the Obligations. Borrower shall cooperate with Lender in obtaining for Lender the benefits of any insurance or other proceeds lawfully or equitably payable to Borrower or Lender in connection with the transactions contemplated hereby and shall pay the expense of an independent appraisal on behalf of Lender in case of a fire or other casualty affecting the Property. (e) MAINTENANCE OF SECURITY. Borrower shall execute and deliver (or cause to be executed and delivered) to Lender all security agreements, financing statements, assignments and such other agreements, documents, instruments and certificates, and supplements and amendments thereto, and take such other actions, as Lender deems necessary or appropriate in order to maintain as 49 51 valid, enforceable and perfected first priority liens and security interests except as permitted herein, all Liens and security interests in the Collateral granted to Lender to secure the Obligations. Except as permitted herein in connection with extensions and modifications in connection with Borrower's normal collection practices, Borrower shall not grant extensions of time for the payment of, compromise for less than the full face value or release in whole or in part, any Purchaser or other Person liable for the payment of, or allow any credit whatsoever except for the amount of cash paid upon, any Collateral or any instrument, chattel paper or document representing the Collateral. (f) PAYMENT OF TAXES AND CLAIMS. Except as noted on Exhibit D, Borrower will pay when due and furnish to Lender such evidence of such payment as Lender shall reasonably request from time to time, all taxes imposed upon the Property, the Collateral, the Borrower, or any of its property, or with respect to any of its franchises, businesses, income or profits, or with respect to the Loan or any of the Loan Documents and all other charges and assessments against Borrower, the Collateral and the Property which Borrower is legally obligated to pay and shall cause the Timeshare Owners' Association to pay when due, all taxes imposed upon the Property, the Collateral, the Timeshare Owners' Association, or any of its property, or with respect to any of its franchises, businesses, income or profits, or with respect to the Loan or any of the Loan Documents which the Timeshare Owners' Association is legally obligated to pay, before any claim (including, without limitation, claims for labor, services, materials and supplies) arises for sums which have become due and payable. If the Timeshare Owners' Association fails to make such payments, Borrower shall promptly pay such amounts. Except for the Liens in favor of Lender granted pursuant to the Loan Documents, and except as otherwise specifically provided for herein, Borrower covenants that no statutory or other Liens whatsoever (including, without limitation, mechanics', materialmen's, judgment or tax liens) shall attach to any of the Collateral or the Property except for such Liens as are expressly provided for pursuant to the Timeshare Declaration, which shall, in any event, be subordinate to the Lien of Lender. In the event any such Lien attaches to any of the Collateral or the Property, Borrower shall, within thirty (30) days after any such Lien attaches, either: (i) cause such Lien to be released of record; or (ii) provide Lender with a bond in accordance with the applicable laws of the State, issued by a corporate surety acceptable to Lender, in an amount and form acceptable to Lender. Notwithstanding anything contained in this Agreement to the contrary, with respect to (a) any taxes, assessments, charges, or Liens which Borrower is required to pay, release or cause to be paid or released; and (b) any law, rule or regulation which Borrower is required to comply with or cause compliance with, such items of the foregoing description need not be paid or complied 50 52 with, as applicable, while being contested in good faith and by appropriate proceedings (in the written opinion of Borrower's independent counsel or based upon other evidence reasonably satisfactory to Lender, which opinion or other evidence shall be submitted to Lender in any case involving over $50,000); and, if relevant, provided further that adequate book reserves (in the written opinion of the Borrower's independent accountants or based upon other evidence reasonably satisfactory to Lender, which opinion or other evidence shall be submitted to Lender) have been established with respect thereto; and provided further that Borrower's title to the Collateral is not materially and adversely affected thereby. (g) INSPECTIONS. Borrower shall, at any time and from time to time and at the expense of Borrower, permit Lender or its agents or representatives to inspect the Property, the Collateral and any of the Borrower's assets or property, and to examine and make copies of and abstracts from its and, to the extent it has access thereto or possession thereof, the Timeshare Owners' Association's, books, accounts, records, original correspondence, computer tapes, disks, software, and other papers as it may desire; and to discuss its affairs, finances and accounts with any of its officers, employees, Affiliates, contractors or independent public accountants (and by this provision Borrower authorizes said accountants to discuss with Lender, its agents or representatives, the affairs, finances and accounts of Borrower). Lender agrees to use reasonable efforts not to unreasonably interfere with Borrower's business operations in connection with any such inspections. Without limiting the foregoing, Lender shall have the right to make such credit investigations as Lender may deem appropriate in connection with its review of Pledged Notes Receivable, and Borrower shall make available to Lender all credit information in Borrower's possession or under its control or to which it may have access, with respect to Purchasers or other obligors under Pledged Notes Receivable as Lender may request. All audits and inspections shall be at Borrower's expense, including all reasonable travel expenses of Lender's employees, provided however, that Lender agrees, so long as no Event of Default has occurred, Lender shall charge Borrower only for one (1) such audit and inspection per Loan Year. (h) REPORTING REQUIREMENTS. So long as any portion of the Obligations remains unsatisfied or this Agreement has not been terminated, Borrower and Guarantor (as to items (ii) and (iii) below) shall furnish (or cause to be furnished, as the case may be) to Lender the following: (i) MONTHLY FINANCIAL REPORTS. As soon as available and in any event within five (5) days after the end of each calendar month, a report, for a monthly period ending not earlier than the 25th of the previous month, showing (A) the trial balance of the Pledged Notes Receivable, (B) an 51 53 aging and delinquency report on the Pledged Notes Receivable, (C) a report detailing the collections on each of the Pledged Notes Receivable and (D) a Borrowing Base report; (ii) ANNUAL FINANCIAL REPORTS. As soon as available and in any event within one hundred twenty (120) days after the end of each of calendar year or other fiscal year as may be applicable with respect to the Borrower (a "Fiscal Year"), an audited statement of income and expense of Borrower for the annual period ended as of the end of such Fiscal Year, and an audited statement of financial condition of Borrower as of the end of such Fiscal Year and a current annual sales report for Intervals at the Property certified by Borrower, all in such detail and scope as may be reasonably required by Lender and, except for the annual sales report, prepared by a certified public accountant acceptable to Lender in accordance with GAAP and on a basis consistent with prior accounting periods; (iii) QUARTERLY FINANCIAL REPORTS. As soon as available and in any event within sixty (60) days after the end of each fiscal quarter of Borrower (a "Fiscal Quarter"), a statement of income and expense of Borrower for such Fiscal Quarter, and a statement of financial condition of Borrower as of the end of such Fiscal Quarter, all in such detail and scope as may be reasonably required by Lender and prepared by Borrower in accordance with GAAP and on a basis consistent with prior accounting periods, except that such Fiscal Quarter reports will be subject to year end adjustments and will not contain footnotes. Each quarterly financial statement of Borrower shall be certified by the chief financial officer of Borrower to be true, correct and complete, and shall otherwise be in form reasonably acceptable to Lender. (iv) OFFICER'S CERTIFICATE. Each set of annual Financial Statements or reports delivered to the Lender pursuant to Sections 7.1(h)(ii) and (iii) of this Agreement will be accompanied by a certificate of the chief financial officer of the Borrower or Guarantor, as the case may be, setting forth that the signers have reviewed the relevant terms of the Agreement (and all other agreements and exhibits between the parties) and have made, or caused to be made, under their supervision, a review of the transactions and conditions of the Borrower and the Property or the Guarantor, as the case may be, from the beginning of the period covered by the Financial Statements or reports being delivered therewith to the date of the certificate and that such review has not disclosed the existence during such period of any condition or event which constitutes a Default or Event of Default or, if any such condition or event existed or exists or will exist, specifying the nature and period of existence thereof and what action the Borrower or Guarantor, as the case 52 54 may be, has taken or proposes to take with respect thereto; (v) SALES REPORTS. As soon as available and in any event within ten (10) days after the end of each month, Borrower shall deliver to Lender, monthly and annually, a monthly or annual sales and cancellation report, detailing the sales and cancellation of all Intervals at the Property for the period covered thereby, certified by Borrower to be true, correct and complete and otherwise in a form reasonably approved by Lender; (vi) AUDIT REPORTS. Promptly upon receipt thereof, one (1) copy of each other report submitted to the Borrower or Guarantor by independent public accountants or other Persons in connection with any annual, interim or special audit made by them of the books of the Borrower or the Property; (vii) NOTICE OF DEFAULT OR EVENT OF DEFAULT. Immediately upon becoming aware of the existence of any condition or event which constitutes a Default or an Event of Default, a written notice specifying the nature and period of existence thereof and what action the Borrower and Guarantor are taking or propose to take with respect thereto. (viii) NOTICE OF CLAIMED DEFAULT. Immediately upon becoming aware that the holder of any material obligation of the Borrower or Guarantor has given notice or taken any other action with respect to a claimed default or event of default thereunder, a written notice specifying the notice given or action taken by such holder and the nature of the claimed default or event of default and what action the Borrower and Guarantor are taking or propose to take with respect thereto. (ix) MATERIAL ADVERSE DEVELOPMENTS. Immediately upon becoming aware of any litigation, claim, action, proceeding, development or other information which may materially and adversely affect the Borrower, the Guarantor, the Collateral, the Property, or the business, prospects, profits or condition (financial or otherwise) of the Borrower, or Guarantor or the ability of the Borrower or Guarantor to perform its Obligations under the Loan Documents, or of the existence of any dispute between Borrower and any governmental or regulatory body or any other party which dispute may materially delay or interfere with Borrower's normal business operations, Borrower and Guarantor shall provide Lender with telephonic or telegraphic notice, followed by telefaxed and mailed written confirmation, specifying the nature of such litigation, development, information or dispute and such anticipated effect. (x) OTHER INFORMATION. Borrower will furnish 53 55 on an annual basis to Lender: (i) a detailed operating budget for the Property and a statement of financial condition and income and expense statement for the Timeshare Owners' Association for the fiscal year just ended within 120 days of each Timeshare Owners' Association fiscal year end; (ii) not later than 30 days prior to the start of each of Borrower's Fiscal Years, a pro forma cash flow and operating budget for Borrower for such ensuing Fiscal Year; and (iii) Borrower and Guarantor will promptly deliver to Lender any other information related to the Loan, the Collateral, the Property, Borrower or Guarantor, consistent with information provided to other lenders to Borrower, as Lender may in good faith request. (xi) HAZARDOUS MATERIALS. Borrower shall promptly notify Lender of any material change in the nature or extent of any Hazardous Materials, maintained on, in or under the Property or used in connection therewith, and will deliver to Lender copies of any citations, orders, notices or other material governmental or other communication received with respect to any other Hazardous Materials, or other environmentally regulated substances affecting the Property. Lender shall have the right, if Lender believes in good faith that an event or situation has occurred which has caused a material environmental impairment or adverse change to the Property, to require Borrower to perform (at Borrower's expense) an environmental audit or, if deemed reasonably necessary by Lender, an environmental risk assessment of the Property. Such audit or risk assessment must be by an environmental consultant satisfactory to Lender. Should Borrower fail to perform such environmental audit or risk assessment within sixty (60) days of the Lender's written request, Lender shall have the right but not the obligation to retain an environmental consultant to perform such environmental audit or risk assessment. All costs and expenses incurred by Lender in the exercise of such rights shall bear interest at the Default Rate set forth herein and shall be secured by the Collateral and shall be payable by Borrower upon demand. (i) RECORDS. Borrower and Guarantor shall keep adequate records and books of account reflecting all financial transactions of Borrower and Guarantor and with respect to the Property in which complete entries will be made in accordance with GAAP. Borrower will maintain to the reasonable satisfaction of Lender accurate and complete books, records and files relating to the Property, the Collateral, the Improvements and the sales of Intervals and all payments in respect of Pledged Notes Receivables. Borrower shall permit Lender to audit and inspect at any time, and shall promptly deliver to Lender upon Lender's request therefor, copies of all such books, records and files. 54 56 (j) MANAGEMENT. The Borrower and the Guarantor shall cause the Property to be managed at all times by Borrower or, upon the prior written consent of Lender, a Person or Persons who have substantial experience, background and demonstrated ability to perform, in accordance with a management agreement satisfactory to Lender, and who are in all other respects reasonably satisfactory to the Lender. Borrower and Guarantor further agree, at all times during the term of this Agreement, that at least three (3) of the following: Herbert B. Hirsch, Jerome J. Cohen, Frederick H. Conte, Don A. Mayerson and Stuart A. Harelik shall remain employed by Borrower and shall be actively involved in Borrower's business. (k) FICA. Upon the request of Lender, Borrower shall furnish to Lender within forty five (45) days after the expiration of each calendar quarter, proof reasonably satisfactory to Lender that Borrower's obligations to make deposits for F.I.C.A., social security and withholding taxes have been satisfied. (l) OPERATING CONTRACTS. Subject to the rights of the Timeshare Owners' Association as set forth in the Timeshare Documents or any applicable law or requirement of any governmental agency, no management agreement for the Resort to which Borrower is a party or as to which Borrower's consent or joinder is required, shall be modified, extended, terminated or entered into, without the prior written approval of Lender. (m) OWNERSHIP INTEREST. There shall be no change in the ownership interests of Borrower. The Borrower shall not enter into proxies, voting trusts, shareholders agreements or similar arrangements for the purpose of vesting voting rights, authority or discretion in any other Person. (n) NOTICES. Borrower shall notify Lender within five (5) Business Days of the occurrence of any event: (i) as a result of which any representation or warranty of Borrower or Guarantor contained in any Loan Documents would be incorrect or materially misleading if made at that time; or (ii) as a result of which Borrower or Guarantor is not in full compliance with all of its covenants and agreements contained in this Agreement or any Loan Document; or (iii) which constitutes or, with the passage of time, notice or a determination by Lender would constitute, an Event of Default. (o) MAINTENANCE. Borrower shall maintain, or shall cause to be maintained, or to the extent provided for pursuant to the Timeshare Declaration, shall use its best efforts to cause the Timeshare Owners' Association to maintain the Property in good repair, working order and condition and shall make all necessary replacements and improvements to the Property so that the value and operating efficiency of the Property will be maintained at all times and so that the Property remains in compliance in all respects with the Timeshare Act, the Timeshare Documents and other 55 57 applicable law. (p) CLAIMS. Borrower shall promptly notify Lender of any material claim, action or proceeding affecting the Property or Collateral, or any part thereof, or any of the security interests or rights granted in favor of Lender hereunder or under any of the Loan Documents. At the request of Lender, Borrower shall appear in and defend in favor of Lender, at Borrower's sole expense, with regard to any such claim, action or proceeding. (q) REGISTRATION AND REGULATIONS. (i) LOCAL LEGAL COMPLIANCE. Borrower will comply, and will cause the Property to comply, with all applicable servitudes, restrictive covenants, applicable planning, zoning or land use ordinances and building codes, all applicable health and Environmental Laws and regulations, and all other applicable laws, rules, regulations, agreements or arrangements. (ii) REGISTRATION COMPLIANCE. Borrower will maintain, or cause to be maintained, all necessary registrations, current filings, consents, franchises, approvals, and exemption certificates, and Borrower will make or pay, or cause to be made or paid, all registrations, declarations or fees with the Division and any other government or any agency or department thereof, whether in the State or another jurisdiction, required in connection with the Property and the occupancy, use and operation thereof, the incorporation of Units into the time-share plan established pursuant to the Timeshare Declaration and the other Timeshare Documents, and the sale, advertising, marketing, and offering for sale of Intervals. All such registrations, filings and reports will be truthfully completed. At Lender's request from time to time, Borrower shall deliver to Lender a copy of(A) such registration, (B) written statements by the applicable state authorities, in form acceptable to Lender, stating that no registration is necessary for the sale of Intervals in the particular state, (C) an opinion of counsel in form acceptable to Lender and rendered by counsel acceptable to Lender, stating that no such registration is necessary, or (D) such other evidence of compliance with applicable laws as Lender may require; and (iii) OTHER COMPLIANCE. The Borrower has, in all material respects, complied with and will comply with all laws and regulations of the United States, the State of Nevada the County of Clark, the City of Las Vegas, Nevada and any other governmental, quasi-governmental or administrative jurisdiction in which Intervals have been sold or offered for sale, or in which sales, offers of sale or solicitations with respect to the Property have been or will be conducted, 56 58 including to the extent applicable, but not limited to: (1) the Timeshare Act; (2) the Consumer Credit Protection Act; (3) Regulation Z of the Federal Reserve Board; (4) the Equal Credit Opportunity Act; (5) Regulation B of the Federal Reserve Board; (6) the Federal Trade Commission's 3-day cooling-off Rule for Door-to-Door Sales; (7) ILSA; (8) Section 5 of the Federal Trade Commission Act; (9) federal postal laws; (10) applicable state and federal securities laws; (11) applicable usury laws; (12) applicable trade practices, home and telephone solicitation, sweepstakes, anti-lottery and consumer credit and protection laws; (13) applicable real estate sales licensing, disclosure, reporting and escrow laws; (14) the ADA; (15) RESPA; (16) all amendments to and rules and regulations promulgated under the foregoing acts or laws; (17) other applicable federal statutes and the rules and regulations promulgated thereunder; and (18) any state law or law of any state (and the rules and regulations promulgated thereunder) relating to ownership, establishment or operation of the Property, or the sale, offering for sale, or financing of Intervals. (r) OTHER DOCUMENTS. Borrower will maintain to the reasonable satisfaction of the Lender, and make available to Lender, accurate and complete files relating to the Property, the Pledged Notes Receivable and other Collateral, and such files will contain true copies of each Pledged Note Receivable, as amended from time to time, copies of all relevant credit memoranda relating to such Notes Receivable and all collection information and correspondence relating thereto. (s) FURTHER ASSURANCES. Borrower will execute and deliver, or cause to be executed and delivered, such other and further agreements, documents, instruments, certificates and assurances as, in the judgment of Lender exercised in good faith may be necessary or appropriate to more effectively evidence or secure, and to ensure the performance of, the Obligations. In addition, Borrower shall deliver to Lender from time to time upon each request by Lender such documents, instruments or other matters or items as Lender may reasonably require to evidence Borrower's compliance with the covenants set forth in this Section 7.1. (t) UTILITIES. Borrower will cause, or to the extent provided for pursuant to the Timeshare Declaration, covenants to use its best efforts to ensure that the Timeshare Owners' Association, or the manager of the Property, as applicable, will cause, electric, gas, sanitary sewer, water facilities, drainage facilities, solid waste disposal, telephone and other necessary utilities to be available to the Property in sufficient capacity to service the Property. (u) AMENITIES. Borrower will cause, or to the extent provided for pursuant to the Timeshare Declaration, will use its 57 59 best efforts to ensure that the Timeshare Owners' Association, or the manager of the Property, as applicable, will cause, the Property to be maintained in good condition and repair, and in accordance with the provisions of the applicable Timeshare Documents, and the Borrower will cause each Purchaser of an Interval at the Property to have continuing access to, and the use of, to the extent of such Purchaser's time-share periods and related or appurtenant services, rights and benefits, all as provided in the Timeshare Declaration and the Timeshare Documents. (v) EXPENSES AND CLOSING FEES. Whether or not the transactions contemplated hereunder are completed, the Borrower shall pay all expenses of the Lender relating to negotiating, preparing, documenting, closing and enforcing this Agreement and all other Loan Documents, including, but not limited to: (i) the cost of preparing, reproducing and binding this Agreement, the other Loan Documents and all Exhibits and Schedules thereto; (ii) the fees and disbursements of Lender's counsel; (iii) Lender's out-of-pocket expenses; (iv) all Loan Costs and all other fees and expenses (including fees and expenses of the Lender's counsel) relating to any Advances, amendments, waivers or consents; (v) all costs, outlays, legal fees and expenses of every kind and character had or incurred in (1) the interpretation or enforcement of any of the provisions of, or the creation, preservation or exercise of rights and remedies under, any of the Loan Documents including the costs of appeal (2) the preparation for, negotiations regarding, consultations concerning, or the defense or prosecution of legal proceedings involving any claim or claims made or threatened against the Lender arising out of this transaction or the protection of the Collateral securing the Loan or Advances made hereunder, expressly including, without limitation, the defense by Lender of any legal proceedings instituted or threatened by any Person to seek to recover or set aside any payment or setoff theretofore 58 60 received or applied by the Lender with respect to the Obligations, and any and all appeals thereof; and (3) the advancement of any expenses provided for under any of the Loan Documents; (vi) all expenses relating to any escrow by the Title Company or any other escrow agent; (vii) the custodial fees payable to Lender with respect to the original Pledged Notes Receivable and related Collateral; (viii) all costs and expenses incurred by Lender under the Loan and all fees and charges under the Loan; and (ix) all real and personal property taxes and assessments, documentary stamp and intangible taxes, sales taxes, recording fees, title insurance premiums and other title charges, document copying, transmittal and binding costs, appraisal fees, lien and judgment search costs, fees of architects, engineers, environmental consultants, surveyors and any special consultants, construction inspection fees, brokers fees, escrow fees, wire transfer fees, and all travel and out-of-pocket expenses of Lender to conduct inspections or audits, except as otherwise specifically provided for herein; Without limitation of the foregoing, Borrower shall pay the costs of UCC and other searches, UCC and other Loan Document recording fees and applicable taxes, and premiums on each Title Policy delivered to Lender pursuant to this Agreement. The provision of this Section shall survive repayment of the Obligations or termination of this Agreement. (w) INDEMNIFICATION OF LENDER. In addition to (and not in lieu of) any other provisions of any Loan Document providing for indemnification in favor of Lender, the Borrower and Guarantor shall defend, indemnify and hold harmless Lender, its subsidiaries, affiliates, officers, directors, agents, employees, representatives, consultants, contractors, servants, and attorneys, as well as the respective heirs, personal representatives, successors or assigns of any or all of them (hereafter collectively 59 61 the "Indemnified Lender Parties"), from and against, and promptly pay on demand or reimburse each of them with respect to, any and all liabilities, claims, demands, losses, damages, costs and expenses (including without limitation, reasonable attorneys' and paralegals' fees and costs), actions or causes of action of any and every kind or nature whatsoever asserted against or incurred by any of them by reason of or arising out of or in any way related or attributable to: (i) this Agreement, the Loan Documents, the Commitment or the Collateral; (ii) the transactions contemplated under any of the Loan Documents or any of the Timeshare Documents, including without limitation, those in any way relating to or arising out of the violation of any federal or state laws, including the Timeshare Act; (iii) any breach of any covenant or agreement or the incorrectness or inaccuracy of any representation and warranty of the Borrower or Guarantor contained in this Agreement or any of the Loan Documents (including without limitation any certification of the Borrower or Guarantor delivered to the Lender); (iv) any and all taxes, including real estate, personal property, sales, mortgage, excise, intangible or transfer taxes (exclusive of income, franchise or similar taxes), and any and all fees or charges, including, without limitation under the Timeshare Act, with respect to the Property or the Loan Documents which may at any time arise or become due prior to the payment, performance and discharge in full of the Obligations; (v) the breach of any representation or warranty as set forth herein regarding any Environmental Laws; (vi) the failure of Borrower to perform any obligation or covenant herein required to be performed pursuant to any Environmental Laws; (vii) the use, generation, storage, release, threatened release, discharge, disposal or presence on, under or about the Property of any Hazardous Materials; (viii) the removal or remediation of any Hazardous Materials from the Property required to be performed pursuant to any Environmental Laws or as a result of recommendations of any environmental consultant or as reasonably required by Lender; (ix) claims asserted by any Person (including without limitation any governmental or quasi-governmental agency, commission, department, instrumentality or body, court, arbitrator or administrative board (collectively, a "GOVERNMENTAL AGENCY"), in connection with or any in any way arising out of the presence, use, storage, disposal, generation, transportation, release, or treatment of any Hazardous Materials on, in, under or affecting the Property; (x) the violation or claimed violation of any Environmental Laws in regard to the Property; or (xi) the preparation of an environmental audit or report on the Property, whether conducted by Lender, Borrower, Guarantor or a third-party, or the implementation of environmental audit recommendations. Such indemnification shall give Borrower or Guarantor the right to participate in the selection of counsel for Lender and in the conduct or settlement of any dispute or proceeding for which indemnification may be claimed. Lender agrees to give Borrower written notice of the assertion of any claim or the commencement of any action or lawsuit described in this Section. It is the express intention of the parties hereto that 60 62 the indemnity provided for in this Section, as well as the disclaimers of liability referred to in this Agreement, are intended to and shall protect and indemnify Lender from the consequences of Lender's own negligence, but not Lender's gross negligence or willful misconduct, whether or not that negligence is the sole or concurring cause of any liability, obligation, loss, damage, penalty, action, judgment, suit, claim, cost, expense or disbursement. The provisions of this Section shall survive the full payment, performance and discharge of the Obligations and the termination of this Agreement, and shall continue thereafter in full force and effect. (x) USE OF BORROWER'S NAME. Borrower shall at all times during the term of the Loan permit Lender to use the name of Borrower, any of its Affiliates, Guarantor and the Property in any press release, advertisement or other promotional materials issued in respect to the Loan. (y) RIGHT TO PROVIDE FUTURE FINANCING. Borrower hereby grants to Lender an absolute option and right of first refusal, at Lender's discretion, to provide financing in connection with the Property or the Collateral. Lender shall have a period of twenty (20) days after written notification from Borrower to Lender of Borrower's financing request to determine whether or not Lender desires to provide such financing and if Lender shall agree to provide such financing Lender shall have a further period of sixty (60) days from the expiration of Borrower's initial notification period to consummate such financing. If Lender has not agreed to provide the requested financing within such twenty (20) days or Lender has failed to provide such financing within sixty (60) days after agreeing to provide such financing, Borrower shall be permitted to obtain such financing from other sources provided that the terms of such financing obtained are not materially less advantageous to Borrower than the terms initially offered to Lender. (z) SALES AND MARKETING. Borrower may conduct its own sales and marketing activities directly or through a subsidiary. In the event that Borrower or such subsidiary does not conduct its own sales and marketing activities, Borrower will only contract with or employ a sales and marketing organization for the Property, which is reasonably acceptable to Lender. (aa) FINANCIAL COVENANTS. Borrower shall not permit or suffer its Tangible Net Worth to be less than $25,000,000 at any time, nor will Borrower permit its cash balances plus unpledged notes receivable to be less than $5,000,000 at any time and Borrower agrees that its net income, determined in accordance with GAAP, shall be $1.00 or greater for each Fiscal Quarter. (bb) LOCKBOX AGENT. Prior to the initial Advance of the 61 63 Receivables Loan, Borrower will enter into a Lockbox Agreement reasonably acceptable to Lender and Borrower in form and substance. The Lockbox Agent shall disburse, on a weekly basis, all of the Pledged Notes Receivable collections to which Lender is entitled to Lender. Lockbox Agent shall have no right of setoff with respect to funds held by Lockbox Agent pursuant to the Lockbox Agreement. Borrower shall pay all costs and fees in connection with the Lockbox Agreement. 7.2. NEGATIVE COVENANTS. So long as any portion of the Obligations remains unsatisfied, Borrower and Guarantor hereby covenant and agree with Lender as follows: (a) LIMITATION ON OTHER DEBT/FURTHER ENCUMBRANCES. Without the prior written consent of Lender which may be granted, withheld or conditioned in Lender's discretion, Borrower will not obtain financing or grant liens with respect to the Collateral (except for common collateral such as Operating Contracts), other than those in favor of Lender. (b) RESTRICTIONS ON TRANSFERS. Borrower shall not, without obtaining the prior written consent of Lender (which consent may be given, withheld or conditioned by Lender in Lender's discretion), whether voluntarily or involuntarily, by operation of law or otherwise, except as otherwise permitted; (i) transfer, sell, pledge, convey, hypothecate, factor or assign all or any portion of the Property or the other Collateral, or contract to do any of the foregoing, including, without limitation, pursuant to options to purchase, and so-called "installment sales contracts", "land contracts", or "contracts for deed" (except that Borrower shall have the right to sell Intervals to Purchasers in arms-length transactions, conduct bulk sales of Pledged Notes Receivable, in accordance with the terms of this Agreement, and Borrower shall be permitted to convey property in lieu of condemnation); (ii) lease or license the Property or any portion of the Property, or all or any portion of the Collateral, or change the legal or actual possession or use thereof; (iii) permit the dilution, transfer, pledge, hypothecation or encumbrance of any of the ownership interests in Borrower except the existing pledge disclosed in the financial statement of Guarantor; (iv) permit the assignment, transfer, change, modification or diminution of the duties or responsibilities of Borrower, the Guarantor or, to the extent within the control of Borrower, of any manager of the Property approved by Lender as manager of the Property (except for an assignment of such duties to a professional management company or companies reasonably acceptable to Lender in advance); or (v) cause or permit the assignment, pledge or other encumbrance of any of the Operating Contracts, except for any pledges to existing lenders or as otherwise permitted herein. Without limiting the generality of the preceding sentence, and subject to the terms of this Agreement, except as otherwise permitted herein, the prior written consent of Lender shall be required for: (A) any transfer of the Collateral or 62 64 any part thereof (except with respect to the sale of Intervals to Purchasers in arms length transactions and bulk sales in accordance with the terms of this Agreement and conveyances in lieu of condemnation) made to a subsidiary, its partners or any Affiliate or otherwise; (B) any merger or consolidation, disposition or other reorganization of Guarantor, provided however, in the event that Lender refuses to give its consent to any merger or consolidation involving Guarantor, Borrower may prepay all Obligations without a prepayment premium provided that such repayment of all Obligations occurs within thirty (30) days of such merger or consolidation not consented to by Lender; and (C) any change in the ownership of stock of Borrower. In the event that Lender, in Lender's discretion, is willing to consent to a transfer which would otherwise be prohibited by this Section 7.2(b) Lender may condition its consent on such terms as it desires, including, without limitation, an increase in the applicable Interest Rates and the requirement that Borrower pay a transfer fee, together with any expenses incurred by Lender in connection with the granting of such consent (including, without limitation, attorneys' fees and expenses). If Borrower violates the terms of this Section 7.2(b), in addition to any other rights or remedies which Lender may have herein, in any other Loan Document, or at law or in equity, Lender may by written notice to Borrower increase, effective immediately as of the date of such violation, the applicable Interest Rate to the applicable Default Rate. (c) USE OF THE LENDER'S NAME. Borrower and Guarantor will not, and will not permit any Affiliate to, without the prior written consent of the Lender, use the name of the Lender or the name of any affiliate of the Lender in connection with any of their respective businesses or activities, except in connection with internal business matters and as required in dealings with governmental agencies. (d) TRANSACTIONS WITH AFFILIATES. Without the prior written consent of Lender, which shall not unreasonably be withheld, Borrower will not enter into any transaction with any Affiliate in connection with the Property, including, without limitation, relating to the purchase, sale or exchange any assets or properties or the rendering of any service, except in the ordinary course of, and pursuant to the reasonable requirements of, the operations of the Property and upon fair and reasonable terms. (e) RESTRICTIVE COVENANTS. Unless required by law, Borrower will not without Lender's prior written consent seek, consent to, or otherwise acquiesce in, any change in any private restrictive covenant, planning or zoning law or other public or private restriction, which would limit or alter the use of the Property or any of the Property. (f) SUBORDINATED OBLIGATIONS. Upon the occurrence and during the continuance of an Event of Default, Borrower will not, 63 65 directly or indirectly: (i) permit any payment to be made in respect of any indebtedness, liabilities or obligations, direct or contingent, to Guarantor or any Affiliate of Guarantor or which are subordinated by the terms thereof or by separate instrument to the payment of principal of, and interest on, the Loan, except in accordance with the terms of such subordination; (ii) permit the amendment, rescission or other modification of any such subordination provisions of any of the Borrower's subordinated obligations in such a manner as to affect adversely the Lender's Lien in and to the Collateral or Lender's senior priority position and entitlement as to payment and rights with respect to the Loan and the Obligations; or (iii) permit the prepayment or redemption, of all or any part of Borrower's obligations to Guarantor or any Affiliate of Guarantor, or of any subordinated obligations of the Borrower except in accordance with the terms of such subordination provisions. (g) TIMESHARE REGIME. Without Lender's prior written consent, Borrower shall not amend, modify or terminate the Timeshare Declaration or other Timeshare Documents, or any other restrictive covenants, agreements or easements regarding the Property; nor shall Borrower further assign its rights as "developer" or "declarant" under the Timeshare Declaration, or file or permit to be filed any additional covenants, conditions, easements or restrictions against or affecting the Property (or any portion thereof) without Lender's prior written consent, unless required by law. (h) NAME CHANGE. Borrower will not change its name and will not change its chief executive office or the location at which it does business without prior written notice to Lender. (i) COLLATERAL. Borrower and Guarantor shall not take any action (nor permit or consent to the taking of any action) which might materially impair the value of the Collateral or any of the rights of Lender in the Collateral. (j) MARKETING/SALES. Borrower shall not market, attempt to sell or sell or permit or justify any sales or attempted sales of any Intervals except in compliance with the Timeshare Act and applicable laws in Nevada and each other jurisdiction where marketing, sales or solicitation activities occur. (k) DISTRIBUTIONS. Borrower agrees, subsequent to the occurrence of an Event of Default and during the continuance thereof, that it will not make any distributions, direct or indirect, to Guarantor unless and until all of the Obligations have been paid in full unless such failure to make such distribution shall cause an event of default to occur under agreements between Guarantor and third parties, in which event such distribution, to the extent necessary to avoid such event of default by Guarantor shall be permitted. 64 66 SECTION 8 8. EVENTS OF DEFAULT 8.1. NATURE OF EVENTS. An "Event of Default" shall exist if any of the following shall occur: (a) PAYMENTS. If Borrower shall fail to make, within five (5) days of receipt of either a billing for or written notice of an amount due, any payment or mandatory prepayment of principal, interest on the Mortgage Loan or the Receivables Loan, any Release Payment, Release Fee or any other fee or amount due to Lender with respect to the Loan. (b) COVENANT DEFAULTS. If Borrower shall fail to perform or observe any covenant (including but not limited to the affirmative covenants contained in Section 7.1), agreement or warranty contained in this Agreement or in any of the Loan Documents, (other than with respect to the failure to make timely payments in respect of the Loan as provided in Section 8.1(a) or violate of any negative covenant in contained in Section 7.2) and, such failure shall continue for thirty (30) days after written notice of such failure is provided by Lender, provided however, that if Borrower commences to cure such failure within such thirty (30) day period, but, because of the nature of such failure, cure cannot be completed within thirty (30) days notwithstanding diligent effort to do so, then, provided Borrower diligently seeks to complete such cure, an Event of Default shall not result unless such failure continues for a total of ninety (90) days. (c) WARRANTIES OR REPRESENTATIONS. If any representation or other statement made by or on behalf of Borrower or Guarantor in this Agreement, in any of the Loan Documents or in any instrument furnished in compliance with or in reference to the Loan Documents, is false, misleading or incorrect in any material respect as of the date made or reaffirmed. (d) ENFORCEABILITY OF LIENS. If any lien or security interest granted by Borrower to Lender in connection with the Loan is or becomes invalid or unenforceable or is not, or ceases to be, a perfected first, or such other priority as is permitted hereunder, priority lien or security interest in favor of Lender encumbering the asset to which it is intended to encumber, and Borrower fails to cause such lien or security interest to become a valid, enforceable, first and prior lien or security interest in a manner satisfactory to Lender within five (5) days after Lender delivers written notice thereof to Borrower. (e) INVOLUNTARY PROCEEDINGS. If a case is commenced or a petition is filed against Borrower or Guarantor under any Debtor Relief Law and in the case of a petition being filed against Borrower or Guarantor, the continuation of such proceeding without 65 67 dismissal for a period of sixty (60) days; a receiver, liquidator or trustee of Borrower or Guarantor or of any material asset of Borrower or Guarantor is appointed by court order and such order remains in effect for more than sixty (60) days; or if any material asset of Borrower or Guarantor is sequestered by court order and such order remains in effect for more than sixty (60) days. (f) PROCEEDINGS. If Borrower or Guarantor voluntarily seeks, consents to or acquiesces in the benefit of any provision of any Debtor Relief Law, whether now or hereafter in effect; consents to the filing of any petition against it under such law; makes an assignment for the benefit of its creditors; admits in writing its inability to pay its debts generally as they become due; or consents or suffers to the appointment of a receiver, trustee, liquidator or conservator for it, him or her or any part of its, his or her assets. (g) ATTACHMENT, JUDGMENT, TAX LIENS. The issuance, filing, levy or seizure against the Collateral, or, with respect to the Property, or against the Borrower or Guarantor, of one or more attachments, injunctions, executions, tax liens or judgments for the payment of money cumulatively in excess of $100,000.00, or the filing of any mechanics' or materialmen's lien or claim of lien which is not discharged in full or stayed, in either case, within thirty (30) days after issuance or filing. (h) FAILURE TO DEPOSIT PROCEEDS. If Borrower shall fail to deliver payments made under the Pledged Notes Receivable directly to Lender as required pursuant to Section 2.5 above, or if Borrower or Guarantor shall take any other act which Lender shall reasonably deem to be a conversion of the Collateral or fraudulent with respect to Lender. (i) TIMESHARE DOCUMENTS. If the Timeshare Declaration, any of the other documents creating or governing the Property, its timeshare regime, or the Timeshare Owners' Association, or the restrictive covenants with respect to the Property, shall be terminated, amended or modified in any material respect without Lender's prior written consent, except as required by law or any government agency. (j) REMOVAL OF COLLATERAL. If Borrower or Guarantor conceals, removes, transfers, conveys, assigns or permits to be concealed, removed, transferred, conveyed or assigned, any of the Collateral or any of its assets in violation of the terms of the Loan Documents or with the intent to hinder, delay or defraud its creditors or any of them including, without limitation, Lender. (k) OTHER DEFAULTS. If a material default shall occur in any of the covenants or Obligations set forth in this Agreement or any of the Loan Documents and not referred to in any other portion of this Section 8.1. 66 68 (l) MATERIAL ADVERSE CHANGE. Any material adverse change in the financial condition of Borrower or Guarantor or in the condition of the Collateral. (m) DISSOLUTION OR DEFAULT OF GUARANTOR. (i) Any unapproved merger, dissolution or liquidation of Guarantor unless the Obligations are prepaid as provided in Section 7.2(b); (ii) any default under any Guaranty and the expiration of any applicable grace period or the revocation or attempted revocation or repudiation thereof, in whole or part, by Guarantor; or (iii) except with Lender's prior written consent, any change in the ownership structure of the Borrower or management or marketing responsibilities with respect to the Borrower or the Property. (n) DEFAULT BY BORROWER IN OTHER AGREEMENTS. Any default by the Borrower or Guarantor: (i) in the payment of any indebtedness to Lender or to any affiliate of Lender and the expiration of any applicable grace period; (ii) in the payment or performance of other indebtedness for borrowed money or obligations secured by any part of the Property or the Collateral and the expiration of any applicable grace period; or (iii) in the payment or performance of other material indebtedness or obligations where such default accelerates or permits the acceleration (after the giving of notice or passage of time or both) of the maturity of such indebtedness, or permits the holders of such indebtedness to elect a majority of the board of directors of Borrower or Guarantor (unless waived by such holder). (o) LOSS OF LICENSE. The loss, revocation or failure to renew or file for renewal of any registration, approval, license, permit or franchise now held or hereafter acquired by the Borrower or with respect to the Property, or the failure to pay any fee, which is necessary for the continued operation of the Property or the Borrower's business in materially the same manner as it is being conducted at the time of such loss, revocation, failure to renew or failure to pay. (p) SUSPENSION OF SALES. The issuance of any stay order, cease and desist order, injunction, temporary restraining order or similar judicial or nonjudicial sanction limiting or otherwise materially adversely affecting any Interval sales activities, other material business operations in respect of the Property, or the enforcement of Lender's remedies. (q) VIOLATION OF NEGATIVE COVENANTS. Borrower or Guarantor violates any negative covenant set forth in Section 7.2. (r) TRANSFER OF PROPERTY. Except for the sale of Intervals in the ordinary course of business in accordance with the terms hereof or as otherwise permitted under the Loan Documents, if Borrower shall, without Lender's prior written consent, sell, 67 69 transfer, convey or further encumber all or any part of its interest in the Property or in any of the Collateral. For purposes of this paragraph, an assignment, sale or transfer shall also include any assignment, sale, transfer or hypothecation of any ownership interests in the Borrower. (s) LIEN AGAINST PROPERTY. If Borrower grants any mortgage, lien or encumbrance upon any of the Collateral unless otherwise approved by Lender in writing, except as otherwise permitted or required under the Loan Documents. (t) ENCROACHMENTS AND PERMITS. If all or any portion of the Improvements encroach upon any street or road setback or easement or upon any adjoining property, or violate any ordinance, regulation, rule or direction of any federal or state agency, or of any governmental or quasi-governmental authority, or any zoning setback line; or if the building permit(s) shall be revoked or suspended or shall lapse, or if any building or other permit or license shall be conditional in nature and Borrower shall fail to punctually satisfy the conditions so as to prevent its invalidity provided however, that if Borrower commences to cure such encroachment, suspension or violation within thirty (30) days of first discovering said condition, but, because of the nature of such encroachment, suspension or violation, cure cannot be completed within thirty (30) days notwithstanding diligent efforts to do so, then, provided Borrower diligently seeks to complete such cure, an Event of Default shall not result unless such encroachment, suspension or violation continues for a total of ninety (90) days. (u) BREACH. If any violation or breach by Borrower shall continue after the expiration of any applicable cure period under any agreement, covenant or restriction affecting title to the Property, including but not limited to any Permitted Exceptions. (v) RECEIVABLES COLLATERAL. Any amendment to or modification of any Pledged Note Receivable, which is an Eligible Note Receivable and without which the Receivables Loan would be in excess of the Borrowing Base, is made without the prior written consent of Lender, other than upgrades or downgrades, and other than modifications and extensions granted by Borrower in connection with its normal collection practices which do not eliminate any defaults of Purchaser thereunder and further provided that notice of such other modifications and extensions specifying the details thereof has been provided to Lender ten (10) Business Days prior to the effective date of such other modification and/or extension with Lender having an absolute right of refusal over the grant of such other modification and/or extension; provided any notice of disapproval is given to Borrower within such ten (10) Business Day period. In addition, Borrower may amend or modify any Pledged Note Receivable even though not otherwise permitted by this Section 8.1(v) so long as concurrently therewith (or five (5) Business Days 68 70 after receipt of Lender's notice of disapproval in the case of modifications or extensions submitted to Lender for approval pursuant to this Section 8.1(v)) Borrower replaces such Pledged Note Receivable with one or more Pledged Notes Receivable with an aggregate outstanding principal balance at least equal to that of the Pledged note Receivable being replaced and otherwise constituting Eligible Notes Receivable. (w) MANAGEMENT. Any change in the management of the Property without the prior written consent of Lender which shall not be unreasonably withheld. SECTION 9 9. REMEDIES 9.1. REMEDIES UPON DEFAULT. Should an Event of Default occur, Lender may take any one or more of the actions described in this Section 9, all without notice to Borrower or Guarantor: (a) ACCELERATION. Without demand or notice of any nature whatsoever, declare the unpaid balance of the Loan, or any part thereof, immediately due and payable, whereupon the same shall be due and payable. (b) TERMINATION OF OBLIGATION TO ADVANCE. With or without proceeding with any sale or foreclosure or demanding payment or performance of the Obligations, without notice, terminate Lender's further performance under this Agreement or any other agreement or agreements between Lender and the Borrower, including, without limitation, any commitment of Lender to lend under this Agreement in its entirety, or any portion of any such commitment, to the extent Lender shall deem appropriate, without further liability or obligation by Lender. (c) JUDGMENT. Reduce Lender's claim to judgment, foreclose or otherwise enforce Lender's security interest in all or any part of the Collateral by any available judicial or other procedure under law. Lender's right to sue and recover a judgment either before, after or during the pendency of any proceeding for the enforcement of any Deed of Trust, and the right of Lender to recover such judgment shall not be affected by any taking, possession or foreclosure sale hereunder or by the exercise of any other right, power or remedy for the enforcement of the terms of any Deed of Trust or the foreclosure of the lien thereof. (d) FORECLOSURE. Whether or not Lender takes possession of the Collateral, Lender may proceed to foreclose any Deed of Trust and to sell the Property in its entirety or in separate parcels, under the judgment or decree of a court or courts of competent jurisdiction and to pursue any other remedy available to 69 71 it, all as Lender shall deem appropriate. Upon commencement of suit or foreclosure of any Deed of Trust, the unpaid principal balance of Loan, if not previously accelerated and declared due, and the interest accrued thereon, together with all other Obligations shall be immediately due and payable. Upon any foreclosure sale pursuant to judicial proceedings, Lender may bid for and purchase all or any portion of the Property and, upon compliance with the terms of sale, may hold, retain and possess and dispose of the Property. In case of a foreclosure sale of all or any part of the Property and of the application of the proceeds of sale to the payment of the Obligations Lender shall be entitled to enforce payment of and to receive all amounts then remaining due and unpaid upon the Loan, and Lender shall be entitled to recover judgment for any portion of the Obligations remaining unpaid, with interest. Borrower agrees, to the full extent that it may lawfully so agree, that no recovery of any such judgment by Lender and no attachment or levy of any execution upon any such judgment upon any of the Property or upon any other property shall in any manner or to any extent affect the lien of any Deed of Trust upon the Property or any part thereof or any lien, rights, powers or remedies of Lender hereunder, but such lien, rights, powers and remedies shall continue unimpaired. (e) LENDER'S RIGHT TO TAKE POSSESSION, OPERATE AND APPLY INCOME. (i) Upon Lender's demand, Borrower shall forthwith surrender to Lender the actual possession of the Property, terminate its position and rights and duties as manager and, to the extent permitted by law, Lender may enter and take possession of all the Property, appoint a new manager for the Property and may exclude Borrower and its agents and employees wholly therefrom. Lender shall have joint access with Borrower to Borrower's books, papers and accounts. If Borrower fails to surrender or deliver all or any portion of the Property or its management duties or privileges to Lender upon demand, Lender may obtain a judgment or decree conferring on Lender the right to immediate possession and management delegation responsibility or requiring Borrower to deliver immediate possession of all or part of the Property to Lender, and Borrower hereby specifically consents to the entry of such a judgment or decree. (ii) Upon every such entering upon or taking of possession, Lender may or may delegate to a designee of Lender, the right to hold, store, use, operate, manage and control the Property and conduct Borrower's business on the Property and, from time to time do any of the following things as Lender may from time to time deem necessary, appropriate or 70 72 desirable: (1) make all maintenance, repairs, renewals, replacements, additions and improvements necessary and proper to the Property and purchase or otherwise acquire additional fixtures, personalty and other property; (2) insure, manage and operate the Property and exercise all of the rights and powers of Borrower (in Lender's name or otherwise) with respect to the insurance, management and operation of the Property; (3) enter into any and all agreements with respect to the exercise by others of any of the powers herein granted to Lender; and (4) perform or cause to be performed any and all work and labor necessary to complete any Improvements. (iii) Lender may collect and receive all the income, revenues, rents, issues and profits of the Property, including those past due as well as those accruing thereafter. Lender shall apply such sums received by Lender, first to the payment of accrued interest and then to the payment of principal and all other sums or indebtedness that may be due hereunder, after deducting therefrom: (1) All expenses of taking, holding, managing and operating the Property (including compensation for the services of all Persons employed for such purposes); (2) The cost of all such maintenance, repairs, renewals, replacements, additions, betterments, improvements, purchases and acquisitions; (3) The cost of insurance; (4) Such taxes, assessments and other charges prior to the liens in favor of Lender, as Lender may determine to pay; (5) Other proper charges upon the Property or any part thereof; and (6) The compensation, expenses and disbursements of the attorneys and agents 71 73 of Lender, including attorneys' fees and costs for any appeal. (iv) If an Event of Default giving rise to pursuit of the foregoing remedy shall have been cured, Lender may, at its option, surrender possession of the Property to Borrower, its successors or assigns; provided, however, that Lender's right to take possession and to pursue any other remedies hereunder or under any of the Loan Documents shall exist if any subsequent Event of Default shall occur. (f) SALE OF COLLATERAL. After notification, if any, provided for in Section 9.2 below, sell or otherwise dispose of, at the office of Lender, or elsewhere, as chosen by Lender, all or any part of the Collateral, and any such sale or other disposition may be as a unit or in parcels, by public or private proceedings, and by way of one or more contracts (it being agreed that the sale of any part of the Collateral shall not exhaust Lender's power of sale, but sales may be made from time to time until all of the Collateral has been sold or until the Obligations, have been paid in full and fully performed), and at any such sale it shall not be necessary to exhibit the Collateral. Borrower and the Guarantor hereby acknowledge and agree that a private sale or sales of the Collateral, after notification as provided for in Section 9.2, shall constitute a commercially reasonable disposition of the Collateral sold at any such sale or sales, and otherwise commercially reasonable action on the part of the Lender. (g) RETENTION OF COLLATERAL/PURCHASE OF COLLATERAL. At its discretion, retain such portion of the Collateral as shall aggregate in value to an amount equal to the Loan, in satisfaction of the Obligations, whenever the circumstances are such that Lender is entitled and elects to do so under applicable law. Lender may buy the Collateral at any public or private sale. (h) RECEIVER. As a matter of strict right and without regard to the value or occupancy of the Property, apply by appropriate procedures for the appointment of a receiver who will enter upon and take possession of the Property, collect the rents and profits therefrom and apply the same as the court may direct. The receiver shall have all the rights and powers permitted under the laws of the State of Nevada. All costs and expenses (including receiver's fees, attorneys fees and costs, including attorneys' fees and costs incurred as a result of any appeal, and agents' compensation) incurred in connection with the appointment of a receiver shall be secured by the Collateral. The right to enter and take possession of the Property, to manage and operate the same and to collect the rents, issues and profits thereof (whether by a receiver or otherwise) shall be cumulative to any other right or remedy hereunder or afforded by law and may be exercised by Lender concurrently therewith or independently thereof. Lender shall be liable to account only for such rents, issues and profit actually 72 74 received by Lender. Notwithstanding the appointment of any receiver, trustee or other custodian, Lender shall be entitled, as pledgee, to the possession or control of any cash or other instruments, at the time held by or payable or deliverable under the terms of this Agreement or the Deed of Trust to Lender. Borrower hereby consents to any such appointment. Lender may also apply by appropriate judicial proceedings for appointment of a receiver for the Receivables Collateral, or any part thereof, and Borrower hereby consents to any such appointment. (i) EXERCISE OF OTHER RIGHTS. Lender shall have all the rights and remedies of a secured party under the Code and other legal and equitable rights to which it may be entitled, and may exercise any and all other rights or remedies afforded by the Loan Documents as Lender shall deem appropriate, at law, in equity or otherwise, including, but not limited to, the right to bring suit or other proceeding, either for specific performance of any covenant or condition contained in the Loan Documents or in aid of the exercise of any right or remedy granted to Lender in the Loan Documents. Lender shall also have the right to require the Borrower to assemble any of the Collateral not in Lender's possession, at Borrower's expense, and make it available to Lender at a place to be determined by Lender which is reasonably convenient to both parties, and Lender shall have the right to take immediate possession of all of the Collateral, and may enter the Property or any of the premises of Borrower or wherever the Collateral shall be located, with or without process of law wherever the Collateral may be, and, to the extent such premises are not the property of Lender, to keep and store the same on said premises until sold (and if said premises be the property of Borrower, Borrower agrees not to charge Lender for use and occupancy, rent, or storage of the Collateral, for a period of at least ninety (90) days after sale or disposition of the Collateral). (j) REPLACEMENT OF LOCKBOX AGENT. Replace the Lockbox Agent and terminate the applicable Lockbox Agreement. 9.2. NOTICE OF SALE. Reasonable notification of time and place of any public sale of the Collateral or reasonable notification of the time after which any private sale or other intended disposition of the Collateral is to be made shall be sent to Borrower and to any other Person entitled under the Code to notice; provided, however, that if the Collateral threatens to decline speedily in value or is of a type customarily sold on a recognized market, Lender may sell or otherwise dispose of the Collateral without notification, advertisement or other notice of any kind. It is agreed that notice sent not less than five (5) calendar days prior to the taking of the action to which such notice relates is reasonable notification and notice for the purposes of this Section 9.2. Lender shall have the right to bid at any public or private sale on its own behalf. Out of money 73 75 arising from any such sale, Lender shall retain an amount equal to all costs and charges, including attorneys' fees for advice, counsel or other legal services or for pursuing, reclaiming, seeking to reclaim, taking, keeping, removing, storing and advertising such Collateral for sale, selling same and any and all other charges and expenses in connection therewith and in satisfying any prior Liens thereon. Any balance shall be applied upon the Obligations, and in the event of deficiency, the Borrower shall remain liable to Lender. In the event of any surplus, such surplus shall be paid to the Borrower or to such other Persons as may be legally entitled to such surplus. If, by reason of any suit or proceeding of any kind, nature or description against the Borrower, or by the Borrower or any other party against Lender, which in Lender's sole discretion makes it advisable for Lender to seek counsel for the protection and preservation of its security interest, or to defend its own interest, such expenses and counsel fees shall be allowed to Lender and the same shall be made a further charge and Lien upon the Collateral. In view of the fact that federal and state securities laws may impose certain restrictions on the methods by which a sale of Collateral comprised of Securities may be effected after an Event of Default, Borrower agrees that upon the occurrence or existence of an Event of Default, Lender may, from time to time, attempt to sell all or any part of such Collateral by means of a private placement restricting the bidding and prospective purchasers to those who will represent and agree that they are purchasing for investment only and not for, or with a view to, distribution. In so doing, Lender may solicit offers to buy such Collateral, or any part of it for cash, from a limited number of investors deemed by Lender, in its reasonable judgment, to be responsible parties who might be interested in purchasing the Collateral, and if Lender solicits such offers from not less than two (2) such investors, then the acceptance by Lender of the highest offer obtained therefrom shall be deemed to be a commercially reasonable method of disposition of such Collateral. 9.3. APPLICATION OF COLLATERAL; TERMINATION OF AGREEMENTS. Upon the occurrence of any Event of Default, Lender may, with or without proceeding with such sale or foreclosure or demanding payment or performance of the Obligations, without notice, terminate Lender's further performance under this Agreement or any other agreement or agreements between Lender and the Borrower, without further liability or obligation by Lender, and may also, at any time, appropriate and apply against any Obligations any and all Collateral in its (or the Lockbox Agent's) possession, any and all balances, credits, deposits, accounts, reserves, indebtedness or other moneys due or owing to the Borrower held by Lender hereunder or under any other financing agreement or otherwise, whether accrued or not. Neither such termination, nor the termination of this Agreement by lapse of time, the giving of notice or otherwise, shall absolve, release or otherwise affect the liability of the 74 76 Borrower in respect of transactions prior to such termination, or affect any of the Liens, security interests, rights, powers and remedies of Lender, but they shall, in all events, continue until all of the Obligations are satisfied. 9.4. SUITS TO PROTECT THE PROPERTY. Lender shall have power to: (a) institute and maintain such suits and proceedings as it may deem expedient to prevent any impairment of the Property by any acts which may be unlawful or which violate this Agreement or any of the Loan Documents ; (b) preserve or protect Lender's interest in the Property and in the income, revenues, rents and profits arising therefrom; and (c) restrain the enforcement of or compliance with any legislation or other government enactment, rule or order that may be unconstitutional or otherwise invalid, if the enforcement of or compliance with such enactment, rule or order would impair Lender's security. All payments made or costs or expenses incurred by Lender in connection with this paragraph, including reasonable attorneys' fees and costs, whether or not suit is filed and, if filed, for all appeals, shall be secured by the Collateral and shall be immediately repaid by Borrower to Lender on demand, with interest thereon from the date incurred until the date repaid by Borrower at the same rate as provided by the Mortgage Loan. 9.5. RIGHTS OF LENDER REGARDING COLLATERAL. In addition to all other rights possessed by Lender, Lender, at its option, may from time to time after there shall have occurred an Event of Default, and so long as such Event of Default remains uncured, at its sole discretion, take the following actions: (a) Transfer all or any part of the Collateral into the name of Lender or its nominee; (b) Take control of any proceeds of any of the Collateral; (c) Extend or renew the Loan and grant releases, compromises or indulgences with respect to the Obligations, any portion thereof, any extension or renewal thereof, or any security therefor, to any obligor hereunder or thereunder; and (d) Exchange certificates or instruments representing or evidencing the Collateral for certificates or instruments of smaller or larger denominations for any purpose consistent with the terms of this Agreement. 9.6. WAIVER OF APPRAISEMENT, VALUATION, STAY, EXTENSION AND REDEMPTION LAWS. To the extent permitted by law, Borrower agrees that in the event of a Default on its part hereunder, neither Borrower nor anyone claiming by, through or under it, shall set up, claim or seek to take advantage of any appraisement, valuation, stay, extension or redemption laws now or hereafter in force, in 75 77 order to prevent or hinder the enforcement or foreclosure of any Deed of Trust or the final and absolute sale of the Property or the final and absolute possession of the Property by the purchasers in foreclosure, and Borrower, for itself and for all who may at any time claim through or under it, hereby waives to the full extent that if may lawfully do so the benefit of all such laws and any and all right to have the assets comprising the Property marshalled upon any foreclosure and Borrower agrees that the Property may be sold in its entirety. Any money collected by Lender or received by Lender following pursuit by Lender of any remedy hereunder or under any of the Loan Documents shall be applied to the payment of the compensation, expenses, costs and disbursements of the agents and attorneys of Lender, to the payment of the amounts of accrued interest and principal and any other amount due and unpaid under the Loan, and to the payment of all other Obligations, in such order as Lender may determine. 9.7. DELEGATION OF DUTIES AND RIGHTS. Lender may execute any of its duties and/or exercise any of its rights or remedies under the Loan Documents by or through its officers, directors, employees, attorneys, agents or other representatives. 9.8. LENDER NOT IN CONTROL. None of the covenants or other provisions contained in this Agreement or in any Loan Document shall give Lender the right or power to exercise control over the affairs and/or management of Borrower. 9.9. WAIVERS. The acceptance by Lender at any time and from time to time of partial payments of the Loan or performance of the Obligations shall not be deemed to be a waiver of any Event of Default then existing. No waiver by Lender of any Event of Default shall be deemed to be a waiver of any other or subsequent Event of Default. No delay or omission by Lender in exercising any right or remedy under the Loan Documents shall impair such right or remedy or be construed as a waiver thereof or an acquiescence therein, nor shall any single or partial exercise of any such right or remedy preclude other or further exercise thereof, or the exercise of any other right or remedy under the Loan Documents or otherwise. Further, except as otherwise expressly provided in this Agreement or by applicable law, Borrower and each and every surety, endorser, guarantor and other party liable for the payment or performance of all or any portion of the Obligations, severally waive notice of the occurrence of any Event of Default, presentment and demand for payment, protest, and notice of protest, notice of intention to accelerate, acceleration and nonpayment, and agree that their liability shall not be affected by any renewal or extension in the time of payment of the Loan, or by any release or change in any security for the payment or performance of the Loan, regardless of the number of such renewals, extensions, releases or changes. If Lender: (a) grants forbearance or an extension of time for the 76 78 payment of any sums secured by the Collateral; (b) takes other or additional security for the payment of the Obligations; (c) waives or does not exercise any right granted in this Agreement or any Loan Documents; (d) releases any part of the Property from the Lien in favor of Lender or otherwise changes any of the terms of this Agreement or any Loan Documents; (e) consents to the filing of any map, plat or replat of the Property; (f) consents to the granting of any easement on the Property; or (g) makes or consents to any agreement subordinating the Lender's Lien against any of the Collateral, except as otherwise expressly provided in any instrument or instruments executed by Lender, any such act or omission by Lender shall not release, discharge, modify, change or affect Borrower's original liability under this Agreement or any of the Loan Documents or otherwise, or the original liability of any maker, general partner, co-signer, endorser, surety or guarantor nor shall any such act or omission preclude Lender from exercising any right, power or privilege granted in this Agreement or any Loan Document in the event of any other concurrent or subsequent default, nor shall the Lender's Lien against any of the Collateral be altered thereby. Upon the sale or transfer by operation of law or otherwise of all or any part of the Collateral, Lender, without further notice, is authorized and empowered to deal with any such transferee as fully and to the same extent as it might deal with Borrower, without in any way releasing or discharging any of Borrower's liabilities or obligations hereunder. 9.10. CUMULATIVE RIGHTS. All rights and remedies available to Lender under the Loan Documents shall be cumulative of and in addition to all other rights and remedies granted to Lender under any of the Loan Documents, at law or in equity, whether or not the Loan is due and payable and whether or not Lender shall have instituted any suit for collection or other action in connection with the Loan Documents. 9.11. EXPENDITURES BY LENDER. Any sums expended by or on behalf of Lender pursuant to the exercise of any right or remedy provided herein, and all expenses payable by Borrower under any provision of this Agreement shall become part of the Obligations, shall be paid by Borrower to Lender upon demand and shall bear interest at the Mortgage Loan Interest Rate, or the Receivables Loan Interest Rate if the Mortgage Loan has been paid, from the date of such expenditure until the date repaid or at the Default Rate after declaration of an Event of Default. 9.12. DIMINUTION IN VALUE OF COLLATERAL. Lender shall not have any liability or responsibility whatsoever for any diminution or loss in value of any of the Collateral, specifically including that which may arise from Lender's negligence or inadvertence (other than Lender's gross negligence or willful misconduct), whether such negligence or inadvertence is the sole or concurring cause of any damage provided that Lender has treated the Collateral with the same degree of care that it treats its own notes and the 77 79 collateral pledged to and held by it from other borrowers. 9.13. DISCONTINUANCE OF PROCEEDINGS. If Lender proceeds to enforce any right or remedy under any Deed of Trust by foreclosure, entry or otherwise and such proceedings shall have been discontinued or abandoned for any reason or shall have been determined adversely to Lender, then Borrower and Lender shall be restored to their former positions and rights hereunder and all rights, powers and remedies of Lender shall continue as if no such proceeding occurred. SECTION 10 10. PARTIAL RELEASES AND FULL RELEASE 10.1 PARTIAL RELEASES. At Borrower's cost and expense, Lender agrees to cause the trustee under the Deed of Trust to execute, acknowledge and deliver from time to time, a release from the lien of the Deed of Trust encumbering the Property, in form and substance acceptable to Lender and the Title Company in their reasonable discretion, of Intervals in connection with the sale of such Intervals as permitted hereunder, upon the written request of Borrower provided that: (a) No Event of Default or Default shall exist; (b) The remaining unreleased portion of the Property complies with all representations and warranties of Borrower contained in the Loan Documents; (c) For each Interval to be released, Borrower pays to Lender, the required Release Payment which amount shall be applied to reduce the outstanding principal balance of the Mortgage Loan and the Release Fee which amount shall be a fee to Lender and not applied in reduction of the principal amount of the Mortgage Loan; (d) Borrower shall have paid all fees required under this Agreement then due; (e) All costs incident to the preparation and recording of the release documents shall be paid by Borrower; (f) Borrower shall execute such documents as Lender reasonably requests to evidence satisfaction of all conditions of the release set forth herein and shall provide Lender with copies of all documents and information reasonably requested by Lender regarding the sale of each Interval; and 78 80 (g) Borrower's escrow agent and Lender shall have agreed upon mutually acceptable escrow instructions setting forth the logistical arrangements for the release of each Interval at settlement of the sale thereof. 10.2 FULL RELEASE. Upon repayment by Borrower of all sums due under the Mortgage Loan and all obligations related to the Mortgage Loan, at Borrower's cost and expense, but without payment of any Release Payment or Release Fee, Lender agrees to cause the trustee under the Deed of Trust to execute, acknowledge and deliver, from time to time, a release from the lien of the Deed of Trust encumbering the Property, in form and substance acceptable to Lender and the Title Company in their reasonable discretion, of any Intervals upon the written request of Borrower provided that: (a) No Event of Default or Default shall exist; (b) The Receivables Loan Revolving Credit Period has not been extended; (c) The Maximum Loan Amount has not been increased; (d) Borrower shall have paid all fees required under this Agreement then due; (e) All costs incident to the preparation and recording of the release documents shall be paid by Borrower; (f) Borrower shall execute such documents as Lender reasonably requests to evidence satisfaction of all conditions of the release set forth herein and shall provide Lender with copies of all documents and information reasonably requested by Lender; and (g) Borrower's escrow agent and Lender shall have agreed upon mutually acceptable escrow instructions setting forth the logistical arrangements for the release of the Intervals. 79 81 SECTION 11 11. CERTAIN RIGHTS OF LENDER 11.1. PROTECTION OF COLLATERAL. Lender may at any time and from time to time take such actions as Lender deems necessary or appropriate to protect Lender's Liens and security interests in and to preserve the Collateral, and to establish, maintain and protect the enforceability of Lender's rights with respect thereto, all at the expense of Borrower. Borrower agrees to cooperate fully with all of Lender's efforts to preserve the Collateral and Lender's Liens, security interests and rights and will take such actions to preserve the Collateral and Lender's Liens, security interests and rights as Lender may direct, including, without limitation, by promptly paying upon Lender's demand therefor, all documentary stamp taxes or other taxes, other than income, franchise or similar taxes, that may be or may become due in respect of any of the Collateral. All of Lender's expenses of preserving the Collateral and its liens and security interests and rights therein shall be added to the Loan. 11.2. PERFORMANCE BY LENDER. If Borrower fails to perform any agreement contained herein, Lender may, after 10 days after notice by Lender to Borrower, itself perform, or cause the performance of, such agreement, and the expenses of Lender incurred in connection therewith shall be payable by Borrower under Section 11.5 below. In no event, however, shall Lender have any obligation or duties whatsoever to perform any covenant or agreement of Borrower contained herein or in any of the Loan Documents, Timeshare Documents or Operating Contracts, and any such performance by Lender shall be wholly discretionary with Lender. The performance by Lender, of any agreement or covenant of Borrower on any occasion shall not give rise to any duty on the part of Lender to perform any such agreements or covenants on any other occasion or at any time. In addition, Borrower acknowledges that Lender shall not at any time or under any circumstances whatsoever have any duty to Borrower or to any third party to exercise any of Lender's rights or remedies hereunder. 11.3. NO LIABILITY OF LENDER. Neither the acceptance of this Agreement by Lender, nor the exercise of any rights hereunder by Lender, shall be construed in any way as an assumption by Lender of any obligations, responsibilities or duties of Borrower arising in connection with the Property or under the Timeshare Documents or Timeshare Act, or under any of the Operating Contracts, or in connection with any other business of Borrower, or the Collateral, or otherwise bind Lender to the performance of any obligations with respect to the Property or the Collateral; it being expressly understood that Lender shall not be obligated to perform, observe or discharge any obligation, responsibility, duty, or liability of Borrower with respect to the Property or any of the Collateral, or under any of the Timeshare Documents, the Timeshare Act or under 80 82 any of the Operating Contracts, including, but not limited to, appearing in or defending any action, expending any money or incurring any expense in connection therewith, except for Lender's gross negligence or willful misconduct. Without limitation of the foregoing, neither this Agreement, any action or actions on the part of Lender taken hereunder, nor the acquisition of the Pledged Notes Receivable and the Assigned Deeds of Trust by Lender prior to or following the occurrence of an Event of Default shall constitute an assumption by Lender of any obligations of Borrower with respect to the Property, the Collateral, the Pledged Notes Receivable, the Assigned Deeds of Trust or any documents or instruments executed in connection therewith, and Borrower shall continue to be liable for all of its obligations thereunder or with respect thereto. Borrower and Guarantor, jointly and severally, agree to indemnify, protect, defend and hold Lender harmless from and against any and all claims, demands, causes of action, losses, damages, liabilities, suits, costs and expenses, including, without limitation, attorneys' fees and court costs, asserted against or incurred by Lender by reason of, arising out of, or connected in any way with: (a) any failure of Borrower or Guarantor to perform any of its covenants or obligations with respect to the Property, the Collateral or to the Purchasers of any of the Intervals; (b) a breach of any certification, representation, warranty or covenant of Borrower or Guarantor set forth in any of the Loan Documents; (c) the ownership of the Pledged Notes Receivable, the Assigned Deeds of Trust and the rights, titles and interests assigned hereby, or intended so to be; (d) the debtor-creditor relationships between Borrower on the one hand and the Purchasers or Lender, as the case may be, on the other; or (e) the Pledged Notes Receivable, the Assigned Deeds of Trust or the operation of the Property or sale of Intervals, except for Lender's gross negligence or willful misconduct. The obligations of Borrower and Guarantor to indemnify, protect, defend and hold Lender harmless as provided in this Agreement are absolute, unconditional, present and continuing, and shall not be dependent upon or affected by the genuineness, validity, regularity or enforceability of any claim, demand or suit from which Lender is indemnified. The indemnity provisions in this Section 11.3 shall survive the satisfaction of the Obligations and termination of this Agreement, and remain binding and enforceable against the Borrower and Guarantor, and Borrower and Guarantor hereby waive, except as otherwise specifically provided herein, all notices with respect to any losses, damages, liabilities, suits, costs and expenses, and all other demands whatsoever hereby indemnified, and agrees that their obligations under this Agreement shall not be affected by any circumstances, whether or not referred to above, which might otherwise constitute legal or equitable discharges of its obligations hereunder. If a court of competent jurisdiction should determine that Borrower or Guarantor is entitled to recover damages from Lender for any reason or upon any cause, claim or counterclaim, in connection with the Loan or the transactions provided for or contemplated pursuant to this 81 83 Agreement or the other Loan Documents, Borrower and Guarantor stipulate and agree that any such damages or awards shall be limited to the amount of the Commitment Fee (or any portion thereof actually paid by Borrower to Lender) and shall not include consequential or punitive damages. 11.4. RIGHT TO DEFEND ACTION AFFECTING SECURITY. Lender may, at Borrower's expense, appear in and defend any action or proceeding at law or in equity which Lender in good faith believes may affect the value of the Collateral, the Improvements, the security interests granted under this Agreement, including without limitation the security interests in the Pledged Notes Receivables and the Assigned Deeds of Trust, or Lender's rights under any of the Loan Documents. 11.5. EXPENSES. All expenses payable by Borrower under any provision of this Agreement shall be part of the Obligations of the Borrower and shall be paid by Borrower to Lender, upon demand, and shall bear interest at the Mortgage Loan Interest Rate, or at the Receivables Loan Interest Rate if the Mortgage Loan has been paid, from the date of demand until repaid by Borrower or at the Default Rate after the declaration of an Event of Default. 11.6. LENDER'S RIGHT OF SET-OFF. Upon an Event of Default, Lender shall have the right to set-off against any Collateral any Obligations then due and unpaid by Borrower. 11.7. NO WAIVER. No failure or delay on the part of Lender in exercising any right, remedy or power under this Agreement or in giving or insisting upon strict performance by Borrower or Guarantor hereunder or in giving notice hereunder shall operate as a waiver of the same or any other power or right, and no single or partial exercise of any such power or right shall preclude any other or further exercise thereof or the exercise of any other such power or right. Lender, notwithstanding any such failure, shall have the right thereafter to insist upon the strict performance by Borrower or Guarantor of any and all of the terms and provisions of this Agreement to be performed by Borrower or Guarantor. The collection and application of proceeds, the entering and taking possession of the Collateral, and the exercise of the rights of Lender contained in the Loan Documents and this Agreement shall not cure or waive any default, or affect any notice of default, or invalidate any acts done pursuant to such notice. No waiver by Lender of any breach or default of or by any party hereunder shall be deemed to alter or affect Lender's rights hereunder with respect to any prior or subsequent default. 11.8. Right of Lender to Extend Time of Payment, Substitute, Release Security, Etc. Without affecting the liability of any Person including without limitation, any Purchasers, if such Purchasers have any such liability, for the payment of any of the Obligations or without affecting or impairing Lender's Lien on the 82 84 Collateral, or the remainder thereof, as security for the full amount of the Loan unpaid and the Obligations, except to the extent Lender has specifically agreed otherwise, Lender may from time to time, without notice: (a) release any Person liable for the payment of any part of the Loan; (b) extend the time or otherwise alter the terms of payment of any part of the Loan; (c) accept additional security for the Obligations of any kind, including deeds of trust or mortgages and security agreements; (d) alter, substitute or release any property securing any part of the Obligations; (e) realize upon any collateral for the payment of all or any portion of the Loan in such order and manner as it may deem fit; or (f) join in any subordination or other agreement affecting this Agreement or the lien or charge thereof. 11.9. ASSIGNMENT OF LENDER'S INTEREST. Lender shall have the right to assign the Loan and all or any portion of its rights in or pursuant to this Agreement or any of the Loan Documents to any subsequent holder or holders of the Mortgage Loan, the Receivables Loan or the Obligations, but no such assignment shall relieve Lender from the primary obligation to make any Advance to which Borrower is entitled hereunder. 11.10. NOTICE TO PURCHASER. Borrower authorizes the Lender (but Lender shall not be obligated) to communicate at any time and from time to time with any Purchaser or any other Person primarily or secondarily liable under a Pledged Note Receivable with regard to the Lien of the Lender thereon and any other matter relating thereto, and by no later than the Closing Date, Borrower shall deliver to Lender a notification to the Purchasers executed in blank by the Borrower and in form acceptable to Lender, pursuant to which the Purchasers (or other obligors) may be directed to remit all payments in respect of the Collateral as Lender may require. 11.11. COLLECTION OF THE PLEDGED NOTES RECEIVABLE. Borrower hereby directs and authorizes each party liable for the payment of the Pledged Notes Receivable, and by no later than the date on which the applicable Receivables Loan Advance is to be made, shall direct in writing each such party, to pay each installment thereon pursuant to the Lockbox Agreement, unless and until directed otherwise by written notice from Lender or, at Lender's direction, from Borrower, after which such parties are and shall be directed to make all further payments on the Pledged Notes Receivable in accordance with the directions of Lender. Following the occurrence of an Event of Default, Lender shall have the right to require that all payments becoming due under the Pledged Notes Receivable be paid directly to Lender, and Lender is hereby authorized to receive, collect, hold and apply the same in accordance with the provisions of this Agreement. In the event that following the occurrence of an Event of Default, Lender or Lockbox Agent does not receive any installment of principal or interest due and payable under any of the Pledged Notes Receivable on or prior to the date upon which such installment becomes due, 83 85 Lender may, at its election (but without any obligation to do so), give (or cause the Lockbox Agent to give) notice of such default to the defaulting party or parties, and Lender shall have the right (but not the obligation), subject to the terms of such Pledged Notes Receivable, to accelerate payment of the unpaid balance of any of the Pledged Notes Receivable in default and to foreclose each of the Assigned Deeds of Trust securing the payment thereof, and to enforce any other remedies available to the holder of such Pledged Notes Receivable with respect to such default. Borrower hereby further authorizes, directs and empowers Lender (or any other Person as may be designated by Lender in writing) to collect and receive all checks and drafts evidencing such payments and to endorse such checks or drafts in the name of Borrower and upon such endorsements, to collect and receive the money therefor. The right to endorse checks and drafts granted pursuant to the preceding sentence is irrevocable by Borrower, and the banks or banks paying such checks or drafts upon such endorsements, as well as the signers of the same, shall be as fully protected as though the checks or drafts have been endorsed by Borrower. 11.12. POWER OF ATTORNEY. Borrower does hereby irrevocably constitute and appoint Lender as Borrower's true and lawful agent and attorney-in-fact, with full power of substitution, for Borrower and in Borrower's name, place and stead, or otherwise, to: (a) endorse any checks or drafts payable to Borrower, with respect to the Collateral, in the name of Borrower and in favor of Lender; (b) to demand and receive from time to time any and all property, rights, titles, interests and liens hereby sold, assigned and transferred, or intended so to be, and to give receipts for same; (c) from time to time to institute and prosecute in Lender's own name any and all proceedings at law, in equity, or otherwise, that Lender may deem proper in order to collect, assert or enforce any claim, right or title, of any kind, in and to the property, rights, titles, interests and liens hereby sold, assigned or transferred, or intended so to be, and to defend and compromise any and all actions, suits or proceedings in respect of any of the said property, rights, titles, interests and liens; (d) upon an Event of Default to change the Borrower's post office mailing address with respect to the Collateral; and (e) generally to do all and any such acts and things in relation to the Collateral as Lender shall in good faith deem advisable. Borrower hereby declares that the appointment made and the powers granted pursuant to this Section 11.12 are coupled with an interest and are and shall be irrevocable by Borrower in any manner, or for any reason, unless and until the Obligations are paid in full or a release of the same is executed by Lender and duly recorded in the appropriate public records of Clark County, Nevada. 11.13. RELIEF FROM AUTOMATIC STAY, ETC. To the fullest extent permitted by law, in the event Borrower or Guarantor shall make application for or seek relief or protection under the federal bankruptcy code ("Bankruptcy Code") or other Debtor Relief Laws, or 84 86 in the event that any involuntary petition is filed against the Borrower or Guarantor under such Code or other Debtor Relief Laws, and not dismissed with prejudice within 45 days, the automatic stay provisions of Section 362 of the Bankruptcy Code are hereby modified as to Lender to the extent necessary to implement the provisions hereof permitting set-off and the filing of financing statements or other instruments or documents; and Lender shall automatically and without demand or notice (each of which is hereby waived) be entitled to immediate relief from any automatic stay imposed by Section 362 of the Bankruptcy Code or otherwise, on or against the exercise of the rights and remedies otherwise available to Lender as provided in the Loan Documents. In addition, in the event relief is sought by or against Guarantor under the Bankruptcy Code, such Guarantor agrees to not seek, directly or indirectly, in any ensuing bankruptcy proceeding, any extension of the exclusivity period otherwise available to a debtor under the Bankruptcy Code, including, without limitation, the exclusivity period provided for under Section 1121(b) of the Bankruptcy Code. Guarantor agree not to contest the validity or enforceability of this Section. 11.14. INVESTIGATIONS AND INQUIRIES. Borrower hereby authorizes Lender to conduct such investigations and inquiries as to credit, operations, the Guarantor, the Property and Collateral as shall be necessary or desirable in connection with monitoring the Loan, and all such Persons of whom Lender may make such inquiry are empowered to cooperate with, and to provide requested information to, Lender. 85 87 SECTION 12 12. TERM OF AGREEMENT This Agreement shall continue in full force and effect and the security interests granted hereby and the duties, covenants and liabilities of the Borrower and Guarantor hereunder and all the terms, conditions and provisions hereof relating thereto shall continue to be fully operative until all of the Obligations and all other obligations to Lender secured by the Collateral have been satisfied in full, Lender has no further obligation to make Advances hereunder and Borrower and Guarantor have provided to Lender, an executed general release of any and all claims and matters, in a form satisfactory to Lender and containing such covenants and provisions as are acceptable to Lender, in Lender's sole discretion. The Borrower expressly agrees that if either the Borrower or the Guarantor make a payment to the Lender, which payment or any part thereof is subsequently invalidated, declared to be fraudulent or preferential, or otherwise required to be repaid to a trustee, receiver or any other party under any Debtor Relief Laws, state or federal law, common law or equitable cause, then to the extent of such repayment, the Obligations or any part thereof intended to be satisfied and the Liens provided for hereunder securing the same shall be revived and continued in full force and effect as if said payment had not been made. SECTION 13 13. MISCELLANEOUS 13.1. NOTICES. All notices, requests and other communications to either party hereunder shall be in writing and shall be given to such party at its address set forth below or at such other address as such party may hereafter specify for the purpose of notice to Lender or Borrower. Each such notice, request or other communication shall be effective: (a) if given by mail, five (5) days after such notice is deposited in the United States Mail with first class postage prepaid, addressed as aforesaid, provided that such mailing is by registered or certified mail, return receipt requested or the date of receipt, if earlier; (b) if given by overnight delivery, the next Business Day after being deposited with a nationally recognized overnight delivery service such as Federal Express or Airborne Express with all fees and charges prepaid, addressed as provided below, or the date of receipt if earlier; or (c) if given by any other means, when delivered at the address specified in this Section 13.1. 86 88 IF TO BORROWER: Preferred Equities Corporation, PEC Building, 4310 Paradise Road, Las Vegas, Nevada 89109, Attention: Frederick H. Conte, Executive Vice President, Telephone: (702) 737-3700, Facsimile: (702) 369-4398, with a copy to Jerome J. Cohen, President, 1125 N.E. 125th Street, Suite 206, North Miami, Florida, 33161, Telephone: (305) 895-6500, Facsimile: (305) 899-1824, with a further copy to Mego Financial Corp., 4310 Paradise Road, Las Vegas, Nevada 89109, Attention: Frederick H. Conte, Telephone: (702) 737-3700, Facsimile: (702) 369-4398, or at such other address as shall be designated by Borrower by written notice to the Lender. IF TO LENDER: Litchfield Financial Corporation, POB 488, Williamstown, Massachusetts 01267 or to 789 Main Road, Stamford, Vermont 05352 Attention Joseph S. Weingarten, Senior Vice President, Telephone: (802) 694-1200, Facsimile: (802) 694-1552. 13.2. SURVIVAL. All representations, warranties, covenants and agreements made by Borrower and Guarantor herein, in the other Loan Documents or in any other agreement, document, instrument or certificate delivered by or on behalf of Borrower or Guarantor under or pursuant to the Loan Documents shall be considered to have been relied upon by Lender and shall survive the delivery to Lender of such Loan Documents (and each part thereof), regardless of any investigation made by or on behalf of Lender. 13.3. GOVERNING LAW. THIS AGREEMENT AND THE OTHER LOAN DOCUMENTS (EXCEPT AS MAY BE EXPRESSLY PROVIDED THEREIN TO THE CONTRARY) SHALL BE GOVERNED BY AND CONSTRUED IN ACCORDANCE WITH THE LAWS OF THE COMMONWEALTH OF MASSACHUSETTS, EXCLUSIVE OF ITS CHOICE OF LAWS PRINCIPLES; PROVIDED, HOWEVER, THAT MATTERS RELATED TO THE RIGHTS AND REMEDIES OF LENDER WITH RESPECT TO ANY REAL PROPERTY SHALL BE GOVERNED BY THE LAW OF THE STATE IN WHICH THE REAL PROPERTY IS LOCATED. 13.4. JURY TRIAL/JURISDICTION. Borrower hereby waives the right to trial by jury in any litigation arising out of, relating to, or connected with this Agreement, it being acknowledged by Borrower that Borrower is a professional developer engaged and knowledgeable in sophisticated commercial real estate transactions and that Borrower makes this waiver of trial by jury knowingly and voluntarily and only after consultation with sophisticated legal counsel of Borrower's choosing. Borrower hereby consents to the non-exclusive personal jurisdiction of the federal and state courts located in Massachusetts in any and all actions between the Borrower and the Lender arising under or in connection with this Agreement, the Loan or any of the Loan Documents. 13.5. LIMITATION ON INTEREST. Lender and Borrower intend to comply at all times with applicable usury laws. All agreements between Lender and Borrower, whether now existing or hereafter arising and whether written or oral, are hereby limited so that in 87 89 no contingency, whether by reason of demand or acceleration of the maturity of the Loan or otherwise, shall the interest contracted for, charged, received, paid or agreed to be paid to Lender exceed the highest lawful rate permissible under applicable usury laws. If, from any circumstance whatsoever fulfillment of any provision hereof, of the Mortgage Loan, the Receivables Loan or of any other Loan Documents shall involve transcending the limit of such validity prescribed by any law which a court of competent jurisdiction may deem applicable hereto, then ipso facto, the obligation to be fulfilled shall be reduced to the limit of such validity; and if from any circumstance Lender shall ever receive anything of value deemed interest by applicable law which would exceed the highest lawful rate, such amount which would be excessive interest shall be applied to the reduction of the principal of the Loan and not to the payment of interest, or if such excessive interest exceeds the unpaid balance of principal of the Loan, such excess shall be refunded to Borrower. All interest paid or agreed to be paid to Lender shall, to the extent permitted by applicable law, be amortized, prorated, allocated and spread throughout the full period until payment in full of the principal so that the interest on the Loan for such full period shall not exceed the highest lawful rate. Borrower agrees that in determining whether or not any interest payment under the Loan Documents exceeds the highest lawful rate, any non-principal payment (except payments specifically described in the Loan Documents as "interest") including without limitation, prepayment fees and late charges, shall to the maximum extent not prohibited by law, be an expense, fee, premium or penalty rather than interest. Lender hereby expressly disclaims any intent to contract for, charge or receive interest in an amount which exceeds the highest lawful rate. The provisions of the Mortgage Loan, the Receivables Loan, this Agreement, and all other Loan Documents are hereby modified to the extent necessary to conform with the limitations and provisions of this Section, and this Section shall govern over all other provisions in any document or agreement now or hereafter existing. This Section shall never be superseded or waived unless there is a written document executed by the Lender and the Borrower, expressly declaring the usury limitation of this Agreement to be null and void, and no other method or language shall be effective to supersede or waive this paragraph. 13.6. INVALID PROVISIONS. If any provision of this Agreement or any of the other Loan Documents is held to be illegal, invalid or unenforceable under present or future laws effective during the term thereof, such provision shall be fully severable, this Agreement and the other Loan Documents shall be construed and enforced as if such illegal, invalid or unenforceable provision had never comprised a part hereof or thereof, and the remaining provisions hereof or thereof shall remain in full force and effect and shall not be affected by the illegal, invalid or unenforceable provision or by its severance therefrom. Furthermore, in lieu of such illegal, invalid or unenforceable provision there shall be 88 90 added automatically as a part of this Agreement and/or the Loan Documents (as the case may be) a provision as similar in terms to such illegal, invalid or unenforceable provision as may be possible and be legal, valid and enforceable. 13.7. SUCCESSORS AND ASSIGNS. This Agreement and the other Loan Documents shall be binding upon and inure to the benefit of Borrower, the Guarantor and Lender and their respective successors and assigns; provided that Borrower and Guarantor may not transfer or assign any of their rights or obligations under this Agreement, the Commitment or the other Loan Documents without the prior written consent of Lender and provided further that Lender shall not be able to assign its obligation, without retaining the primary responsibility, to make Advances to Borrower under this Agreement. This Agreement and the transactions provided for or contemplated hereunder or under any of the Loan Documents are intended solely for the benefit of the parties hereto. No third party shall have any rights or derive any benefits under or with respect to this Agreement, the Commitment or the other Loan Documents except as provided in advance in a writing signed on behalf of Lender and the Borrower. No Person other than the Borrower, shall have standing to require satisfaction of such conditions in accordance with their terms or be entitled to assume that Lender will refuse to make advances in the absence of strict compliance with any or all thereof, and no other Person, other than the Borrower, under any circumstance, shall be deemed to be a beneficiary of such conditions, any and all of which Lender freely may waive in whole or in part at any time if, in its sole discretion, it deems it desirable to do so. Borrower agrees to and shall indemnify Lender from any liability, claim or loss and attorneys' fees and costs resulting from the disbursement of the Loan proceeds or from the condition of the Property, whether related to the qualify of construction or otherwise and whether arising during or after the term of the Loan. This provision shall survive the repayment of the Loan and shall continue in full force and effect so long as the possibility of such liability, claim or loss exists. 13.8. AMENDMENT. This Agreement may not be amended or modified, and no term or provision hereof may be waived, except by written instrument signed by the parties hereto. 13.9. COUNTERPARTS; EFFECTIVENESS. This Agreement may be signed in any number of counterparts, each of which shall be an original, with the same effect as if the signature thereto and hereto were on the same instrument. This Agreement shall become effective upon Lender's receipt of one or more counterparts hereof signed by Borrower, Guarantor and Lender. 13.10. LENDER NOT FIDUCIARY. The relationship between Borrower and Lender is solely that of debtor and creditor, and Lender has no fiduciary or other special relationship with Borrower 89 91 or Guarantor, and no term or provision of any of the Loan Documents shall be construed so as to deem the relationship between Borrower and Lender to be other than that of debtor and creditor. Nothing herein contained shall be construed to create a partnership or joint venture between Borrower and Lender, and the parties hereby acknowledge that no such relationship exists between them. 13.11. RETURN OF NOTES RECEIVABLE. In the event Borrower complies with its Obligations under this Agreement with respect to Pledged Notes Receivable that cease to be Eligible Notes Receivable, and Borrower thereafter desires to enforce such ineligible Note Receivable against the Purchaser thereof, then provided that no Event of Default has occurred which has not been cured to Lender's reasonable satisfaction (as evidenced by a written acceptance of such cure executed by Lender), and no Default has occurred, then within fifteen (15) days after its receipt of a written request from Borrower, Lender shall endorse the ineligible Note Receivable "Pay to the order of Preferred Equities Corporation without recourse" and deliver such ineligible Note Receivable and any related Collateral to Borrower. In the event Borrower complies with its obligations under Section 8.1(v) with respect to the replacement of Pledged Notes Receivables, then provided that no Event of Default has occurred which has not been cured to Lender's reasonable satisfaction (as evidenced by a written acceptance of such cure executed by Lender), and no Default has occurred, then within fifteen (15) days after its receipt of a written request from Borrower, Lender shall endorse the replaced Note Receivable "Pay to the order of preferred Equities Corporation without recourse" and deliver such replaced Note Receivable and any related Collateral to Borrower. In the event Borrower complies with its Obligations under this Agreement with respect to offering to Lender the first opportunity to purchase Pledged Notes Receivable, in bulk, provided that Lender has not exercised such right or has not consummated said purchase within the time periods provided in Section 2.6(b)(iii) and provided further that no Event of Default has occurred which has not been cured to Lender's reasonable satisfaction (as evidenced by a written acceptance of such cure executed by Lender) then within fifteen (15) days after its receipt of a written request from Borrower and any required fee set forth in Section 2.6(b)(iii) and the amount of any Advances outstanding against all of the Pledged Notes Receivable to be released, Lender shall endorse the Pledged Notes Receivable which are part of such bulk sale "Pay to the order of Preferred Equities Corporation without recourse" and deliver such Pledged Notes Receivable and any related Collateral to Borrower. In the event Borrower complies with its Obligations under this Agreement and there are Pledged Notes Receivable in excess of the amount necessary to support, as Collateral, the Receivables Loan 90 92 and provided further that no Event of Default has occurred which has not been cured to Lender's reasonable satisfaction (as evidenced by a written acceptance of such cure executed by Lender) then not more frequently than once each Fiscal Quarter or when the unpaid principal of Pledged Notes Receivable is in excess of the amounts necessary to support, as Collateral, the Receivable Loan in excess of $100,000, within fifteen (15) days after its receipt of a written request from Borrower, Lender shall endorse those of the Pledged Notes Receivable which are in excess of the amount of Pledged Notes Collateral necessary, in Lender's reasonable discretion, to support the Receivables Loan "Pay to the order of Preferred Equities Corporation without recourse" and deliver such Pledged Notes Receivable and any related Collateral to Borrower. In the event that all Obligations hereunder are fully satisfied, then within fifteen (15) days thereafter, Lender shall endorse the Pledged Notes Receivable "Pay to the order of Preferred Equities Corporation without recourse" and deliver such Pledged Notes Receivable, together with any other nonrecourse Collateral reassignment documents requested and prepared by Borrower, at Borrower's sole cost and expense. In addition, if requested by Borrower in its written request, Lender shall execute and deliver to Borrower UCC-3 termination statements covering the Note Receivable being returned to Borrower, provided that such termination statements are limited to the specific Notes Receivable being released and are prepared by Borrower at Borrower's sole cost and expense. 13.12. ACCOUNTING PRINCIPLES. Where the character or amount of any asset or liability or item of income or expense is required to be determined or any consolidation or other accounting computation is required to be made for the purposes of this Agreement, the same shall be determined or made in accordance with GAAP consistently applied at the time in effect, to the extent applicable, except where such principles are inconsistent with the requirements of this Agreement. 13.13. TOTAL AGREEMENT. This Agreement and the other Loan Documents, including the Exhibits and Schedules to them, is the entire agreement between the parties relating to the subject matter hereof, incorporates or rescinds all prior agreements and understandings between the parties hereto relating to the subject matter hereof, cannot be changed or terminated orally or by course of conduct, and shall be deemed effective as of the date it is accepted by the Lender at the offices set forth above. 13.14. LITIGATION. TO THE FULLEST EXTENT NOT PROHIBITED BY APPLICABLE LAW WHICH CANNOT BE WAIVED, EACH OF THE BORROWER, THE GUARANTOR AND LENDER HEREBY KNOWINGLY, VOLUNTARILY, INTENTIONALLY AND IRREVOCABLY WAIVES ANY AND ALL RIGHT TO A TRIAL BY JURY IN ANY ACTION OR PROCEEDING TO ENFORCE OR DEFEND OR CLARIFY ANY RIGHT, POWER, REMEDY OR DEFENSE ARISING OUT OF OR RELATED TO THIS 91 93 AGREEMENT, THE OTHER LOAN DOCUMENTS, OR THE TRANSACTIONS CONTEMPLATED HEREIN OR THEREIN, WHETHER SOUNDING IN TORT OR CONTRACT OR OTHERWISE, OR WITH RESPECT TO ANY COURSE OF CONDUCT, COURSE OF DEALING, STATEMENTS (WHETHER VERBAL OR WRITTEN) OR ACTIONS OF ANY PARTY; AND EACH AGREES THAT ANY SUCH ACTION OR PROCEEDING SHALL BE TRIED BEFORE A JUDGE AND NOT BEFORE A JURY. EACH OF THE BORROWER, GUARANTOR AND LENDER FURTHER WAIVES ANY RIGHT TO SEEK TO CONSOLIDATE ANY SUCH LITIGATION IN WHICH A JURY TRIAL HAS BEEN WAIVED WITH ANY OTHER LITIGATION IN WHICH A JURY TRIAL CANNOT OR HAS NOT BEEN WAIVED. FURTHER, THE BORROWER AND GUARANTOR HEREBY CERTIFY THAT NO REPRESENTATIVE OR AGENT OF LENDER, NOR LENDER'S COUNSEL, HAS REPRESENTED, EXPRESSLY OR OTHERWISE, THAT LENDER WOULD NOT, IN THE EVENT OF SUCH LITIGATION, SEEK TO ENFORCE THIS WAIVER OF RIGHT TO JURY TRIAL PROVISION. THE BORROWER AND THE GUARANTOR ACKNOWLEDGE THAT THE PROVISIONS OF THIS SECTION ARE A MATERIAL INDUCEMENT TO LENDER'S ACCEPTANCE OF THIS AGREEMENT AND THE OTHER LOAN DOCUMENTS. The waiver and stipulations of the Borrower, the Guarantor, and Lender in this Section 13.14 shall survive the final payment or performance of all of the Obligations of the Borrower and all other obligations secured by the Collateral and the resulting termination of this Agreement. 13.15. SUBMISSIONS. All documents, agreements, reports, surveys, appraisals, insurance, financial information or other submissions (collectively, the "Submissions") required under the Loan Documents shall be in form and content reasonably satisfactory to Lender and performed at Borrower's expense. Lender shall have the prior right of approval of any Person responsible for preparing each Submission (a "Preparer") and may reject any Submissions if Lender believes in its reasonable opinion that the experience, skill, reputation or other aspect of the Preparer is unsatisfactory in any respect. All reports and appraisals related to the Property hereafter required pursuant to the Loan Documents shall be addressed to Lender and include the following language: "The undersigned acknowledges that Litchfield Financial Corporation is relying on the within information in connection with its Advances to Borrower on the Property." 13.16. INCORPORATION OF EXHIBITS. This Agreement, together with all Exhibits and Schedules hereto, constitute one document and agreement which is referred to herein by the use of the defined term Agreement. Such Exhibits and Schedules are incorporated herein as to fully set out in this Agreement. The definitions contained in any part of this Agreement shall apply to all parts of this Agreement. 13.17. CONSENT TO ADVERTISING AND PUBLICITY OF TIMESHARE DOCUMENTS. The Borrower and Guarantor agree that the Lender may 92 94 issue and disseminate to the public information describing the credit accommodation entered into pursuant to this Agreement, including the names and addresses of Borrower, the Guarantor and any subsidiaries and Affiliates, the amount, interest rate, maturity, collateral, and a general description of the Borrower's business, upon consent of the Borrower which shall not be unreasonably withheld. 13.18. DIRECTLY OR INDIRECTLY. Where any provision in the Agreement refers to action to be taken by any Person, or which such Person is prohibited from taking, such provisions shall be applicable whether such action is taken directly or indirectly by such Person. 13.19. HEADINGS. Section headings have been inserted in the Agreement as a matter of convenience of reference only; such section headings are not a part of the Agreement and shall not be used in the interpretation of this Agreement. 13.20. GENDER. Words of any gender in this Agreement shall include each other gender where appropriate. 13.21. TIME. Time is of the essence of this Agreement. 13.22. CONFLICT. The provisions of this Agreement shall control in the event of any conflict among it, the Commitment and any other Loan Document. 13.23. LENDER RECORDS AND LOAN ACCOUNT. Lender shall maintain an account on its books in the name of Borrower (the "Loan Account") on which Borrower will be charged with all Advances, including the Mortgage Loan, and all other sums due from Borrower to Lender or advanced by Lender for Borrower's account, including, accrued interest, expenses, and any other Obligations of Borrower. The Loan Account will be credited with all payments received by Lender from Borrower or for Borrower's account. Lender shall render statements regarding the Loan Account to Borrower, including principal, interest, fees, and including an itemization of all charges and expenses constituting Loan Costs owing, and such statements shall be conclusively presumed to be correct and accurate and constitute an account stated between Borrower and Lender unless, within 30 days after receipt thereof by Borrower, Borrower shall deliver to Lender written objection thereto describing the error or errors contained in any such statements. 13.24. DIVISION. If the Division requires changes to the Loan Documents with respect to insurance, condemnation or releases to protect Purchasers and such modifications would not materially adversely affect Lender's rights hereunder, Lender agrees to so modify the Loan Documents. 93 95 IN WITNESS WHEREOF, Borrower, Lender and the Guarantor have caused this Agreement to be duly executed and delivered effective as of the date first above written. BORROWER: PREFERRED EQUITIES CORPORATION, a Nevada corporation By: /s/ RICHARD L. RODRIGUEZ --------------------------------------------------- Name/Title: Richard L. Rodriguez, Vice President [CORPORATE SEAL] LENDER: LITCHFIELD FINANCIAL CORPORATION, a Massachusetts corporation By: Name/Title: GUARANTOR: MEGO FINANCIAL CORP., a New York corporation By: /s/ JON A. JOSEPH --------------------------------------------------- Name/Title: Jon A. Joseph, Vice President [SEAL] 94 96 IN WITNESS WHEREOF, Borrower, Lender and the Guarantor have caused this Agreement to be duly executed and delivered effective as of the date first above written. BORROWER: PREFERRED EQUITIES CORPORATION, a Nevada corporation By: /s/ RICHARD L. RODRIGUEZ --------------------------------------------------- Name/Title: Richard L. Rodriguez, Vice President [CORPORATE SEAL] LENDER: LITCHFIELD FINANCIAL CORPORATION, a Massachusetts corporation By: /s/ JOSEPH S. WEINGARTEN ---------------------------------------------------- Name/Title: Joseph S. Weingarten, Senior Vice President GUARANTOR: MEGO FINANCIAL CORP., a New York corporation By: /s/ JON A. JOSEPH --------------------------------------------------- Name/Title: Jon A. Joseph Vice President [SEAL] 94 97 IN WITNESS WHEREOF, Borrower, Lender and the Guarantor have caused this Agreement to be duly executed and delivered effective as of the date first above written. BORROWER: PREFERRED EQUITIES CORPORATION, a Nevada corporation By: /s/ RICHARD L. RODRIGUEZ --------------------------------------------------- Name/Title: Richard L. Rodriguez, Vice President [CORPORATE SEAL] LENDER: LITCHFIELD FINANCIAL CORPORATION, a Massachusetts corporation By: Name/Title: GUARANTOR: MEGO FINANCIAL CORP., a New York corporation By: /s/ JON A. JOSEPH --------------------------------------------------- Name/Title: Jon A. Joseph, Vice President [SEAL] 94 98 EXHIBIT A TO LOAN AND SECURITY AGREEMENT LEGAL DESCRIPTION OF PROPERTY An undivided /5202 interest in that portion of the Southwest Quarter (SW 1/4) of Section 16, Township 21 South, Range 61 East, M.D.B.&M., and being a portion of Block four (4) of Flamingo Estates, as shown by map thereof on File in Book 5 of Plats, Page 22, in the Office of the County Recorder of Clark County, Nevada, described as Lots one (1) and two (2), as shown by Parcel Map in File 70, Page 30 recorded September 19, 1991 as Document No. 00581 in Book 910919 of Official Records, Clark County, Nevada; Excepting therefrom all gas and oil rights that now exist or may be developed upon said land as reserved by Rose Rabin, in Deed recorded February 18, 1952 as Document No. 381100, in the Office of the County Recorder of Clark County, Nevada, and subsequently conveyed to Harry Cobb, by Deed recorded March 25, 1957 as Document No. 102052 of Official Records, Clark County Nevada 99 EXHIBIT B TO LOAN AND SECURITY AGREEMENT LITIGATION 96 100 LITIGATION 1. JACKSON v. CENTRAL NEVADA UTILITIES COMPANY & PREFERRED EQUITIES CORPORATION In August 1991, Frederick and Lucille Jackson filed an action in the Nye County, Nevada, Judicial Court, Case No. 11885, against Central Nevada Utilities Company and Preferred Equities Corporation for damages alleged to have resulted from sewage backing up into the Plaintiffs' home. The suit alleges that CNUC is the alter ego of PEC and requests damages in excess of $10,000 for alleged damages to the Plaintiffs' residence, in excess of $10,000 to the contents of the Plaintiffs' residence, punitive damages in excess of $10,000, diminution in value of the residence, storage charges, mental pain and suffering and costs and attorney fees. The suit alleges gross negligence, trespass and absolute liability for operation of an inherently dangerous instrumentality. The case has been accepted by Company's insurance carrier for defense, subject to the limits of the policy. The Company feels the case is fully insured and will not have a material adverse effect on the business or financial condition of the Company. 2. WILLIAM BRELIANT v. PREFERRED EQUITIES CORPORATION District Court, Clark County, Nevada Case No. A281761, filed February 22, 1990 The complaint requests a reformation of an easement for parking on property adjacent to the Company's offices in Las Vegas, removal of an alleged encroachment, to require rental for parking pursuant to the easement, and for compensation for security guard expenses. The Court granted PEC's motion to dismiss the case based on the pleadings and arguments of counsel. The Plaintiffs filed an appeal. They filed a new lawsuit based on an alleged abuse of the easement. The new lawsuit claims overuse of the easement, requests reformation of the easements, an injunction prohibiting overuse of the easement, damages in excess of $10,000, attorney's fees and costs. Agreement has been reached to dismiss the second suit after entry of a final, nonappealable decision has been entered in the first case. The Supreme Court reversed the dismissal of the initial case and remanded it for trial. The second case was stayed pending a final disposition of the first case. Trial was held during November 1994. A decision favorable to the Company was issued and appealed by the Plaintiff. The Supreme Court of Nevada reversed the Trial Court decision and directed the Trial Court to declare a parking easement to be extinguished. The Company filed a Petition for Rehearing in connection with the Supreme Court Order, which was denied. The Company does not feel that this decision will have a material adverse effect on the property or on the business or financial condition of the Company. 3. ELIZABETH & GERALD GARROW v. DELOS HAUGHTON, JAMES CHASTINE & 1. 101 PREFERRED EQUITIES CORPORATION District Court, Clark County, Nevada Case No. A 306000 In April 1992, Mr. and Mrs. Garrow filed an action for damages alleged to have resulted from an automobile accident that occurred October 12, 1991. The accident involved one of the vans owned by the corporation. The case, which is being defended by the corporation's insurance carrier, requests general damages in an amount less than $25,000, medical expenses, damages for loss of services in an amount in excess of $25,000, and costs and attorney fees. The Company feels the case is fully insured and will not have a material adverse effect on the business or financial condition of the Company. 4. BARBARA J. LOUGHRY v. THE BRIG INC., dba OCEANFRONT RESTAURANT & LOUNGE Superior Court, Atlantic County, New Jersey Case No. ATL-L-001997-93 In May 1993, Plaintiff filed a complaint for damages for alleged injuries that are claimed to have resulted from a fight in the Oceanfront Restaurant in the Brigantine Inn. The case has been tendered to Tony Pullella, restaurant operator, and his insurance carrier. The Company's insurance carrier has also been notified. The case does not specify the amount of damages, but the Company feels the case is fully insured and will not have a material adverse effect on the business or financial condition of the Company. 5. EMILIO VALENTIN v. BRIGANTINE INN LTD., PREFERRED EQUITIES CORPORATION & BRIGANTINE NAUTILUS Superior Court, Atlantic County, New Jersey Case No. ATL-L-001992-93 In May 1993, Plaintiff, a minor, filed a complaint for unspecified damages alleged to have occurred as a result of claimed negligence in maintenance and operation of the swimming pool at the Brigantine Inn. The case has been tendered to the health club operator for defense and has been sent to the Company's insurance carrier. The Company feels that the case is fully insured and will not have a material adverse effect on the business or financial condition of the Company. In March 1994, the complaint was amended to add Brigantine Preferred Properties, Inc. as a defendant. 6. LEON AND DOROTHY CURL v. PEC, d.b.a. GRAND FLAMINGO CLUB HOTEL & DOVER ELEVATOR COMPANY United States District Court, Northern District of Texas Case No. 4-94CV-253 y; filed April 14, 1994 and served April 4, 1994 The Plaintiffs filed suit for damages as a result of an alleged incident on June 28, 1992. The 2. 102 Plaintiffs claim an elevator door at the Grand Flamingo Club slammed shut, knocking Mr. Curl to the floor. The complaint alleges the elevator door was operating improperly, that the hotel failed to have it repaired, and requests $335,000 damages together with interest and costs. The case was forwarded to the insurance carrier for defense. The case was settled for $5,100 and dismissed. 7. CONCETTA DESIDERIO v. BRIGANTINE INN, BRIGANTINE PREFERRED PROPERTIES, et al. Superior Court, Bergen County, New Jersey Case No. BER-L-3712-95 Plaintiff filed an action for damages alleged to have resulted from a fall in the Oceanfront Restaurant at the Brigantine Inn on or about May 31, 1994. The complaint alleges negligence and requests damages, interest and costs, but does not specify the amount of damages. The complaint has been forwarded to the insurance carrier and the Company feels the case is fully insured and will not have a material adverse effect on the business or financial condition of the Company. 8. ROYLENE MOTEN v. PREFERRED EQUITIES CORPORATION District Court, Clark County, Nevada Case No. A347146; filed June 14, 1995 and served June 27, 1995 On June 14, 1995, Roylene Moten filed a complaint in the Clark County, Nevada District Court against Preferred Equities Corporation. The Plaintiff requests general damages in excess of $10,000; special damages in excess of $10,000; and attorney's fees and costs. The Plaintiff claims to have fallen boarding one of the Company's vans as a result of alleged negligence on the part of an employee of the Company. The complaint has been forwarded to the insurance carrier. The Company feels the case is fully insured and will not have a material adverse effect on the business or financial condition of the Company. 9. IN RE MEGO FINANCIAL CORP. SECURITIES LITIGATION United States District Court, District of Nevada Case No. CV-9-95-01082-LDG(LPH) On or about June 10, 1996, the United States District Court, District of Nevada, approved a stipulation for consolidation of two cases (Christopher Dunleavy vs. Mego Financial Corp. [the "Company"], certain of the Company's officers and directors and the Company's independent auditors, Deloitte & Touche LLP ["Dunleavy Case"]; and Alan Peyser vs. the Company and certain of the Company's officers and directors ["Peyser Case"]). The complaint in the Dunleavy Case alleges that certain financial reports prepared and issued by the Company, including certain financial statements certified by Deloitte & Touche, were false and misleading, that one of the director defendants engaged in "insider trading," and alleges other violations of federal securities statutes and common law. The Complaint seeks 3. SEE ATTACHED UPDATE OF ITEM 9. 103 to have the Plaintiff (who allegedly purchased 100 shares of the Company's common stock on November 9, 1995) and other purchasers of the Company's common stock between January 14, 1994 and November 9, 1995 declared to be a class, that the action be declared to be a class action, and asks for damages in an unspecified amount, costs, attorney's fees, and such other relief as the court may deem just and proper. The Complaint in the Peyser Case alleges among other things that the Defendants violated the federal securities laws by making statements and issuing certain financial reports in 1994 and 1995 that overstated the Company's earnings and business prospects. The named Plaintiff seeks to represent a class consisting of purchasers of the Company's common stock between November 28, 1994 and November 9, 1995. The Complaint seeks damages in an unspecified amount, costs, attorney's fees and such other relief as the court may deem just and proper. The Company believes that it has substantial and valid defenses to the allegations in each case and in the consolidated case. The time for responsive pleadings has been extended sine die by agreement with Plaintiffs' counsel. The Company understands that the Plaintiffs plan to amend their Complaints, after which the defendants will have an appropriate time to respond. On December 26, 1996, Michael Nadler ("Nadler") filed a purported class action complaint against Mego Financial Corp. certain of its officers and directors, and its independent auditors. On or about July 26, 1996, Nadler filed a motion in the above matter requesting that he be added as a class representative and that his attorney be added as additional counsel for the class. On December 26, 1996, Michael Nadler ("Nadler") filed a purported class action complaint against Mego Financial Corp., certain of its officers and directors, and its independent auditors. On or about December 26, 1996, Nadler filed a motion in the above matter requesting that he be added as a class representative and that his attorney be added as additional counsel for the class. On or about January 2, 1997, Nadler withdrew his motion to be added as a class representative, which had been pending. On January 9, 1997, Nadler filed a motion for relief from certain portions of a pretrial order entered in the Dunleavy and Peyer cases. On February 13, 1997 the Defendants moved to dismiss Nadler's complaint. On March 13, 1997, Nadler filed a motion for the filing of a consolidated complaint, for certification of a class, the holding of a pretrial conference and suspension of briefing on the Defendants' motion to dismiss. The Company opposed such motion. On March 31, 1997, the court denied Nadler's motion to be included as a putative class representative and denied, without prejudice to refile after either the filing of a consolidated complaint or a ruling on Nadler's motion for the filing of a consolidated complaint, Nadler's motion for the relief from certain portions of the pretrial order, Nadler's motion to consolidate and defendants' motion to dismiss Nadler's complaint. The Nadler complaint claims that the Defendants violated the federal securities laws and common law and contained allegations similar to those in the Dunleavy and Peyser complaints. Mego Financial Corp. believes that it has substantial defenses to the Nadler complaint; however, is not presently able to predict the outcome of this matter. 10. JOHN K. O'BRIEN v. PREFERRED EQUITIES CORPORATION, CALVADA SPRINGS CORPORATION & CENTRAL NEVADA UTILITIES COMPANY. 4. 104 District Court, Nye County, Nevada Case No. 13576; filed December 4, 1995 and served January 2, 1996 The Plaintiff requests general and compensatory damages in excess of $10,000, miscellaneous and incidental damages in excess of $10,000, damages for costs of medical care and treatment, costs and attorney's fees. The Plaintiff claims to have been injured on December 15, 1993 by driving a motor vehicle into a trench allegedly dug by the Defendants. The Plaintiff claims the Defendants were negligent in constructing the ditch and failing to properly warn of the existence of the ditch. The complaint was forwarded to the insurance carrier. The plaintiff and the Company's insurance carrier agreed to submit the claim to binding arbitration rather than having the case go to trial. The Company feels the case is fully insured and will not have a material adverse effect on the business or financial condition of the Company or other defendants. 11. ANTHONY PULLELLA v. BRIGANTINE PREFERRED PROPERTIES, INC., SUCCESSOR IN INTEREST TO BRIGANTINE INN, LTD. & THE BRIG INC. Superior Court, Chancery Division, Atlantic County, New Jersey Case ATL-C-175-96; filed November 22, 1996 and served December 9, 1996 The Complainant requests an order for the Defendants to convey the Oceanfront Restaurant and Lounge, part of the Brigantine Inn Resort Club, to the Plaintiff pursuant to alleged obligations in a lease and management agreement. The Complaint also requests an order for the sale and conveyance to the Plaintiff of the capital stock of The Brig Inc., owner of the liquor license, and requests unspecified compensatory and punitive damages. The Plaintiff filed a Notice of Lis Pendens on the portion of the property involved in the case. The Company believes the Defendants have valid defenses to the Complaint and does not the believe the matter will have a material adverse effect on the business or financial condition of the Company. 12. THOMAS J. MULVEY v. PREFERRED EQUITIES CORPORATION aka Calvada Springs Corporation, District Court, Clark County, Nevada Case No. A371479, filed March 26, 1997. Served March 31, 1997 The Plaintiff requests general and special damages in excess of $10,000, attorneys fees, costs and interest. The plaintiff claims to have been injured on or about April 21, 1995 as the result of an assault and robbery by an unidentifed individual at or near the Grand Flamingo Terraces. The Company feels the case is fully insured and will not have a material adverse effect on the business or financial condition of the Company. 5 105 PART II OTHER INFORMATION Item 1. Legal Proceedings On December 26, 1996, in the matter of "In re Mego Financial Corp. Securities Litigation," Master File No. CV-9-95-01082-LDG (RLH)(the "Litigation"), in the United States District Court for the District of Nevada (the "Court"), which matter was described in the Company's Form 10-K for the fiscal year ended August 31, 1996 (the "1996 10-K"), Michael Nadler ("Nadler") filed a purported class action complaint against the Company, certain of the Company's officers and directors, and the Company's independent auditors. On February 13, 1997, defendants moved to dismiss Nadler's complaint. On March 13, 1997, Nadler filed a "Motion for the Filing of a Consolidated Complaint and a Class Certification Motion, the Holding of a Pretrial Conference and the Suspension of Briefing on Defendants' Motions to Dismiss." The Company opposed that motion. On March 31, 1997, the Court issued an Order that, among other things, denied, without prejudice to refiling after either the filing of a consolidated complaint or a ruling on Nadler's motion for the filing of a consolidated complaint, defendants' motions to dismiss Nadler's complaint. On May 31, 1997, the Court issued an Order denying Nadler's "Motion to Compel Compliance with Local Rule 26-6" against the Company and its officers and directors, and granting that motion against other parties, who have moved for reconsideration. On May 12, 1997, counsel for the plaintiffs in the Dunleavy and Peyser actions, which were described in the 1996 10-K, and counsel for the defendants executed a Memorandum of Understanding with respect to a proposed settlement. The proposed settlement, which is subject to a number of conditions, including approval by the Court, calls for certification, for settlement purposes only, of a class consisting of all purchasers of Mego Financial stock (excluding the defendants and their respective directors, executive officers, partners and affiliates and their respective immediate families, heirs, successors and assigns) during the period from January 14, 1994 through November 9, 1995, inclusive, and for creation of a settlement fund of $1.725 million. The portion of this amount to be contributed by the Company, net of anticipated insurance proceeds, is not expected to have a material adverse effect on the Company. The parties anticipate submitting papers to the Court in due course seeking approval of the settlement. Final approval of the settlement is expected to dispose of all class claims in the Litigation, including those asserted by Nadler. The Company believes that it has substantial defenses to all of the complaints that have been filed against it; however, the Company presently cannot predict the outcome of this matter. 31 106 EXHIBIT C TO LOAN AND SECURITY AGREEMENT That real property located in Clark County, Nevada, described as: That portion of the Southwest Quarter (SW 1/4) of Section 16, Township 21 South, Range 61 East, M.D.B.&M., and being a portion of Block four (4) of Flamingo Estates, as shown by map thereof on File in Book 5 of Plats, Page 22, in the Office of the County Recorder of Clark County, Nevada, described as Lots one (1) and two (2), as shown by Parcel Map in File 70, Page 30, recorded September 19, 1991 as Document No. 00581 in Book 910919 of Official Records, Clark County, Nevada; Excepting therefrom all gas and oil rights that now exist or may be developed upon said land as reserved by Rose Rabin, in Deed recorded February 18, 1952 as Document No. 381100, in the Office of the County Recorder of Clark County, Nevada, and subsequently conveyed to Harry Cobb, by Deed recorded March 25, 1957 as Document No. 102052 of Official Records, Clark County, Nevada. 107 EXHIBIT D TO LOAN AND SECURITY AGREEMENT UNPAID TAXES AND UNFILED TAX RETURNS The State of Texas has requested from RVS Marketing, a subsidiary of Borrower, a series of franchise tax returns for the periods ended December 31, 1995 and February 29, 1996. No request for additional time to file the franchise tax return for the year ended February 28, 1997 was filed. The total amount of tax due is not anticipated to exceed $100.00. EX-10.131 5 EMPLOYMENT AGREEMENT - STUART HARELIK & MEGO FIN. 1 EXHIBIT 10.131 [PREFERRED EQUITIES CORPORATION LOGO] October 9, 1996 Mr. Stuart Harelik Saddle Mountain Ranch 23760 U.S. Highway 40 Steamboat Springs, Colorado 80847 Dear Mr. Harelik: This letter (the "Fourth Amendment") is intended to extend and amend your employment letter agreement dated January 25, 1989 with Preferred Equities Corporation (the "Company"), as amended by the First Amendment dated July 11, 1990, the Second Amendment dated October 25, 1991, and as further amended by the Third Amendment dated September 1, 1994 (the "Amendment"). 1) The term of the Agreement is hereby extended from August 31, 1998 to August 31, 2000. 2) The "Contingent Bonus" provisions of the Agreement are amended as follows: a) The following Paragraph shall be substituted for Paragraph 3(a) of the Third Amendment: "a) You shall be entitled to receive a contingent bonus (the "Contingent Bonus"), if earned, for the twelve month period from September 1 to August 31, of each fiscal year of the Agreement, as amended by this Fourth Amendment, commencing with fiscal 1995, equal to the sum of (x) one and one-quarter percent (1.25%) of the amount of Net Sales during such fiscal year in excess of $20,000,000 up to $50,000,000 of such sales, plus (y) three-quarters of one percent (0.75%) of the amount by which the amount of Net Sales during such fiscal year exceeds $50,000,000, to be paid as hereinafter set forth." b) The following Paragraphs shall be substituted for Paragraphs 3(b)(iv) and 3(b)(v) of the Third Amendment: "iv) The Contingent Bonus for each of the entire fiscal years ending August 31, 1995, 1996, 1997, 1998 and 1999 shall be calculated and paid after deducting the aggregate amount of any installments of the Contingent Bonus paid for the First, Second or Third Quarters' Net Sales in such year and shall be paid on or before September 30 of such year." 2 page two "v) The Contingent Bonus for the entire fiscal year ending August 31, 2000, shall be calculated and paid after deducting the aggregate amount of any installments of the Contingent Bonus paid for the First, Second, and Third Quarters' Net Sales in such year, and shall be paid on or before November 30, 2000, except that such amount shall be calculated and paid on or before September 30, 2000, if the term of your employment has been extended in writing beyond August 31, 2000." 4) Anything in the Agreement or this Fourth Amendment to the contrary notwithstanding, it is specifically agreed that sales of timeshare interests in any project of the Company located in the City of New York, New York shall not be included within the definition of "Net Sales", nor shall you be entitled to any compensation relating to such New York City project or sales relating thereto. Should the Company and you later agree upon your role in any such project, any compensation due to you for your services would be agreed upon in a new and separate agreement. 5) Except as modified herein all terms, definitions and conditions of the Agreement shall remain in full force and effect. If the foregoing correctly sets forth our understanding as to the modifications to the Agreement, please so indicate by executing a copy of this letter in the space provided below and returning it to the undersigned. Very truly yours, PREFERRED EQUITIES CORPORATION By: /s/ JEROME J. COHEN --------------------------- Jerome J. Cohen, President Accepted and Approved this 9th day of October, 1996 /s/ STUART HARELIK - --------------------- Stuart Harelik EX-10.132 6 EMPLOYMENT AGREEMENT - JON A JOSEPH & MEGO FIN. 1 EXHIBIT 10.132 AMENDED AND RESTATED EMPLOYMENT AGREEMENT THIS AMENDED AND RESTATED EMPLOYMENT AGREEMENT ("Amendment") is entered into by and between MEGO FINANCIAL CORPORATION, a New York corporation (the "Company"), with its principal office located at 4310 Paradise Road, Las Vegas, Nevada 89109 and JON A. JOSEPH (the "Employee") as of August 31, 1997. BACKGROUND OF THE AGREEMENT On July 7, 1995, the Company and the Employee entered into an EMPLOYMENT AGREEMENT (the "Agreement") whereby the Employee was hired as a Vice President and Associate General Counsel of the Company, pursuant to the terms of the Agreement, for a period of time expiring on August 31, 1997. The Company and the Employee desire to extend the term of the Agreement pursuant to the terms and conditions of this Amendment. In consideration of the foregoing and other good and valuable consideration, the Company and the Employee hereby agree as follows: 1. Other than as modified by this Amendment, the terms and conditions of the Agreement are hereby restated and ratified in full. 2. Duties and Performance - Section 2. of the Agreement is hereby amended by adding thereto: In addition to the above described duties, Employee shall serve as Vice President and General Counsel of the Company's wholly owned subsidiary, Preferred Equities Corporation. 3. Term - Section 3. of the Agreement is hereby amended by deleting the existing Section in its entirety and replacing it with the following: This Agreement shall commence on the 7th day of July, 1995 (the "Effective Date"), and terminate on August 31, 2000, unless sooner terminated as provided in this Agreement. 4. Compensation - Section 4. of the Agreement is hereby amended by deleting the existing Section in its entirety and replacing it with the following: 4. Compensation. (a) Unless otherwise agreed in writing by the Company and the Employee, the Company shall pay to the Employee, in partial compensation of his services, a salary of $175,000.00 per annum for each year of this Agreement (the "Base Compensation"). The Base Compensation shall be payable in equal installments, the frequency of which shall be determined by the Company, but in no event less frequently than monthly. The Company shall withhold and pay over to the appropriate 2 governmental agency all payroll taxes (including income, social security and unemployment compensation taxes) required by federal, state and local governments having jurisdiction over the Company. (b) Employee shall be included in the group of executives considered for an annual bonus under the Company's Executive Incentive Compensation Plan. Employee shall receive a minimum payment of $25,000.00 per year, payable on or before January 15, of 1998 and 1999, whether or not any bonuses are payable under said Executive Compensation Plan. (c) In addition to the compensation described in Paragraph 4(a) and (b) above, on or before September 10, 1997, the Company will grant a qualified stock option to Employees under the Company's Key Employee Stock Option Plan (the "Plan") for the purchase of 30,000 shares of the Company's Common stock at an option price determined in accordance with the Plan. Employee acknowledges that he has been provided with and is familiar with the Plan and terms and conditions of the option. (d) The Company hereby ratifies and affirms the grant of the qualified stock option under the Plan in the amount of 25,000 shares of the Company's common stock granted to Employee on April 29, 1997 at an option price of $5.625 a share. (e) So long as Employee is performing his duties hereunder, Employee shall receive a monthly automobile allowance of $1,000.00 a month. (f) Employee shall be entitled to such health, dental, medical, disability, life and other insurance and 401(k) benefits as are provided to other executives of the Company. (g) In addition to the foregoing, Employee will be entitled to incur reasonable expenses for promoting the business of the Company. The Company shall reimburse the Employee for all such reasonable business expenses, including cost of travel, meals and lodging while traveling and business entertainment. The Company will make available to Employee a country club membership at Spanish Trail Country Club, to be used for entertaining persons in connection with the Corporation's business. the Company will pay all dues and assessments associated with such membership and Employee will pay for Employee's non-business related charges. IN WITNESS WHEREOF, the parties hereto have executed this Amendment as of the 31st day of August, 1997. COMPANY: MEGO FINANCIAL CORPORATION /s/ JEROME J. COHEN -------------------------------- By: Jerome J. Cohen, President EMPLOYEE: /s/ JON A. JOSEPH -------------------------------- By: Jon A. Joseph EX-27.1 7 FINANCIAL DATA SCHEDULE
5 YEAR AUG-31-1997 SEP-01-1996 AUG-31-1997 12,425 0 45,615 11,341 37,294 0 39,512 15,292 178,303 0 65,569 0 0 210 73,027 178,303 48,879 67,496 7,493 44,555 27,597 0 8,458 (4,656) (12,662) 8,006 11,334 0 0 19,340 0.99 0.99 Net of income taxes of $9,062 and minority interest of $2,358 - Related to Spin-off of Mego Mortgage Corporation subsidiary.
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