10-Q 1 a69978e10-q.txt FORM 10-Q FOR QUARTER ENDED FEBRUARY 28, 2001 1 ================================================================================ SECURITIES AND EXCHANGE COMMISSION Washington, D. C. 20549 FORM 10-Q (MARK ONE) [X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE QUARTERLY PERIOD ENDED: FEBRUARY 28, 2001 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 (I. R. S. EMPLOYER INCORPORATION OR ORGANIZATION) IDENTIFICATION NO.) 4310 PARADISE ROAD, LAS VEGAS, NEVADA 89109 (ADDRESS OF PRINCIPAL EXECUTIVE OFFICES) (ZIP CODE) (702) 737-3700 (REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE) 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 [ ] APPLICABLE ONLY TO CORPORATE ISSUERS: As of April 11, 2001, there were 3,500,557 shares of Common Stock, $.01 par value per share, of the Registrant outstanding. ================================================================================ 2 MEGO FINANCIAL CORP. AND SUBSIDIARIES INDEX
Page ---- PART I FINANCIAL INFORMATION Item 1. Condensed Financial Statements (unaudited) Condensed Consolidated Balance Sheets at February 28, 2001 and August 31, 2000..........................................1 Condensed Consolidated Income Statements for the Three and Six Months Ended February 28, 2001 and February 29, 2000..................................2 Condensed Consolidated Statements of Stockholders' Equity for the Six Months Ended February 28, 2001.................................................3 Condensed Consolidated Statements of Cash Flows for the Six Months Ended February 28, 2001 and February 29, 2000..................................4 Notes to Condensed Consolidated Financial Statements............................5 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations......................................................7 Item 3. Quantitative and Qualitative Disclosures About Market Risk.....................15 PART II OTHER INFORMATION Item 1. Legal Proceedings...............................................................15 Item 5 Other Information...............................................................15 Item 6. Exhibits and Reports on Form 8-K................................................16 SIGNATURE..................................................................................17
i 3 PART I FINANCIAL INFORMATION ITEM 1. CONDENSED FINANCIAL STATEMENTS MEGO FINANCIAL CORP. AND SUBSIDIARIES CONDENSED CONSOLIDATED BALANCE SHEETS (thousands of dollars, except per share amounts) (unaudited)
FEBRUARY 28, AUGUST 31, ASSETS 2001 2000 ------------ ---------- Cash and cash equivalents $ 1,323 $ 1,069 Restricted cash 3,123 1,255 Notes receivable, net of allowance for cancellations and discounts of $13,839 at February 28, 2001 and $13,234 at August 31, 2000 92,117 83,156 Interest only receivables, at fair value 2,954 2,701 Timeshare interests held for sale 19,632 23,307 Land and improvements inventory 3,126 4,113 Other investments 4,485 4,492 Property and equipment, net of accumulated depreciation of $16,158 at February 28, 2001 and $17,632 at August 31, 2000 16,771 23,167 Deferred selling costs 5,665 5,231 Prepaid debt expenses 2,004 2,060 Other assets 16,128 18,041 --------- --------- TOTAL ASSETS $ 167,328 $ 168,592 ========= ========= LIABILITIES AND STOCKHOLDERS' EQUITY Liabilities: Notes and contracts payable $ 103,577 $ 109,131 Accounts payable and accrued liabilities 22,755 19,544 Reserve for notes receivable sold with recourse 3,931 4,033 Deposits 3,362 2,841 Accrued income taxes 2,311 2,975 --------- --------- Total liabilities before subordinated debt 135,936 138,524 --------- --------- Subordinated debt 4,286 4,286 Stockholders' equity: Preferred stock, $.01 par value (authorized--5,000,000 shares, none outstanding) Common stock, $.01 par value (authorized--50,000,000 shares; 3,500,557 shares issued and outstanding at February 28, 2001 and August 31, 2000) 35 35 Additional paid-in capital 13,068 13,068 Retained earnings 15,025 12,679 Accumulated other comprehensive loss (1,022) -- --------- --------- Total stockholders' equity 27,106 25,782 --------- --------- TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 167,328 $ 168,592 ========= =========
See notes to condensed consolidated financial statements. 1 4 MEGO FINANCIAL CORP. AND SUBSIDIARIES CONDENSED CONSOLIDATED INCOME STATEMENTS (thousands of dollars, except per share amounts) (unaudited)
THREE MONTHS ENDED SIX MONTHS ENDED ----------------------------- ------------------------------ FEBRUARY 28, FEBRUARY 29, FEBRUARY 28, FEBRUARY 29, 2001 2000 2001 2000 ------------ ------------ ------------ ------------ REVENUES Timeshare interest sales, net $ 12,108 $ 10,906 $ 26,126 $ 22,897 Land sales, net 5,085 4,563 9,827 8,582 Interest income 3,550 3,172 6,759 6,043 Financial income 850 269 1,329 541 Gain on sale of notes receivable -- -- 292 -- Gain on sale of investments -- 678 1,608 678 Incidental operations 388 511 878 1,135 Other 932 919 1,974 1,839 ----------- ----------- ----------- ----------- Total revenues 22,913 21,018 48,793 41,715 ----------- ----------- ----------- ----------- COSTS AND EXPENSES Direct cost of: Timeshare interest sales 2,455 2,210 5,612 4,588 Land sales 777 741 1,546 1,297 Interest expense 3,088 3,113 6,132 5,979 Marketing and sales 11,057 8,593 22,521 17,867 General and administrative 4,409 4,395 9,323 8,273 Incidental operations 353 499 707 1,099 Depreciation 351 461 743 951 ----------- ----------- ----------- ----------- Total costs and expenses 22,490 20,012 46,584 40,054 ----------- ----------- ----------- ----------- INCOME BEFORE INCOME TAXES 423 1,006 2,209 1,661 INCOME TAXES (BENEFIT) -- -- (137) -- ----------- ----------- ----------- ----------- NET INCOME APPLICABLE TO COMMON STOCK $ 423 $ 1,006 $ 2,346 $ 1,661 =========== =========== =========== =========== INCOME PER COMMON SHARE Basic: Net income applicable to common stock $ 0.12 $ 0.29 $ 0.67 $ 0.47 =========== =========== =========== =========== Weighted-average number of common shares and common share equivalents outstanding 3,500,557 3,500,557 3,500,557 3,500,557 =========== =========== =========== =========== Diluted: Net income applicable to common stock $ 0.12 $ 0.29 $ 0.67 $ 0.47 =========== =========== =========== =========== Weighted-average number of common shares and common share equivalents outstanding 3,500,557 3,500,557 3,500,557 3,500,557 =========== =========== =========== ===========
See notes to condensed consolidated financial statements. 2 5 MEGO FINANCIAL CORP. AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (thousands of dollars, except per share amounts) (unaudited)
COMMON STOCK ACCUMULATED $.01 PAR VALUE ADDITIONAL OTHER ------------------------ PAID-IN RETAINED COMPREHENSIVE SHARES AMOUNT CAPITAL EARNINGS LOSS TOTAL ------------------------------------------------------------------------------------- Balances at August 31, 2000 3,500,557 $ 35 $ 13,068 $ 12,679 $ 25,782 Net income for the six months ended February 28, 2001 2,346 2,346 Cumulative effect of change in accounting principle as of September 1, 2000 for unrealized loss on interest rate swaps, net of related income tax of $87 $ (168) (168) Unrealized loss on interest rate swaps for the six months ended February 28, 2001, net of related income tax of $495 (854) (854) ------------------------------------------------------------------------------------- Total comprehensive income 1,324 --------- Balances at February 28, 2001 3,500,557 $ 35 $ 13,068 $ 15,025 $ (1,022) $ 27,106 =====================================================================================
See notes to condensed consolidated financial statements. 3 6 MEGO FINANCIAL CORP. AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (thousands of dollars) (unaudited)
SIX MONTHS ENDED --------------------------- FEBRUARY 28, FEBRUARY 29, 2001 2000 ------------ ------------ CASH FLOWS FROM OPERATING ACTIVITIES Net income $ 2,346 $ 1,661 -------- -------- Adjustments to reconcile net income to net cash used in operating activities: Charges to allowance for cancellations (4,085) (3,831) Provision for cancellations 3,702 2,717 Amortization of interest rate swap 106 -- Gain on sale of notes receivable (292) -- Gain on sale of other assets (1,608) (678) Cost of sales 7,158 5,885 Depreciation 743 951 Additions to interest only receivable (562) -- Amortization of interest only receivables 309 271 Repayments on notes receivable 22,337 24,334 Additions to notes receivable (40,614) (36,347) Proceeds from sale of notes receivable 9,889 -- Purchase of land and timeshare interests (2,496) (2,483) Changes in operating assets and liabilities: (Increase) decrease in restricted cash (1,868) 399 (Increase) decrease in other assets 1,969 (3,574) Increase in deferred selling costs (434) (920) Increase (decrease) in accounts payable and accrued liabilities 1,556 (759) Increase in deposits 521 427 Decrease in accrued income taxes (137) -- -------- -------- Total adjustments (3,806) (13,608) -------- -------- Net cash used in operating activities (1,460) (11,947) -------- -------- CASH FLOWS FROM INVESTING ACTIVITIES Purchase of property and equipment (592) (435) Proceeds from the sale of property and equipment 7,853 -- Proceeds from the sale of other investments 7 1,001 Additions to other investments -- (29) Payments on other investments -- 30 -------- -------- Net cash provided by investing activities 7,268 567 -------- -------- CASH FLOWS FROM FINANCING ACTIVITIES Proceeds from borrowings 27,310 33,675 Reduction of debt (32,864) (22,288) Payments on subordinated debt -- (215) Increase in subordinated debt -- 237 -------- -------- Net cash provided by (used in) financing activities (5,554) 11,409 -------- -------- NET INCREASE IN CASH AND CASH EQUIVALENTS 254 29 CASH AND CASH EQUIVALENTS-- BEGINNING OF PERIOD 1,069 1,821 -------- -------- CASH AND CASH EQUIVALENTS-- END OF PERIOD $ 1,323 $ 1,850 ======== ======== SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION Cash paid during the year for: Interest, net of amounts capitalized $ 6,090 $ 5,795 ======== ========
See notes to condensed consolidated financial statements. 4 7 MEGO FINANCIAL CORP. AND SUBSIDIARIES NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS FEBRUARY 28, 2001 (unaudited) 1. FINANCIAL STATEMENTS In the opinion of management, when read in conjunction with the audited Consolidated Financial Statements for the years ended August 31, 2000 and 1999, contained in the Form 10-K of Mego Financial Corp. (Mego Financial) filed with the Securities and Exchange Commission for the year ended August 31, 2000, the accompanying unaudited Condensed Consolidated Financial Statements contain all of the information necessary to present fairly the financial position of Mego Financial and Subsidiaries at February 28, 2001, the results of its operations for the three and six months ended February 28, 2001 and 2000, the change in stockholders' equity for the six months ended February 28, 2001 and the cash flows for the six months ended February 28, 2001 and February 29, 2000. All intercompany accounts between the parent and its subsidiaries have been eliminated. The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America (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. In the opinion of management, all material adjustments necessary for the fair presentation of these statements have been included herein, which are normal and recurring in nature. The results of operations for the three and six months ended February 28, 2001 are not necessarily indicative of the results to be expected for the full year. 2. NATURE OF OPERATIONS Mego Financial is a premier developer and operator of timeshare properties and a provider of consumer financing to purchasers of timeshare intervals and land parcels through its wholly-owned subsidiary, Preferred Equities Corporation (PEC), established in 1970. PEC is engaged in originating, selling, servicing and financing consumer receivables generated through timeshare interest and land sales. Mego Financial and its subsidiaries are herein collectively referred to as the Company as the context requires. 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. 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 either hypothecates or sells, and typically services. In February 1988, Mego Financial acquired PEC, pursuant to an assignment by the Assignors (Comay Corp., Growth Realty Inc., RER Corp., and H&H Financial, Inc.) of their contract right to purchase PEC. 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. 3. INTEREST RATE SWAP AND CUMULATIVE EFFECT ON CHANGE IN ACCOUNTING PRINCIPLE Effective September 1, 2000, the Company adopted the requirements of Financial Accounting Standards No. 133 (SFAS 133) "Accounting for Derivative Instruments and Hedging Activities", which was amended by SFAS No. 137. In August 2000, the Company entered into a $25 million, 5-year, interest rate swap transaction with a financial institution to hedge potential exposure to its variable rate notes payable portfolio. The interest rate swap is considered and was documented as a highly effective cash flow hedge. Beginning September 1, 2000, the unrealized gain or loss mark to market, net of related income tax effect, is recorded into a separate Stockholders' equity caption titled Accumulated other comprehensive loss. The cumulative effect of change in accounting principle of $168,000, which is net of related income tax, was recorded as of September 1, 2000 under the same caption. 5 8 4. STOCKHOLDERS' EQUITY Mego Financial's stock option plan (Stock Option Plan), provides for grants of non-qualified and qualified incentive stock options to officers, key employees and directors. Options for 48,570 shares of Mego Financial common stock were outstanding as of February 28, 2001. 6 9 ITEM 2. 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 section contains certain forward-looking statements and information relating to Mego Financial Corp. (Mego Financial) (Mego Financial and its subsidiaries are referred to herein collectively as the Company as the context requires) 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 expectations 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 Condensed Consolidated Financial Statements, including the notes thereto, contained elsewhere herein and in the Company's Form 10-K for the fiscal year ended August 31, 2000. GENERAL The business of the Company is primarily the marketing, financing, and sale of timeshare interests, retail lots and land parcels, servicing the related receivables, and managing timeshare properties. The Company, through its subsidiary Preferred Equities Corporation (PEC), provides financing to purchasers of its timeshare interests and land. This financing is generally evidenced by notes secured by deeds of trust or mortgages. These notes receivable are payable over a period up to twelve years, bear interest at rates generally ranging from 12.5% to 15.5% and require equal monthly installments of principal and interest. PEC PEC recognizes revenue primarily from sales of timeshare interests and land in resort areas, gain on sale of receivables and interest income. PEC periodically 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 three 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 period 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 quarter the revenue is recognized is accounted for as a reversal of the revenue with an adjustment to cost of sales. Cancellation of a note receivable subsequent to the quarter the revenue was recognized is charged to the allowance for cancellations. 7 10 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 Condensed Consolidated Balance Sheets. 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 of 15% for the six months ended February 28, 2001 and February 29, 2000. PEC has developed its assumptions based on experience with its own portfolio, available market data and consultation with its financial advisors. 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 a 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 adjusted for 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 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, historical cancellation experience, 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. Fees for servicing notes receivable originated 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 marketing and sales expenses, general and administrative expenses, direct costs of sales of timeshare interests and land, depreciation and amortization and interest expense. 8 11 Marketing and sales costs directly attributable to unrecognized sales are accounted for as deferred selling costs until such time as the sale is recognized. PEC has entered into financing arrangements with certain purchasers of timeshare interests and land whereby a 5% 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 36 or fewer monthly payments. Notes receivable of $6.4 million at February 28, 2001 and August 31, 2000 were made under this arrangement. Land sales as of February 28, 2001 exclude $20.3 million of sales not yet recognized under generally accepted accounting principles (GAAP) since the requisite payment amounts have not yet been received or the respective recission periods have not yet expired. Of the $20.3 million unrecognized land sales, the Company estimates that it will ultimately recognize $16.7 million of revenues, which would be reduced by a related provision for cancellations of $1.3 million, estimated deferred selling costs of $4.7 million and cost of sales of $2.5 million, for an estimated net profit of $8.2 million. RESULTS OF OPERATIONS Three Months Ended February 28, 2001 Compared to Three Months Ended February 29, 2000 Total revenues for the Company increased 9.0% or $1.9 million to $22.9 million during the three months ended February 28, 2001 from $21.0 million during the three months ended February 29, 2000. The increase was primarily due to a net increase of $1.7 million in timeshare interest and land sales to $17.2 million during the three months ended February 28, 2001 from $15.5 million during the three months ended November 30, 2000 (net timeshare interest sales increased by $1.2 million and net land sales increased by $500,000), an increase in interest income to $3.6 million during the three months ended February 28, 2001 from $3.2 million during the three months ended February 29, 2000, an increase in financial income to $850,000 during the three months ended February 28, 2001 from $269,000 during the three months ended February 28, 2000, and no gains on sale of receivables and investments and other assets during the three months ended February 28, 2001, compared to a gain on sale of investments during the three months ended February 28, 2000 of $678,000. Gross sales of timeshare interests increased to $13.6 million during the three months ended February 28, 2001 from $12.0 million during the three months ended February 29, 2000, an increase of 13.4%. Net sales of timeshare interests increased to $12.1 million during the three months ended February 28, 2001 from $11.0 million during the three months ended February 28, 2000, an increase of 11.0%. The provision for cancellations increased to 11.1% of gross sales of timeshare interests for the three months ended February 28, 2001 from 9.2% for the three months ended February 29, 2000, primarily due to a downward adjustment based on the results of the customary quarterly review of the allowance adequacy during the three months ended February 29, 2000. Gross sales of land increased to $5.3 million during the three months ended February 28, 2001 from $4.8 million during the three months ended February 29, 2000, an increase of 11.7%. Net sales of land increased to $5.1 million during the three months ended February 28, 2001 from $4.6 million during the three months ended February 29, 2000, an increase of 11.4%. The provision for cancellations represented 4.4% and 4.2, respectively, of gross sales of land for the three months ended February 28, 2001 and February 29, 2000. Interest income increased to $3.5 million during the three months ended February 28, 2001 from $3.2 million for the three months ended February 29, 2000, an increase of 11.9%, primarily due to increased average notes receivable balances for the comparative quarters. Financial income increased to $850,000 during the three months ended February 28, 2001 from $269,000 for the three months ended February 29, 2000, an increase of 216.0%. The increase was primarily due to the comparative increased volume of sold loans and the increase in spread on those sold loan portfolios with a variable, pass-through interest rate. 9 12 There was no gain on sale of other investments for the three months ended February 28, 2001 compared to a net gain of $678,000 resulting from the sale of two golf courses recorded for the three months ended February 29, 2000. Total costs and expenses for the Company increased to $22.5 million for the three months ended February 28, 2001 from $20.0 million for the three months ended February 29, 2000, an increase of 12.4%. The increase resulted primarily from an increase in direct costs of timeshare sales to $2.5 million from $2.2 million, an increase of 11.1%; and an increase of $2.5 million in marketing and sales expense, an increase of 28.7%. The increase in direct costs of timeshare sales is attributable to higher net timeshare sales during the current fiscal quarter compared to the same quarter last year. As a percentage of gross sales of timeshare interests and land, marketing and sales expenses related thereto increased to 58.4% for the three months ended February 28, 2001 from 51.2% for the three months ended February 29, 2000. The increase in marketing and sales expenses is due primarily to higher gross sales, new sales offices and general increases related to a competitive sales environment. Interest expense was $3.1 million during the three months ended February 28, 2001 and February 29, 2000 due to offsetting factors. There was a higher average outstanding balance of Notes and contracts payable during the three months ended February 28, 2001 compared to the three months ended February 29, 2000, and this was offset by a decrease in interest expense as a result of the reduction of debt related to the sale of the office buildings and the decrease in overall interest expense related to the prime rate decline. Pretax income of $423,000 was earned during the three months ended February 28, 2001 compared to a pretax income of $1.0 million during the three months ended February 29, 2000. No income taxes were recorded for the three months ended February 28, 2001 and February 29, 2000. Income taxes are recorded, and the liability is adjusted, based on an ongoing review of related facts and circumstances. Net income applicable to common stock amounted to $423,000 during the three months ended February 28, 2001 compared to net income applicable to common stock of $1.0 million during the three months ended February 29, 2000, primarily due to the foregoing. Six Months Ended February 28, 2001 Compared to Six Months Ended February 29, 2000 Total revenues for the Company increased 17.0%, or $7.0 million, to $48.8 million during the six months ended February 28, 2001 from $41.7 million during the six months ended February 29, 2000. The increase was primarily due to an increase in timeshare and land sales to $36.0 million during the six months ended February 28, 2001 from $31.5 million during the six months ended February 29, 2000 (net timeshare sales increased by $3.2 million and net land sales increased by $1.2 million), an increase in interest income to $6.8 million during the six months ended February 28, 2001 from $6.0 million during the six months ended February 29, 2000, and a gain on sale of notes receivable and investments of $1.9 million during the six months ended February 29, 2000 compared to $678,000 during the six months ended February 29, 2000. Gross sales of timeshare interests increased to $29.4 million during the six months ended February 28, 2001 from $25.3 million during the six months ended February 29, 2000, an increase of 16.2%. Net sales of timeshare interests increased to $26.1 million during the six months ended February 28, 2001 from $22.9 million during the six months ended February 29, 2000, an increase of 14.1%. The provision for cancellations increased to 11.1% of gross sales of timeshare interests for the six months ended February 28, 2001 from 9.5% for the six months ended February 29, 2000, primarily due to a downward adjustment based on the results of the customary quarterly review of the allowance adequacy during the six months ended February 29, 2000. Gross sales of land increased to $10.3 million during the six months ended February 28, 2001 from $8.9 million during the six months ended February 29, 2000, an increase of 15.3%. Net sales of land increased to $9.8 million during the six months ended February 28, 2001 from $8.6 million during the six months ended February 28, 2000, an increase of 14.5%. The provision for cancellations increased to 4.2% of gross sales of land for the six 10 13 months ended February 28, 2001 from 3.6% for the six months ended February 29, 2000, primarily due to a downward adjustment based on the results of the customary quarterly review of the allowance adequacy during the six months ended February 29, 2000. Interest income increased to $6.8 million for the six months ended February 28, 2001 from $6.0 million for the six months ended February 29, 2000, an increase of 11.8%, primarily due to increased notes receivable for the current period. Financial income increased to $1.3 million during the six months ended February 28, 2001 from $541,000 for the six months ended February 29, 2000, an increase of 145.7%. The increase was primarily due to the comparative increased volume of sold loans and the increase in spread on those sold loan portfolios with a variable, pass-through interest rate. A net gain on sale of investments of $1.6 million, resulting from the sale of the Company's two office buildings, and a gain of $292,000 on the sale of notes receivable, were recorded for the six months ended February 28, 2001 compared to a net gain on sale of other investments of $678,000, resulting from the sale of two golf courses in Pahrump, recorded for the six months ended February 29, 2000. Total costs and expenses for the Company increased to $46.6 million for the six months ended February 28, 2001 from $40.1 million for the six months ended February 29, 2000, an increase of 16.3%. The increase resulted primarily from an increase in direct costs of timeshare sales to $5.6 million from $4.6 million, an increase of 22.3%; an increase in marketing and sales expenses to $22.5 million from $17.9 million, an increase of 26.0%; and, an increase in general and administrative expenses to $9.3 million from $8.3 million, an increase of 12.7%. The increase in direct costs of timeshare sales is attributable to higher net timeshare sales during the current fiscal period compared to the same period last fiscal year. As a percentage of gross sales of timeshare interests and land, marketing and sales expenses related thereto increased to 56.8% for the six months ended February 28, 2001 from 52.2 % for the six months ended February 29, 2000. The increase in marketing and sales expense is due primarily to higher gross sales, new sales offices and general increases related to a competitive sales environment. 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, the Company generally realizes lower profit margins from sales of timeshare interests than from sales of land. The increase in General and administrative expenses is primarily due to the inclusion of the rent expense related to the sale and leaseback of the two office buildings in fiscal 2001, the expense for which was formerly reported in Interest and Depreciation expense; an increase in recording and filing fees and escrow costs related to the increased sales volume; and, reserves for the Company's guaranty of office and equipment leases related to a previously affiliated company. Pre-tax income of $2.2 million was earned during the six months ended February 28, 2001 compared to pre-tax income of $1.7 million during the six months ended February 29, 2000. An income tax benefit of $137,000 was recorded for the six months ended February 28, 2001 compared to no income tax provision during the six months ended February 29, 2000, due to the use of net operating loss carryforwards which were previously fully reserved and currently are used to offset income on a consolidated basis. Income taxes are recorded, and the liability is adjusted, based on an ongoing review of related facts and circumstances. Net income applicable to common stock was $2.3 million during the six months ended February 28, 2001 compared to net income applicable to common stock of $1.7 million during the six months ended February 29, 2000, primarily due to the foregoing. 11 14 LIQUIDITY AND CAPITAL RESOURCES Cash and cash equivalents for the Company were $1.3 million at February 28, 2001 compared to $1.1 million at August 31, 2000. PEC's cash requirements arise from the acquisition of timeshare properties and land, payments of operating expenses, payments of principal and interest on debt obligations, payments of marketing and sales expenses in connection with sales of timeshare interests and land, and payments of income taxes to Mego Financial. Marketing and sales 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 advances under PEC's lines of credit in the aggregate amount of $133.5 million, sales of receivables and cash flow from operations. At February 28, 2001, no commitments existed for material capital expenditures. At February 28, 2001, PEC had arrangements with 4 institutional lenders 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 lines of credit of up to an aggregate of $123.5 million. Such lines of credit are secured by timeshare and land receivables and mortgages. At February 28, 2001, an aggregate of $102.2 million was outstanding under such lines of credit, and $21.3 million was available for borrowing. Under the terms of these lines of credit, PEC may borrow 65% to 90% of the balances of the pledged timeshare and land receivables. PEC is required to comply with certain covenants under these agreements, which, among other things, require PEC to meet certain minimum tangible net worth requirements. The most stringent of such requirements provides that PEC maintains a minimum tangible net worth of $25 million. At February 28, 2001, PEC's tangible net worth was $33.0 million. Summarized lines of credit information and accompanying notes relating to these lines of credit outstanding at February 28, 2001, consist of the following (thousands of dollars):
BORROWING MAXIMUM AMOUNT AT BORROWING REVOLVING FEBRUARY 28, 2001 AMOUNTS EXPIRATION DATE (a) MATURITY DATE INTEREST RATE ------------------- ------------- -------------------- --------------- -------------------- $ 51,963 $ 65,000 (b) December 31, 2001 Various Prime + 2.0 - 2.25% ------------------ ------------ 16,986 15,000 (c) December 1, 2002 Various Prime + 2.0 7,842 11,500 (d) December 31, 2001 Various Prime + 2.0 - 3.00% ------------------ ------------ 24,828 26,500 Considered one borrowing line for the maximum amount. ------------------ ------------ 23,452 30,000 (e) April 30, 2003 Various Libor + 4.0 - 4.25% 1,972 1,972 (f) July 30, 2003 Prime + 2.25% ------------------ ------------ $ 102,215 $ 123,472 ================== ============
(a) When the revolver expires as shown, the loans convert to term loans with maturities as stated below. In addition, management expects to extend the lines on similar terms. (b) Restrictions include PEC's requirement to maintain a minimum tangible net worth of $25 million. Other restrictions include: PEC's requirement to maintain costs and expenses for marketing and sales and general and administrative expenses relating to net processed sales for each fiscal quarter; PEC's requirement to maintain a minimum net processed sales requirement for each fiscal quarter; and PEC's requirement not to exceed a ratio of 4:1 of consolidated total liabilities to consolidated tangible net worth. At February 28, 2001, $48.4 million of loans secured by receivables were outstanding related to financings at prime plus 2%, of which $20.8 million of loans secured by land receivables mature May 15, 2011 and $27.6 million of loans secured by timeshare receivables mature May 15, 2008. The outstanding borrowing amount includes a real estate loan with an outstanding balance of $1.1 million maturing December 31. 2001, bearing interest at prime plus 2.25%. The remaining Acquisition and Development (A&D) loans, receivables loans and a resort lobby loan outstanding of $2.5 million are at prime plus 2% and mature December 31, 2001. 12 15 (c) 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 February 28, 2001, $5.9 million was outstanding under the A&D loan, which matures on June 30, 2004, and $11.1 million was outstanding under the receivables loan, which matures on May 31, 2004. (d) Restrictions include PEC's requirement to maintain a minimum tangible net worth of $15 million. This credit line consists of receivable financing with a maturity date of May 31, 2004, under which $4.5 million was outstanding at February 28, 2001, and a real estate loan of $3.3 million with a maturity date of December 31, 200l. (e) 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. At February 28, 2001, $1.7 million was outstanding under the A&D loans which have a maturity date of April 30, 2003 and bear interest at the 90-day London Interbank Offering Rate (LIBOR) plus 4.25%. The available receivable financings, of which $21.7 million was outstanding at February 28, 2001, are at 90-day LIBOR plus 4% and have a maturity date of June 5, 2005. (f) Restrictions include PEC's requirement to maintain a minimum tangible net worth of $25 million. A schedule of the cash shortfall arising from recognized and unrecognized sales for the periods indicated is set forth below (thousands of dollars):
SIX MONTHS ENDED --------------------------- FEBRUARY 28, FEBRUARY 29, 2001 2000 ------------ ------------ Marketing and selling expenses attributable to recognized and unrecognized sales $ 22,025 $ 18,787 Less: Down payments (6,375) (5,678) -------- -------- Cash Shortfall $ 15,650 $ 13,109 ======== ========
During the six months ended February 28, 2001, PEC sold $9.6 million in notes receivable. PEC did not sell any notes receivable during the six months ended February 29, 2000. 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 in either cash or receivables generally at the option of the purchaser. At February 28, 2001 and August 31, 2000, PEC was contingently liable to replace or repurchase notes receivable sold with recourse totaling $61.7 million and $59.6 million, respectively. At February 28, 2001, the repurchase provisions provide for substitution of receivables as recourse for $55.1 million of sold notes receivable and cash payments for repurchase relating to $6.6 million of sold notes receivable. The undiscounted amounts of the recourse obligations on such notes receivable were $4.4 million and $4.5 million at February 28, 2001 and August 31, 2000, respectively. PEC continually 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. The components of the Company's debt, including lines of credit consist of the following (thousands of dollars): 13 16
FEBRUARY 28, AUGUST 31, 2001 2000 ------------ ---------- Notes collateralized by receivables $ 85,805 $ 80,593 Mortgages collateralized by real estate properties 16,546 27,407 Installment contracts and other notes payable 1,226 1,131 -------- -------- Total $103,577 $109,131 ======== ========
FINANCIAL CONDITION Changes in the aggregate of the allowance for cancellations, excluding discounts, and the reserve for notes receivable sold with recourse for the six months ended February 28, 2001 consisted of the following (thousands of dollars): Balance at beginning of period $ 16,860 Provision for cancellations 3,702 Amounts charged to allowance for cancellations, net (4,087) -------- Balance at end of period $ 16,475 ========
The allowance for cancellations and the reserve for notes receivable sold with recourse consisted of the following at these dates (thousands of dollars):
FEBRUARY 28, AUGUST 31, 2001 2000 ------------ ---------- Allowance for cancellations, excluding discounts $ 12,544 $ 12,827 Reserve for notes receivable sold with recourse 3,931 4,033 -------- -------- Total $ 16,475 $ 16,860 ======== ========
February 28, 2001 Compared to August 31, 2000 Cash and cash equivalents increased to $1.3 million at February 28, 2001 from $1.1 million at August 31, 2000. Notes receivable, net, increased $8.9 million to $92.1 million at February 28, 2001 from $83.2 million at August 31, 2000, as a result of net new receivables added, less sale of receivables, during the six months ended February 28, 2001. Timeshare interests held for sale decreased 15.8% to $19.6 million at February 28, 2001 from $23.3 million at August 31, 2000. Land and improvements inventory decreased 24.0% to $3.1 million at February 28, 2001 from $4.1 million at August 31, 2000. Notes and contracts payable decreased 5.1% to $103.6 million at February 28, 2001 from $109.1 million at August 31, 2000. This was primarily due to the debt paydown in connection with the sales of two office buildings and sale of notes receivables. 14 17 Reserve for notes receivable sold with recourse decreased 2.5% to $3.9 million at February 28, 2001 from $4.0 million at August 31, 2000. Recourse to the Company on sales of notes receivable is governed by the agreements between the purchasers and the Company. Stockholders' equity increased 5.1% to $27.1 million at February 28, 2001 from $25.8 million at August 31, 2000. ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK The Company engages in business activities that expose it to interest rate risk. The financial exposure is managed as an integral part of the Company's risk management program, which seeks to reduce the potentially adverse effects that the volatility of the interest rate market may have on the Company's operating results. The Company does not engage in speculative transactions or hold financial instruments for trading purposes. In August 2000, the Company entered into a $25 million, 5-year, interest rate swap transaction to hedge potential exposure to its variable rate notes' portfolio. The interest rate swap is considered and is documented as a highly effective cash flow hedge. The swap will mature in fiscal 2005, and the unrealized depreciation as of February 28, 2001 was $1.5 million. The fixed interest rate of the swap is 10.94%. Other than as previously noted, there was no material change for the quarter ended February 28, 2001 in the information about the Company's "Quantitative and Qualitative Disclosures About Market Risk" as disclosed in its Annual Report on Form 10K for the fiscal year ended August 31, 2000. PART II OTHER INFORMATION ITEM 1. LEGAL PROCEEDINGS On February 6, 2001, plaintiff John Ruell filed a purported class action lawsuit in the District Court, Nye County, Nevada. The complaint alleges two causes of action against defendant PEC: (1) a claim requesting specific performance of an alleged obligation to provide an airport taxiway and water service to lot owners in Calvada Meadows Unite 2; and, (2) Fraud. The Complaint is alleged to be brought on behalf of a class consisting of all lot owners in Calvada Meadows Unit 2 located in Nye County, Nevada and seeks unspecified damages in excess of $10,000 and unspecified punitive damages. On March 14, 2001, PEC filed a motion to dismiss the complaint on the grounds that (i) all of the claims are barred by the Plaintiffs failure to exhaust administrative remedies and the primary administrative jurisdiction of the Nevada Public Utilities Commission; (ii) all of the claims are barred by the filed tariff doctrine; (iii) all of the claims are barred by the applicable statute of limitations; (iv) the claim for specific performance is inapplicable to the construction contracts at issue and money damages are an adequate remedy, precluding specific performance as a remedy, and (v) the fraud claim is barred due to the failure to plead fraud with particularity and because the mere failure to fulfill a promise to perform an act in the future does not amount to fraud. The hearing on PEC's motion to dismiss is scheduled for May 21, 2001. There has been no material change in the status of other litigation reported in the Company's Annual Report on Form 10-K for the year ended August 31, 2000. ITEM 5. OTHER INFORMATION On March 7, 2001, Leonard Toboroff was elected to the Board of Directors. 15 18 ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K EXHIBITS
EXHIBIT NUMBER DESCRIPTION ------- ----------- 10.225 First Amendment to Loan and Security Agreement by and between Preferred Equities Corporation and Dorfinco Corporation dated November 30, 2000. 10.226 First Amendment to General Loan and Security Agreement between Steamboat Suites, Inc., and Preferred Equities Corporation dated February 1, 2001. 10.227 Eighth Amendment to Forbearance Agreement and Amendment No. 13 to Second Amended and Restated and Consolidated Loan and Security Agreement between Finova Capital corporation and Preferred Equities Corporation dated December 29, 2000. 10.228 Twelfth 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 February 15, 2001.
No reports on Form 8-K were filed during the period. 16 19 SIGNATURE Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. MEGO FINANCIAL CORP. By: /s/ Charles G. Baltuskonis ------------------------------------- Charles G. Baltuskonis Senior Vice President and Chief Accounting Officer Date: April 11, 2001 17