10-Q 1 d10q.txt FORM 10-Q =============================================================================== 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: March 31, 2002 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 May 1, 2002, there were 5,577,183 shares of Common Stock, $.01 par value per share, of the Registrant outstanding. ================================================================================ MEGO FINANCIAL CORP. AND SUBSIDIARIES INDEX -----
Page ---- PART I FINANCIAL INFORMATION Item 1. Condensed Financial Statements (unaudited) Condensed Consolidated Balance Sheets at March 31, 2002 and December 31, 2001...................1 Condensed Consolidated Statement of Operations for the Three Months Ended March 31, 2002 and February 28, 2001.........................................................2 Condensed Consolidated Statements of Cash Flows for the Three Months Ended March 31, 2002 and February 28, 2001.........................................................3 Notes to Condensed Consolidated Financial Statements............................................4 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations.......................................................................6 Item 3. Quantitative and Qualitative Disclosures About Market Risk.....................................12 PART II OTHER INFORMATION Item 1. Legal Proceedings..............................................................................12 Item 2. Changes in Securities..........................................................................13 Item 3. Sale of Central Nevada Utilities Company.......................................................13 Item 4. Exhibits and Reports on Form 8-K...............................................................13 SIGNATURE...................................................................................................15
i 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)
ASSETS March 31, 2002 December 31, 2001 -------------- ----------------- Cash and cash equivalents $ 2,955 $ 1,271 Restricted cash 5,991 6,708 Notes receivable, net of allowance of $13,369 and $14,557 at March 31, 2002 and December 31, 2001, respectively 112,020 109,347 Retained interests in receivables sold, at fair value 3,333 3,688 Vacation ownerships held for resale 19,887 17,865 Land and improvements inventory 2,994 2,757 Assets available for sale 3,392 3,468 Property and equipment, net 9,790 9,690 Deferred financing costs 2,063 2,071 Deferred selling costs 5,336 5,422 Other assets 9,623 14,910 Assets related to discontinued operations 15,121 15,156 -------------- ---------------- TOTAL ASSETS $ 192,505 $ 192,353 ============== ================ LIABILITIES AND STOCKHOLDERS' EQUITY Liabilities: Notes and contracts payable $ 127,621 $ 131,530 Accounts payable 1,520 1,873 Accrued liabilities 12,071 11,775 Interest rate swap liability 1,920 2,251 Deferred income 3,377 2,097 Reserve for notes receivable sold with recourse 3,131 3,560 Customer deposits 2,592 2,831 Deferred income taxes 433 1,289 Liabilities related to discontinued operations 9,838 9,545 -------------- ---------------- Total liabilities before subordinated debt 162,503 166,751 -------------- ---------------- Subordinated debt 4,211 4,211 Commitments and contingencies Stockholders' equity: Preferred stock, $.01 par value (authorized--5,000,000 shares, none outstanding) - - Common stock, $.01 par value (authorized--50,000,000 shares; 4,784,307 shares issued and outstanding at March 31, 2002 and 3,500,557 shares at December 31, 2001 48 35 Additional paid-in capital 18,836 13,068 Retained earnings 8,174 9,773 Accumulated other comprehensive loss (1,267) (1,485) -------------- ----------------- Total stockholders' equity 25,791 21,391 -------------- ----------------- TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 192,505 $ 192,353 ============== =================
See notes to condensed consolidated financial statements. 1 MEGO FINANCIAL CORP. AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (thousands of dollars, except per share amounts) (unaudited)
Three Months Ended ------------------------------ March 31, February 28, 2002 2001 -------------- ------------- REVENUES Vacation ownership sales $ 9,157 $ 13,626 Land sales 6,324 5,321 Interest income 4,034 3,550 Financial income 192 850 Other 1,120 932 -------------- ------------- Total revenues 20,827 24,279 COSTS AND EXPENSES Direct cost of: Vacation ownership sales 1,480 2,455 Land sales 1,084 777 Interest expense 3,170 3,088 Marketing and sales 8,846 11,057 General and administrative 4,550 4,409 Provision for cancellations 1,342 1,754 Depreciation 434 351 Restructuring charges 2,480 - -------------- ------------- Total costs and expenses 23,386 23,891 -------------- ------------- (LOSS) INCOME FROM CONTINUING OPERATIONS BEFORE INCOME TAX BENEFIT (2,559) 388 INCOME TAX BENEFIT 787 - -------------- ------------- (LOSS) INCOME FROM CONTINUING OPERATIONS (1,772) 388 Discontinued operations Income from discontinued operations 232 47 Income tax expense (59) (12) -------------- ------------- INCOME FROM DISCONTINUED OPERATIONS, NET OF TAX 173 35 -------------- ------------- NET (LOSS) INCOME APPLICABLE TO COMMON STOCK $ (1,599) $ 423 ============== ============= (LOSS) INCOME PER COMMON SHARE Basic and Diluted: From continuing operations $ (0.41) $ 0.11 From discontinued operations 0.04 0.01 ============== ============= Diluted: Net income applicable to common stock $ (0.37) $ 0.12 -------------- ------------- Weighted-average number of common shares and common share equivalents outstanding 4,276,007 3,500,557 ============== =============
See notes to condensed consolidated financial statements. 2 MEGO FINANCIAL CORP. AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (thousands of dollars, except per share amounts)
Three Months Ended ------------------------------ March 31 February 28 2002 2001 ------------- ------------- CASH FLOWS FROM OPERATING ACTIVITIES Net (loss) income $ (1,599) $ 423 ------------- ------------- Adjustments to reconcile net (loss) income to net cash provided by (used in) operating activities: Charges to allowance for cancellations (3,317) (2,380) Provision for cancellations 913 1,754 Gain on sale of assets available for sales and other assets - 8 Cost of vacation ownership interest and land sales 2,564 3,232 Depreciation 434 351 Repayments on notes receivable 14,602 12,698 Additions to notes receivable (15,300) (19,590) Purchase of land and vacation ownership interests (4,823) (1,405) Changes in operating assets and liabilities: Restricted cash 717 (2,610) Deferred financing costs 8 (427) Retained interests in receivables sold 355 (142) Other assets 5,287 2,343 Deferred selling costs 86 99 Accounts payable (353) (301) Accrued liabilities 296 1,597 Interest rate swap liability (113) 378 Deferred income 1,280 86 Customer depostis (239) 333 Assets related to discontinued operations 35 33 Liabilities related to discontinued operations 293 100 Deferred income taxes (856) 284 ------------- ------------- Net cash provided by (used in) operating activities 270 (3,844) CASH FLOWS FROM INVESTING ACTIVITIES Purchase of property and equipment (458) (129) Proceeds from the sale of other investments - - ------------- ------------- Net cash provided by investing activities (458) (129) CASH FLOWS FROM FINANCING ACTIVITIES Proceeds from borrowings 12,300 13,885 Reduction of debt (16,209) (8,211) Proceeds from issuance of common stock 5,781 - ------------- ------------- Net cash provided by financing activities 1,872 5,674 NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS 1,684 1,701 CASH AND CASH EQUIVALENTS -- BEGINNING OF PERIOD 1,271 4,227 ------------- ------------- CASH AND CASH EQUIVALENTS -- END OF PERIOD $ 2,955 $ 5,928 ============== ============= SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION Cash paid during the period ended March 31, 2002 for: Interest, net of amounts capitalized $ 3,215 $ 3,238 Income taxes $ 136 $ -
See notes to condensed consolidated financial statements. 3 MEGO FINANCIAL CORP. AND SUBSIDIARIES NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS For the three months ended March 31, 2002 (unaudited) 1. Financial Statements In the opinion of management, when read in conjunction with the audited Consolidated Financial Statements as of and for the four month period ended December 31, 2001 and for the years ended August 31, 2001 and 2000, included in the Form 10-KT of Mego Financial Corp. (the Company) filed with the Securities and Exchange Commission, the accompanying unaudited Condensed Consolidated Financial Statements contain all of the information necessary to present fairly the financial position of the Company and subsidiaries at the results of its operations and cash flows for the three then months ended March 31, 2002 and February 28, 2001. In February 2002 the Company changed its fiscal year end from August 31 to December 31. Accordingly the financial information for the three months ended March 31, 2002 is based on the Company's new fiscal year and the information presented for the three months ended February 28, 2001 is based on the Company's old fiscal year (and is considered to be comparable to the March 31, 2002 information for purposes of this quarterly report.) The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the amounts reported in the financial statements. 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 months ended March 31, 2002 are not necessarily indicative of the results to be expected for the year ended December 31, 2002. The balance sheet at December 31, 2001 has been derived from the audited financial statements at that date but does not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements. For further information, refer to the consolidated financial statements and footnotes thereto included in the Company and Subsidiaries' annual report on Form 10-KT for the year period December 31, 2001. 2. Nature of Operations The Company is a developer and operator of vacation ownership and a provider of consumer financing to purchasers of its vacation ownership intervals and land parcels through its wholly-owned subsidiary, Leisure Homes Corporation (LHC), formerly Preferred Equities Corporation (PEC), established in 1969. The Company, through its wholly-owned subsidiary Leisure Resorts Corporation (LRC), manages vacation ownership and receives management income in association therewith. By providing financing to virtually all of its customers, LHC also originates consumer receivables that it hypothecates, sells and services. 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. The Company's executive officers are located at 4310 Paradise Road, Las Vegas, Nevada, 89109, and its telephone number is (702) 737-3700. 3. Sale of CNUC In September 2001, the FASB issued SFAS No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets", on asset impairment that is applicable to financial statements issued for fiscal years beginning after December 15, 2001. 4. Interest Rate Swaps To manage its exposure to interest rate risk in August 2000, the Company entered into an interest rate swap agreement with a notional amount of $25 million that expires in August 2005. The Company entered into another similar interest rate swap agreement in August 2001 for a notional amount of $20 million that expires in August 2006. The swaps convert the floating interest rate on certain of the Company's long-term debt obligat_ into fixed interest rates. As of March 31, 2002, and February 28, 2001, the fair value of the swaps was approximately $1,919,867 and $1,654,872, respectively. 4 The FASB's new rules on asset impairment provides a single accounting model for long-lived assets to be disposed of and supersede SFAS 121 and APB Opinion No. 30, "Reporting the Results of Operations -- Reporting the Effects of Disposal of a Segment of a Business, and Extraordinary, Unusual and Infrequently Occurring Events and Transactions". On October 2, 2001, Central Nevada Utilities Company (CNUC) entered into an agreement with Utilities Inc. providing for the acquisition by Utilities Inc. of all the assets of CNUC for $5.5 million (Asset Sale). Utilities Inc. deposited in escrow $500,000 of the purchase price to assure its performance of the agreement. The transaction was subject to the approval of the Nevada Public Utilities Commission, who approved the transaction on April 9, 2002. From the proceeds $5.2 million was used to repay the Subordinated Debt and accrued interest and the at-risk payment. Upon adoption of SFAS No. 144 as of January 1, 2002, the Company began reporting the operations of its wholly-owned subsidiary, CNUC, as discontinued operations. Recent Developments At the annual meeting of the Company held on January 17, 2002, the Company's shareholders approved the following matters: . Elected an entire new Company board of directors, consisting of Floyd W. Kephart, Spencer I. Browne, Michael H. Greco, James D. Locke, Ross Mangano, Thomas G. Palmer and Edward J. Wegel. . Approved the issuance and sale to LC Acquisition Corp. (LCAC) of 750,000 shares of the Company's common stock and the issuance and sale to Doerge Capital Management, later assigned by Doerge Capital Management to Charles Stewart, of 500,000 shares of the Company's common stock in each case for a purchase price of $4.00 per share. . Approved the sale by certain former officers, directors and other shareholders to LC Acquisition Corp. of an aggregate of 1,269,634 shares of the Company's common stock at a price of $4.00 per share. . Approved the amendment of the payment and security terms of certain outstanding subordinated debt issued by Mego to certain affiliates of former officers, directors and other shareholders and the related security agreements. On December 3, 2001, the Company entered into a Fifteenth Amendment (Fifteenth Amendment) to the Assignment and Assumption Agreement between the Company and Comay Corp., Growth Realty, Inc., RER Corp., and H&H Financial, Inc., affiliates of the Company (Assignors), which would: terminate the pledge of the PEC outstanding stock and replace such pledge with a pledge of all of the outstanding stock of CNUC; defer payment of the remaining principle payments of the Subordinated Debt owed to the Assignors aggregating $4.2 million and all accumulated interest from March 1, 2001 until the sale of CNUC is consummated or terminated, but in no event later than August 31, 2002; and limit recourse to the pledged stock of CNUC and an assignment of up to $5.2 million of the proceeds of the Asset Sale. In exchange for the Assignors agreeing to such amendment, including the deferment of principle and accrued interest payments, the release of the pledge of the PEC stock and the limitation of recourse to the CNUC stock (stock may be transferred only with the consent of the Nevada Public Utilities Commission) and the assignment of up to $5.2 million of the proceeds of the Asset Sale, the Company agreed to an at-risk payment to the Assignors in an amount equal to $644,643, which was paid upon the closing of the sale of CNUC. Because the cost to modify the terms of the Subordinated debt of approximately $645,000 exceeded 10 percent of the present value of the remaining debt cash flows under the term of the original subordinated debt agreement, the modification represented a substantial modification. Accordingly, the modification was accounted for like, and reported in the same manner as, an extinguishment in the Company's Form 10-KT for the period ended December 31, 2001 in accordance with EITF 96-19, "Debtor's Accounting for a Modification or Exchange of Debt Instruments." The completion of the transactions approved by the Company's shareholders took place immediately following the shareholders' meeting. The next day, the new board of directors met to begin planning the restructuring and expansion of the Company's core businesses and the initiation and acquisition of complementary business activities. At that meeting, Floyd W. Kephart was elected Chairman of the Board, Chief Executive Officer and President of the Company. The new management's business plan is to focus the company on being a leisure and vacation solutions provider. Elements of the Company's plan include the following: . Expanding its core vacation ownership business through internal development and acquisition of existing vacation ownership operations. . On March 4, 2002, Leisure Services Corporation (LSC), a wholly- owned Company subsidiary was incorporated in Nevada. LSC will be responsible for all Company customer contacts and relationships. On March 29, 2002, LSC entered into a Management Agreement to perform management and related services for Adventure Bound, Inc., a Tempe, Arizona provider of travel and travel related services. The Company, through LSC and Adventure Bound, Inc., intends to offer travel and travel related services to its customers and potential customers. On May 14, 2002, LSC amended the management agreement to perform management and related services for Cheap Seats, Inc. a wholly-owned subsidiary of LCAC. The Company, through LSC and Adventure Bound, Inc., in conjunction with Cheap Seats, intends to offer tour, travel and travel related services to its current and potential customers. . On March 20, 2002, Leisure Resorts Corporation ("LRC") a wholly- owned Company subsidiary was incorporated in Nevada. LRC will perform all vacation ownership resort and related homeowner association management services which were previously performed by LHC. . On March 21, 2002, the Company entered into a letter of intent with Raintree Resorts International, Inc. (Raintree). Under the terms of the proposed agreement, Raintree will become a wholly owned subsidiary of the Company. The transaction is subject to the successful completion of an inspection period, signing of a definitive purchase and sale agreement, and the appropriate approval of both Companies. Raintree is a developer, marketer and operator of luxury vacation ownership resorts in North America with resorts in Mexico, the United States and Canada. On May 5, 2002, the Company amended its Letter of Intent with Raintree to acquire three operations and properties in an initial transaction to be closed on or before June 1, 2002; to perform due diligence on the remaining properties; to negotiate with the Senior Debenture Holders of Raintree; and to complete all transactions on or before December 31, 2004. 6. Commitments and Contingencies Litigation--On August 27, 1998, an action was filed in Nevada District ---------- Court, County of Clark, No. A 392585, by Robert and Jocelyne Henry, husband and wife individually and on behalf of all others similarly situated against LHC, LHC's wholly-owned subsidiary, Central Nevada Utilities Company (CNUC), and certain other defendants. The plaintiffs' complaint asked for class action relief claiming that LHC and CNUC were guilty of collecting certain betterment fees and not providing associated sewer and water lines. The court determined that plaintiffs had not properly pursued their administrative remedies with the Nevada Public Utilities Commission (PUC) and dismissed plaintiffs' complaint, as amended, without prejudice. Notwithstanding plaintiffs' appeal of the dismissal, plaintiffs filed for administrative relief with the PUC. On November 17, 1999, the PUC found that CNUC, the only defendant over which the PUC has jurisdiction, was not in violation of any duties owed the plaintiffs or otherwise in violation of CNUC's approved tariffs. Subsequent to the PUC's decision, plaintiffs voluntarily dismissed their appeal. On May 4, 2000, plaintiffs re-filed their complaint in Nevada District Court, naming all of the above parties with the exception of CNUC. The May 4, 2000 complaint is virtually identical to the amended complaint discussed above and asserts six claims for relief against defendants: breach of deed restrictions, two claims for breach of contract, unjust enrichment, consumer fraud in violation of NRS 41.600 and violation of NRS 119.220, with all claims arising out of the alleged failure to provide water and sewer utilities to the purchasers of land in the subdivisions commonly known as Calvada Valley North and Calvada Meadows located in Nye County, Nevada. On September 8, 2000, the Company filed a motion to dismiss each of the claims made in the complaint. The Court granted the motion to dismiss with respect to Frederick H. Conte in his individual capacity and denied the motion in all other respects in an order entered on December 19, 2000. Plaintiffs then filed a motion to certify class, which defendants opposed. On September 5, 2001, the Court held that "as to Classes A and B, the showings required under NRCP 23(a) and (b)(2) have been made to the extent injunctive relief / specific performance of the subject alleged contractual obligations is sought, and the Court will certify Classes A and B to such extent only. In all other respects, the Court does not deem certification to be appropriate as to both Classes A and B". As a result of this decision, the Court refused to certify a class for the claims of: breach of contract, unjust enrichment, consumer fraud in violation of NRS 41.600 and violation of NRS 119.220. Accordingly, the defendants are no longer subject to class claims for monetary damages. The defendants' only potential liability is for the construction of water and sewer facilities. The case is now beginning the discovery phase of the litigation. The case is scheduled for a jury trial on August 13, 2002. The Company does not believe that any likely outcome of this case will have a material adverse effect on the Company's financial condition or results of operations. In the general course of business the Company and LHC, at various times, have each 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 effect on its financial condition or results of operations. 7. Subsequent Events . On April 17, 2002, Preferred Equities Corporation's ("PEC") name was changed to Leisure Homes Corporation ("LHC"). LHC will continue PEC's current lines of business and operations except resort management operations will now be performed by LRC. . The Company has incorporated Leisure Industries Corporation of America, Inc. in Delaware and proposes, subject to stockholder approval, to merge into that company and thus change its corporate domicile from New York to Delaware. In anticipation of the name change, the Company changed its NASDAQ trading symbol from "MEGO" to "LESR" on April 15, 2002. The Company's wholly- owned subsidiary, Preferred Equities Corporation, changed its name to Leisure Homes Corporation. The Company also formed two new subsidiaries, Leisure Resorts Corporation and Leisure Services Corporation. Leisure Resorts Corporation will perform all vacation ownership resort and related homeowner management services. Leisure Services Corporation will be responsible for all of the Company's customer contacts and relationships. . On April 18, 2002, the Company entered into a Sale Agreement with Atlantic Development Corporation to acquire 2,021 platted one- acre lots located in Mojave County, Arizona, approximately 20 miles south of the Hoover Dam. The Company is to acquire the lots through the exchange of 540,416 shares of the Company's common stock, valued at $6 per share, for a total consideration of $3,242,496 for all of Atlantic Development Corporation's issued and outstanding stock. Closing of the transaction is subject to the receipt of a Public Report from the State of Arizona allowing the sale of the lots. Application for the Public Report has been made, and the Company expects the Public Report to be issued not later than August, 2002. . On April 19, 2002, LHC and Cedant Corporation ("Cendant") mutually agreed to terminate that certain AGREEMENT ("Agreement") entered into as of April 18, 1995 by between LHC and Cedant. Under the Agreement, LHC was granted a license to use the name "Ramada Vacation Suites" in the sale of LHC's vacation ownership product. LHC and Cendant have agreed that on or before May 1, 2002, LHC and its affiliates will delete any and all references to the names "Ramada" and "Ramada Vacation Suites" in its sales, marketing and resort operations. All signage using the "Ramada" and "Ramada Vacation Suites" names is to be removed on or before September 30, 2002. The Company will continue as a Ramada franchisee for the hotel premises located at its Orlando, Florida vacation ownership resort. In consideration of the termination of the Agreement, LHC has agreed to enter into consulting agreements with Resorts Condominiums International ("RCI") a Cendant subsidiary, or certain of RCI's subsidiaries and affiliates, in an amount not to exceed $300,000.00. The termination of the Agreement will eliminate the Company's payment to Cendant of approximately $2,000,000.00 a year. It is unknown whether the discontinuance of the Company's use of the "Ramada" and "Ramada Vacation Suites" names will have a negative affect on sales. 8. Restructuring Charges In January, 2002 the Company's Board of Directors approved a business restructuring. Among other things, this restructuring included: seven terminations at senior management levels; relocation of corporate office facilities from 1500 E. Tropicana Avenue and 4310 Paradise Road to newer office facilities in closer proximity to one another; discontinuance of the license agreement with Cendant Corporation whereby the Company licensed the use of the mane "Ramada Vacation Suites" in its vacation ownership and resort operations; and approval of change in the name of the resort facilities from "Ramada Vacation Suites" to "Leisure Resorts". 6 As a result of these restructurings, the Company recorded a non-recurring charge of $2.5 million. Included in this total were: severance benefits associated with former senior management and officers of approximately $1.9 million; future rental expense to be incurred on vacated office space of $311,000; and non-cash charges associated with the termination of the Cendant license agreement in the amount of $308,000. As of March 31, 2002 the Company has paid in cash $814,000 and expects to pay the remainder by the end of fiscal 2002. Restructuring charges, in certain cases, are based on estimates and subject to change; however, the Company does not believe revisions to the above estimates will be material. 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 contains 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 expectations and estimates as to the Company's business operations, including the introduction of new vacation ownership 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. The economic downturn in the tourism industry following the September 11, 2001 terrorist attacks had an adverse impact on the operating results of the Company's first fiscal quarter, which impact potentially can continue in the foreseeable future. The Company has a mixture of customers who fly and drive into the various resort locations. At this time, there can be no assurances that this economic downturn due to a decrease in travel and anxiety about possible future terrorist attacks will not extend to future periods. 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 Company's Form 10-KT for the year ended December 31, 2001, and the Condensed Consolidated Financial Statements, including the notes thereto, contained elsewhere herein. General The business of the Company is the marketing, financing and sale of vacation ownership interests, retail lots and land parcels, servicing receivables related to the purchase money financing of vacation ownership and land sales and managing vacation ownership. LHC provides financing to purchasers of its vacation ownership interests and land. This financing is generally evidenced by notes secured by deeds of trust and 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. LHC has entered into financing arrangements with certain purchasers of vacation ownership interests and land parcels 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 $4.7 million at March 31, 2002 and $5.7 million at December 31, 2001 were made under such arrangement. 7 The Company recognizes revenue primarily from sales of vacation ownership interests and land sales in resort areas, interest income, gain on sale of receivables, financial income from servicing the related receivables and management fees from operating and managing vacation ownership. LHC periodically sells its consumer receivables while generally retaining the servicing rights. Revenue from sales of vacation ownership 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 vacation ownership 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 vacation ownership interests typically meet these requirements at the time of sale. The sale price is recorded as revenue and the allocated cost related to such net revenue of the vacation ownership 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 has been recovered or is in the process of being recovered. Cancellation of a note receivable in the quarter the related sales 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. The Company generally sells its notes receivable at par value. When the Company sells notes receivable, it retains certain participation in the cash flows of the notes receivable sold and generally retains the associated servicing rights. The sales are generally subject to limited recourse provisions as provided in the respective notes receivable sales agreements. Under these agreements, the Company is generally obligated to replace or repurchase accounts that become 60 to 90 days delinquent or are otherwise subject to replacement or repurchase in either cash or receivables. 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 Balance Sheet. Gain on sale of receivables depends in part on the previous carrying amount of the financial assets involved in the transfer, allocated between the assets sold and the retained interests based on their relative fair value at the date of the transfer. To obtain fair values on the retained interests (both at the point of the related receivable sale and periodically thereafter) the Company generally estimates fair value based on the present value of future expected cash flows estimated using management's best estimates of certain key assumptions including: default dates; rates of prepayment; loss reserve rates and discount rates commensurate with the risks involved. The Company's retained interests in receivables sold are carried at fair market value as either derivatives or available-for-sale investments. Unrealized holding gains or losses on the retained interests are included in earnings for those transactions structured so that the Company, through its retained interests, receives fixed interest amounts and pays the buyer variable amounts based on a floating rate index, as the resulting financial interest meets the definition of a derivative in accordance with Statement of Financial Standards No. 133 "Accounting for Derivative Instruments and Hedging Activities". Unrealized holding gains, if any, on retained interests in receivables sold not meeting the definition of a derivative would be included in shareholders' equity, net of income taxes. Losses in such retained interests are reflected in earnings. 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. LHC records provision for cancellations at the time revenue is recognized, based on historical experience and current economic factors. The related allowance for cancellations represents LHC'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. LHC'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. 8 Fees for servicing notes receivable originated by LHC 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. Retained interests in receivables sold 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 LHC's portfolio, the accretion of the discount on the retained interests in receivables sold 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 vacation ownership interests and land, depreciation and interest expense. Marketing and sales costs directly attributable to unrecognized sales are accounted for as deferred selling costs until such time as the sale is recognized. Land sales as of March 31, 2002, exclude $17.6 million of sales not yet recognized under generally accepted accounting principles since the requisite payment amounts have not yet been received or the respective rescission periods have not yet expired. Of the $17.6 million unrecognized land sales, the Company estimates that it will ultimately recognize $15.0 million of revenues, which would be reduced by a related provision for cancellations of $2.6 million, estimated deferred selling costs of $3.73 million and cost of sales of $3.0 million, for an estimated net profit of $6.0 million. Results of Operations Three Months Ended March 31, 2002 compared to Three Months Ended February 28, 2001 Total revenues for the Company decreased 14.4% or $3.5 million to $20.8 million during the three months ended March 31, 2002 from $24.2 million during the three months ended February 28, 2001. The net decrease was primarily due to a net decrease of $3.5 million in vacation ownership interest and land sales to $15.5 million during the three months ended March 31, 2002 from $18.9 million during the three months ended February 28, 2001 vacation ownership interest sales decreased by $4.5 million and land sales increased by $1.0 million and an increase in interest income to $4.0 million during the three months ended March 31, 2002 from $3.6 million during the three months ended February 28, 2001. Interest income increased to $4.0 million during the three months ended March 31, 2002 from $3.6 million for the three months ended February 28, 2001, an increase of 13.6%, primarily due to an increase in notes receivable balance during the period. Total costs and expenses for the Company decreased to $23.4 million for the three months ended March 31, 2002 from $23.9 million for the three months ended February 28, 2001, a decrease of 2.1%. The decrease resulted primarily from the net effect of the following: a decrease in direct costs of vacation ownership interest sales to $1.5 million from $2.5 million, a decrease of 40%; and, a decrease to $8.8 million from $11.1 million in marketing and sales expense, a decrease of 20%. As there are substantially variable cost elements in marketing and sales, the percentage of marketing and sales expenses to gross sales would remain relatively constant in periods of lower sales. As the tourism industry has experienced an economic downturn since the September 11, 2001 terrorist attacks, the Company believes that the decline in sales volume is directly related to such events, but is unable to quantify the sales volume decline that is directly attributable to such events. Interest expense increased to $3.2 million during the first 2002 quarter from $3.1 million during the first 2001 quarter, an increase of 2.7%. 9 A pretax loss of $2.6 million was recorded during the first 2002 quarter compared to pretax income of $0.4 million earned during the first 2001 quarter. In January, 2002 the Company's Board of Directors approved a business restructuring. Among other things, this restructuring included: seven terminations at senior management levels; relocation of corporate office facilities from 1500 E. Tropicana Avenue and 4310 Paradise Road to newer office facilities in closer proximity to one another; discontinuance of the license agreement with Cendant Corporation whereby the Company licensed the use of the name "Ramada Vacation Suites" in its vacation ownership and resort operations; and approval of change in the name of the resort facilities from "Ramada Vacation Suites" to "Leisure Resorts". As a result of these restructurings, the Company recorded a non-recurring charge of $2.5 million. Included in this total where: severance benefits associated with former senior management and officers of approximately $1.9 million; future rental expense to be incurred on vacated office space of $311,000; and non-cash charges associated with the termination of the Cendant license agreement in the amount of $308,000. As of March 31, 2002 the Company has paid in cash $814,000 and expects to pay the remainder by the end of fiscal 2002. Restructuring charges, in certain cases, are based on estimates and subject to change; however, the Company does not believe revisions to the above estimates will be material. An income tax benefit of $0.8 million was recorded for the period ended, March 31, 2002 compared to an income tax benefit of $0 recorded for the period ended, February 28, 2001. The income tax calculation for the period ended, February 28, 2001 was reduced due to the use of net operating loss carry forwards which were previously fully reserved and were used to offset income on a consolidated basis. Income taxes are recorded based on an ongoing review of related facts and circumstances. Net loss applicable to common stock amounted to $1.6 million during the period ended, March 31, 2002 compared to net income applicable to common stock of $0.4 million during the period ended, February 28, 2001, primarily due to the foregoing. Liquidity and Capital Resources The following discussion relates to our financial position at March 31, 2002 and the results of our operations for the period then ended. In January, 2002, the Company's new management adopted a business plan contemplating, among other things, the substantial expansion of our vacation resort business, and the initiation and acquisition of businesses that complement our vacation resort business. See "Business - Recent Events" for a discussion of the elements of our business plan. This change in our business model, as well as the risks and uncertainties inherent in our historical business, are expected to cause our results of operations and the components thereof to change materially in the future. In addition, we will require substantial additional capital in the near term to implement certain elements of our business plan, including the acquisition of the three properties from Raintree and other businesses. There is no assurance that we will be able to raise the necessary capital in a timely manner and on terms acceptable to us. Any failure to raise the necessary capital may have a material adverse effect on our operations and financial results. At March 31, 2002, no commitments existed for material capital expenditures. However, if the Company completes the transactions contemplated by the outstanding Letters of Intent as stated in Item 1 and adheres to the Company's business plan, the Company will incur material capital expenditures in the future. At March 31, 2002, the Company had arrangements, as amended for subsequent agreement revisions, with institutional lenders for the financing of receivables in connection with sales of vacation ownership interests and land and the acquisition of vacation ownership properties and land, which provide for lines of credit of up to an aggregate of $167.0 million. Such lines of credit are secured by vacation ownership and land receivables and mortgages. At March 31, 2002, an aggregate of $120.9 million was outstanding under such lines of credit and $46.1 million was available for borrowing (subject to the availability of qualified collateral). Under the terms of these lines of credit, LHC may borrow 65% to 90% of the balances of the pledged vacation ownership and land receivables. 10 LHC is required to comply with certain covenants under these agreements which, among other things, require LHC to meet certain minimum tangible net worth requirements. The most stringent of such requirements provides that LHC maintains a minimum tangible net worth of $27.5 million. At March 31, 2002, LHC's tangible net worth was $36.8 million. Summarized lines of credit information and accompanying notes relating to these lines of credit outstanding at March 31, 2002, consist of the following: (thousands of dollars)
Outstanding at Maximum Revolving Lender March 31, 2002 Amounts Expiration Date (a) Maturity Date (a) Interest Rate ------ -------------- ----------- --------------------- -------------------- -------------------- Finova $ 57,780 $ 65,000 December 31, 2002 2/28/02 - 5/15/10 Prime + 2.0 - 2.25% Textron 28,652 35,000 December 1, 2002 12/31/02 - 12/31/05 Prime + 2.0 - 3% GE Capital 27,178 40,000 April 30, 2003 March 30, 2006 Libor + 4.0 - 4.25% HSBC 165 - Inactive February 6, 2006 Prime + 1.0% Capital Source 5,791 27,000 9/11/03 - 3/11/05 August 11, 2005 Prime + 2.5% ------------- --------- September 11, 2003 March 11, 2005 $ 119,566 $ 167,000 ============= =========
(a) As it has typically done in the past, management expects the Revolving Expiration Date and Maturity Date on similar terms. When the Revolving Expiration Date expires as shown, the loans convert to term loans with maturities as stated or extended. LHC is required to comply with certain financial and non-financial covenants under these line of credit agreements. Among other things, these agreements require LHC to meet certain minimum tangible net worth requirements, maintain certain liabilities to tangible net worth ratios and maintain marketing & sales and general & administrative expenses, as defined, relative to net processed sales for each rolling 12-month period below a certain percentage. The maximum percentage related to costs and expenses referred to above has been exceeded in the last four quarters. This does not constitute an Event of Default as defined under this loan agreement, or this line of credit; however, it gives the lender the option to suspend advances to LHC. The lender has not elected to exercise this option, but has continued to make regular advances and has verbally informed LHC that it intends to continue such advances. The maximum loan-to-value ratio referred to above was exceeded in the last two quarters. As a result, there presently exists the right of the Lender to declare an Event of Default as defined under this loan agreement, or this line of credit. Default of the loan-to-value ratio, under this line, can only cause the lender to cease advance to the Company. The lender has agreed to forbear from exercising any of its remedies under the loan agreement through July 31, 2002 as set forth in the side letter dated January 3, 2002. In exchange for the lender agreeing to the provisions of the side letter, the Company was required to pay the lender $250,000. Under this letter, the Company has pledged additional eligible receivables on a schedule to bring this line into compliance by July 31, 2002. Scheduled maturities of the Company's notes and contracts payable are as follows: Period Ended March 31, (thousands of dollars) ---------------------- 2002......................... $ 5,533 2003......................... 5,549 2004......................... 13,605 2005......................... 18,356 2006......................... 28,198 Thereafter................... 56,380 ---------- ................... $ 127,621 ---------- A schedule of the cash shortfall arising from recognized and unrecognized sales for the periods indicated is set forth below: (thousands of dollars) March 31, February 28, -------------------------- 2002 2001 ----------- ----------- Marketing and selling expenses attributable to recognized and unrecognized sales $ 9,037 $ 22,025 Less: Down payments (2,438) (6,375) ----------- ----------- Cash Shortfall $ 6,599 $ 15,650 =========== =========== The Company sells notes receivable subject to recourse provisions as contained in each agreement. At December 31, 2001, total sold notes receivable was $47.0 million. The Company 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. The repurchase provisions provide for substitution of receivables as recourse for $49.4 million of sold notes receivable and cash payments for repurchase relating to $6.6 million of sold notes receivable. 11 The undiscounted amounts of the recourse obligations on such notes receivable were $3.1 million and $3.6 million at March 31, 2002 and December 31, 2001, respectively. LHC 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) March 31, December 31, 2002 2001 ------------ ------------ Notes collateralized by receivables $ 104,725 $ 106,599 Mortgages collateralized by real estate properties 15,313 14,781 Installment contracts and other notes payable 7,583 10,150 ------------ ------------ Total $ 127,621 $ 131,530 ============ ============ Financial Condition 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, 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, including the reserve for notes receivable sold with recourse for the three months ended March 31, 2002 consisted of the following: (thousands of dollars) March 31, 2002 ---------- Balance at beginning of period $ 18,470 Provision for cancellations 1,342 Amounts charged to allowance for cancellations, net (3,312) ----------- 16,500 Reserve for notes sold with recourse (3,131) ----------- Allowance for cancellations 13,369 =========== March 31, 2002 compared to December 31, 2001 Cash and cash equivalents increased to $3.3 million at March 31, 2002 from $1.7 million at December 31, 2001. Notes receivable, net, increased 2.4% to $112.0 million at March 31, 2002 from $109.3 million at December 31, 2001. 12 Land and improvements inventory and vacation ownership interests held for sale increased 11.3% to $19.9 million at March 31, 2002 from $17.9 million at December 31, 2001. (thousands of dollars) March 31, December 31, ------------ ------------ 2002 2001 ------------ ------------ Vacation ownership interests $ 18,029 $ 13,771 Vacation ownership interests in development 1,858 4,094 ------------ ------------ Total $ 19,887 $ 17,865 ============ ============ Notes and contracts payable increased 3.0% to $127.6 million at March 31, 2002 from $131.5 million at December 31, 2001. Stockholders' equity increased 20.6% to $25.8 million at March 31, 2002 from $21.4 million at December 31, 2001. Item 3. Quantitative and Qualitative Disclosures About Market Risk There was no material change for the quarter ended March 31, 2002 in the information about the Company's "Quantitative and Qualitative Disclosures About Market Risk" as disclosed in its Annual Report on Form 10-KT for the year ended December 31, 2001. PART II OTHER INFORMATION Item 1. Legal Proceedings There has been no material change in the status of litigation reported in the Company's Annual Report on Form 10-KT for the year ended December 31, 2001. Item 2. Changes in Securities On January 18, 2002, the Company issued 750,000 shares of its Common Stock to LC Acquisition Corp. for cancellation of indebtedness in the amount of $3,000,000. The Company issued 500,000 shares to Charles K. Stewart, as assignee of the purchase commitment of Doerge Capital Management. These transactions were approved by the stockholders of the Company at a meeting held on January 17, 2002. The issuance of the shares was exempt from the registration requirements of the Securities Act of 1933, as amended, pursuant to Section 4(2) thereof. In January, 2002, the Company issued a warrant to purchase 175,000 shares of Common Stock at $4.00 per share to Roan/Meyer Associates, LP as compensation for financial advisory services. The issuance of the warrant was exempt from the registration requirements of the Securities Act pursuant to Section 4(2) thereof. The warrant has been exercised in full and the resale of the shares issued upon exercise of the warrant has been registered under the Securities Act. During the quarter ended March 31, 2002, the Company issued for $4.40 per share a total of 226,767 shares of Common Stock and warrants to purchase 226,767 shares at an exercise price of $5.00 per share. The warrants are callable if the underlying Common Stock trades for $7.00 per share for a consecutive period of ten days. The purchasers of the shares were Stonestreet Limited Partnership, Perg Galleon LLC, Michael D. Brown, Jeffrey Catuara, Robert W. Baird, Hazlett Burt & Watson and William C. White. The issuance of the shares and accompanying warrants was exempt from the registration requirements of the Securities Act pursuant to Section 4(2) thereof. 13 Item 3. Sale of Central Nevada Utilities Company On April 11, 2002, LHC's wholly owned subsidiary, Central Nevada Utilities Company completed the sale of substantially all of its assets to Utilities, Inc. for $5,500,000. $5,200,000 was used to pay the Subordinated Debt in full. This sale is not expected to have a significant impact on the Company's 2002 results of operation. The Company estimates that the gain on the sale of CNUC to be approximately $371,000. Item 4. Exhibits and Reports on Form 8-K Exhibits -------- Exhibit Description ------- ----------- Number ------ 10.238 Termination Agreement dated January 17, 2002 between The Company Corp and Jerome J. Cohen. 10.239 Employment Agreement dated January 17, 2002 between The Company Corp and Herbert B. Hirsch. 10.240 Amended, Restated and Increased Receivables Promissory Note No. 2 for $40,000,000 dated December 20, 2001 by Preferred Equities Corporation to Heller Financial Inc. 10.241 Purchase Money Promissory Note between M & J Wilkow as agent for The Villas at Monterey Limited Partnership and Tango Bay of Orlando for $5,927,164.65 dated August 15, 2001. 10.242 Letter Agreement and Amendment No. 4 dated January 3, 2002 between Preferred Equities Corporation and FINOVA Capital Corporation regarding the Biloxi Property. 10.243 Letter Agreement dated January 23, 2002 between FINOVA Capital Corporation and Preferred Equities Corporation regarding the purchase of the Great Vacations Resort of Hershey. 10.244 Loan and Security Agreement dated March 11, 2002 for Acquisition and for Construction of 158 Ida with Promissory Notes and First Modification Agreement for Receivables between Preferred Equities Corporation and Capital Source Finance LLC. 10.245 Employment Contract by and between The Company Corporation and Jon Arlington Joseph dated January 1, 2002. A report on Form 8-K was filed on January 30, 2002. This form 8-K refers to the Company's change in control, reporting the consummation of the transactions reported in December. A report on Form 8-K was filed on March 1, 2002. This form 8-K refers to the Company's change in fiscal year, reporting the Board's decision to change the fiscal year from August 31st to December 31st. A report 8-K was filed on March 1, 2002. This form 8-K refers to the Company's other events, reporting the sale to Charles Stewart of 500,000 shares pursuant to the assignment to and assumption by him of the Doerge subscription agreement. 14 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/ Robert S. Understein ------------------------------- Robert S. Understein Chief Financial Officer Date: May 21, 2002 15