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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM 10-K/A
AMENDMENT NO. 1
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934 (FEE REQUIRED)
FOR THE FISCAL YEAR ENDED AUGUST 31, 1996
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934 (NO FEE REQUIRED)
FOR THE TRANSITION PERIOD FROM TO
COMMISSION FILE NUMBER 1-8645
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MEGO FINANCIAL CORP.
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
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NEW YORK 13-5629885
(STATE OR OTHER JURISDICTION OF (IRS EMPLOYER
INCORPORATION OR ORGANIZATION) IDENTIFICATION NO.)
4310 PARADISE ROAD, LAS VEGAS, NEVADA 89109
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES) (ZIP CODE)
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REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE: 702-737-3700
SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT: NONE
SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT:
COMMON STOCK, $.01 PAR VALUE
(TITLE OF CLASS)
Indicate by check mark whether the registrant: (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes [X] No [ ]
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of the Registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. Yes [X]
As of November 8, 1996, 18,433,121 shares of the registrant's Common Stock
were outstanding. The aggregate market value of Common Stock held by
non-affiliates of the registrant as of November 8, 1996 was approximately
$170,506,369, based on a closing price of $9.25 for the Common Stock as reported
on the NASDAQ National Market on such date. For purposes of the foregoing
computation, all executive officers, directors and 5 percent beneficial owners
of the registrant are deemed to be affiliates. Such determination should not be
deemed to be an admission that such executive officers, directors or 5 percent
beneficial owners are, in fact, affiliates of the registrant.
DOCUMENTS INCORPORATED BY REFERENCE
None
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PART I
ITEM 1. BUSINESS
GENERAL
The Company is a specialty financial services company that, through its
wholly-owned subsidiary, Preferred Equities Corporation (PEC), and its 81.3%
owned subsidiary, Mego Mortgage Corporation (MMC), is engaged primarily in
originating, selling and servicing consumer receivables generated through home
improvement loans and timeshare and land sales. MMC originates Title I home
improvement loans insured by the Federal Housing Administration (FHA) of the
Department of Housing and Urban Development (HUD) and conventional home
improvement and equity loans through a network of loan correspondents and home
improvement contractors. PEC markets and finances timeshare interests in select
resort areas, as well as retail lots and land parcels. By providing financing to
virtually all of its customers, PEC also originates consumer receivables that it
sells and services. Timeshare and land sales have historically accounted for
most of the Company's revenues and profits; however, since March 1994, when MMC
commenced operations, originating, selling and servicing home improvement loans
have accounted for an increasing portion of revenues and profits. Total revenues
contributed by PEC were $60.6 million, $56.8 million and $47.4 million for 1996,
1995 and 1994, respectively. Total revenues contributed by MMC were $25 million,
$13.6 million and $751,000 for 1996, 1995, and 1994, respectively. For
additional information regarding the Company's business segments, see Note 25 of
Notes to Consolidated Financial Statements and Management's Discussion and
Analysis of Financial Condition and Results of Operations.
As further described in Management's Discussion and Analysis of Financial
Condition and Results of Operations -- Subsequent Event, in November 1996 MMC
issued 2,300,000 shares of its common stock and $40 million of 12.5% Senior
Subordinated Notes due 2001 in public offerings. As a result of these
transactions, the Company's ownership in MMC declined to 81.3% and consolidated
outstanding debt increased $40 million.
The Company was incorporated under the laws of the state of New York in
1954 under the name Mego Corp. and, in 1992, changed its name to Mego Financial
Corp. In January 1988, the Company sold a controlling interest in the Company
consisting of approximately 43% of the then outstanding common stock after the
sale to affiliates of the Assignors. See "Item 13. Certain Relationships and
Related Transactions" and Note 2 of Notes to Consolidated Financial Statements.
In February 1988, the Company acquired PEC, pursuant to an assignment by the
Assignors of their contract right to purchase PEC. The Company's executive
offices are located at 4310 Paradise Road, Las Vegas, Nevada, and its telephone
number is (702) 737-3700.
MEGO MORTGAGE CORPORATION
GENERAL
MMC is a specialized consumer finance company that originates, purchases,
sells and services consumer loans consisting primarily of home improvement loans
secured by liens on the improved property. Through its network of Correspondents
and Dealers, MMC initially originated only Title I Loans. The Title I program
provides for insurance of 90% of the principal balance of the loan, and certain
other costs. MMC began offering Conventional Loans through its Correspondents in
May 1996. The Company established MMC and entered the home improvement lending
market to take advantage of PEC's servicing and collection capabilities, the
experience of the Company's senior executives in home improvement lending, the
similar customer profile of home improvement borrowers and purchasers of its
time share interests and land parcels, and relatively stable prepayment
expectations.
MMC's borrowers are individuals who own their home and have appropriate
verifiable income but may have limited access to traditional financing sources
due to insufficient home equity, limited credit history or high ratios of debt
service to income. These borrowers require or seek a high degree of personalized
service and prompt response to their loan applications. As a result, MMC's
borrowers generally are not averse to paying higher interest rates that MMC
charges for its loan programs as compared to the interest rates charged by banks
and other traditional financial institutions. MMC has developed a proprietary
credit index profile that
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includes as a significant component the credit evaluation score methodology
developed by Fair, Isaac and Company (FICO) to classify borrowers on the basis
of likely future performance. The other components of MMC's scoring system
include debt to income ratio, employment history and residence stability. MMC
charges varying rates of interest based upon the borrower's credit profile and
income. MMC quotes higher interest rates for those borrowers exhibiting a higher
degree of risk. The borrowers' credit standing and/or lack of collateral may
preclude them from obtaining alternate funding. For the year ended August 31,
1996, the loans originated by MMC had a weighted-average interest rate of
14.03%.
The credit evaluation methodology developed by FICO takes into
consideration a number of factors in the borrower's credit history. These
include, but are not limited to, (i) the length of time the borrower's credit
history has been on file with the respective credit reporting agency, (ii) the
number of open credit accounts, (iii) the amount of open revolving credit
availability, (iv) the payment history on the open credit accounts and (v) the
number of recent inquiries for the borrower's credit file which may indicate
additional open credit accounts not yet on file. Based on this information FICO
will assign a score to the borrower's credit file which is updated periodically.
Based on their statistical analysis, this score will indicate the percentage of
borrowers in that score range expected to become 90 days delinquent on an
additional loan. The score ascribed by FICO weighs heavily in MMC's approval
process; however its effects, whether positive or negative, can be mitigated by
the other factors described above.
MMC's loan originations increased to $139.4 million during the fiscal year
ended August 31, 1996 from $87.8 million during the fiscal year ended August 31,
1995 and $8.2 million during the six months in which it originated loans in the
fiscal year ended August 31, 1994. MMC's revenues increased to $25 million for
the year ended August 31, 1996 from $13.6 million for the fiscal year ended
August 31, 1995 and $751,000 for the fiscal year ended August 31, 1994. For the
year ended August 31, 1996, the Company had net income of $6.9 million compared
to $3.6 million for the year ended August 31, 1995. As a result of the
substantial growth in loan originations, MMC has operated since March 1994, and
expects to continue to operate for the foreseeable future, on a negative cash
flow basis.
MMC sells substantially all the loans it originates through either whole
loan sales to third party institutional purchasers or securitizations at a yield
below the stated interest rate on the loans, retaining the right to service the
loans and receive any amounts in excess of the guaranteed yield to the
purchasers. MMC completed its first two securitizations of Title I Loans in
March and August 1996 totalling $133 million and expects to sell a substantial
portion of its loan production through securitizations in the future. At August
31, 1996, MMC serviced $209.5 million of loans it had sold, and $4.7 million of
loans it owned.
HOME IMPROVEMENT LOAN INDUSTRY
According to data released by the Commerce Department's Bureau of the
Census, expenditures for home improvement and repairs of residential properties
have exceeded $100 billion per year since 1992 with 1995 expenditures estimated
at $112.6 billion. MMC targets the estimated $40 billion of those expenditures
which are for owner-occupied single-family properties where improvements are
performed by professional remodelers. As the costs of home improvements
escalate, home owners are seeking financing as a means to improve their property
and maintain and enhance its value. The National Association of Home Builders
Economics Forecast in 1995 estimates that home improvement expenditures will
exceed $200 billion by the year 2003. Two types of home improvement financing
are available to borrowers, the Title I program administered by the FHA, which
is authorized to partially insure qualified lending institutions against losses,
and uninsured loans where the lender relies more heavily on the borrower's
creditworthiness, debt capacity and the underlying collateral. Both types of
loans are generally secured with a real estate mortgage lien on the property
improved.
The conventional home improvement financing market continues to grow as
many homeowners have limited access to traditional financing sources due to
insufficient home equity, limited credit history or high ratios of debt service
to income. Conventional loan proceeds can be used for a variety of improvements
such as large remodeling projects, both interior and exterior, kitchen and bath
remodeling, room additions and in-ground swimming pools. Borrowers also have the
opportunity to consolidate a portion of their outstanding debt in order to
reduce their monthly debt service.
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According to the FHA, the amount of single family Title I Loans originated
has grown from $375 million during 1988 to $1.3 billion during 1995. Based on
FHA data, MMC estimates that it had an 8.6% market share of the property
improvement Title I Loan market in calendar 1995. Out of approximately 3,100
lenders participating in the program in 1995, according to FHA data, MMC was the
third largest originator of property improvement Title I Loans. Under Title I,
the payment of approximately 90% of the principal balance of a loan is insured
by the United States of America in the event of a payment default. The Title I
program generally limits the maximum amount of the loan to $25,000 and restricts
the type of eligible improvements and the use of the loan proceeds. Under Title
I, only property improvement loans to finance the alteration, repair or
improvement of existing single family, multifamily and non-residential
structures are allowed. The FHA does not review individual loans at the time of
approval. In the case of a Title I Loan less than $7,500, no equity is required
in the property to be improved and the loan may be unsecured.
BUSINESS STRATEGY
MMC's strategic plan is to continue to expand its lending operations while
maintaining its credit quality. MMC's strategies include: (i) offering new loan
products; (ii) expanding its existing network of Correspondents and Dealers;
(iii) entering new geographic markets; (iv) realizing operational efficiencies
through economies of scale; and (v) using securitizations to sell higher volumes
of loans on more favorable terms. At August 31, 1996, MMC had developed a
nationwide network of approximately 310 active Correspondents and approximately
435 active Dealers. MMC's Correspondents generally offer a wide variety of loans
and its Dealers typically offer home improvement loans in conjunction with debt
consolidation. By offering a more diversified product line, including
Conventional Loans, and maintaining its high level of service, MMC has increased
the loan production from its existing network of Correspondents. MMC anticipates
that as it expands its lending operations, it will realize economies of scale
thereby reducing its average loan origination costs and enhancing its
profitability. In addition, MMC intends to continue to sell its loan production
through securitizations as opportunities arise. Through access to
securitization, the Company believes that it has the ability to sell higher
volumes of loans on more favorable terms than in whole loan sales.
PRODUCT EXTENSION AND EXPANSION
MMC intends to continue to review its loan programs and introduce new loan
products to meet the needs of its customers. MMC will also evaluate products or
programs that it believes are complementary to its current products for the
purpose of enhancing revenue by leveraging and enhancing MMC's value to its
existing network of Correspondents and Dealers. MMC believes that its
introduction of new loan products will enhance its relationship with its Dealers
and Correspondents and enable it to become a single source for their various
financing needs. Since it commenced operations, MMC has originated Title I Loans
from both its Dealers and Correspondents. In May 1996, MMC broadened these
activities to include non-FHA insured home improvement loans and combination
home improvement and debt consolidation loans. To date, these non-FHA insured
loans have been originated solely through Correspondents. All of these loans,
which permit loan amounts up to $60,000 with fixed rates and 20-year maturities,
are secured by a lien, generally junior in priority, on the respective primary
residence. MMC intends to offer pure debt consolidation loans in the first
quarter of fiscal 1997. MMC also intends to offer non-FHA insured loans through
its Dealer division in the first quarter of 1997 and to make direct debt
consolidation loans to borrowers originated by the Dealer division in
conjunction with home improvement financing.
EXPANSION OF CORRESPONDENT OPERATIONS
MMC seeks to increase originations of loans from select Correspondents. MMC
has expanded its product line to include Conventional Loans to meet the needs of
its existing network of Correspondents. Prior to May 1996, MMC originated only
Title I Loans. This limited its ability to attract the more sophisticated
Correspondent that offered a multitude of loan products and, accordingly,
limited MMC's market penetration. The Company began offering Conventional Loans
to existing select Correspondents in May 1996. In order to maintain MMC's
customer service excellence, the Company has gradually increased the number of
Correspondents to which it has offered Conventional Loans. Since MMC commenced
offering Conventional
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Loans, the loan production of MMC's Correspondent division has significantly
increased. MMC believes that it is well positioned to expand this segment
without any material increase in concentration or quality risks.
EXPANSION OF DEALER OPERATIONS
MMC seeks to expand its Dealer network and maximize loan originations from
its existing network by offering a variety of innovative products and providing
consistent and prompt service at competitive prices. The Company will provide
conventional products as well as its existing Title I product to its Dealers in
order to meet the needs of the diverse borrower market. MMC targets Dealers that
typically offer financing to their customers and attempts to retain and grow
these relationships by providing superior customer service, personalized
attention and prompt approvals and fundings. MMC has been unable to fully meet
the needs of its Dealers because of Title I program limits on the amount and
types of improvements which may be financed. MMC intends to meet the needs of
its Dealers with new Conventional Loan programs. These programs allow for more
expensive project financing such as in-ground swimming pools and substantial
remodeling as well as financing for creditworthy borrowers with limited equity
who are in need of debt consolidation and borrowers with marginal
creditworthiness and substantial equity in their property. With this strategy,
MMC believes it can achieve further market penetration of its existing Dealer
network and gain new Dealers and market share in areas in which the Title I
product is less successful because of its restrictions.
NATIONWIDE GEOGRAPHIC EXPANSION
MMC intends to continue to expand its Correspondent and Dealer network on a
nationwide basis and to enhance its value to its existing network. MMC's
strategy involves (i) focusing on geographic areas that the Company currently
underserves and (ii) tailoring MMC's loan programs to better serve its existing
markets and loan sources.
MAXIMIZATION OF FLEXIBILITY IN LOAN SALES
MMC employs a two-pronged strategy of disposing of its loan originations
primarily through securitizations and, to a lesser extent, through whole loan
sales. By employing this dual strategy, MMC has the flexibility to better manage
its cash flow, diversify its exposure to the potential volatility of the capital
markets and maximize the revenues associated with the gain on sale of loans,
given market conditions existing at the time of disposition. MMC has recently
been approved by Federal National Mortgage Association (FNMA) as a
seller/servicer of Title I Loans, as a result of which MMC is eligible to sell
such loans to FNMA on a servicing retained basis.
LOAN PRODUCTS
MMC originates Title I and Conventional Loans. Both types of loans are
typically secured by a first or junior lien on the borrower's principal
residence, although MMC occasionally originates and purchases unsecured loans
with borrowers that have an excellent credit history. Borrowers use loan
proceeds for a wide variety of home improvement projects, such as
exterior/interior remodeling, structural additions, roofing and plumbing, as
well as luxury items such as in-ground swimming pools, and for debt
consolidation. MMC lends to borrowers of varying degrees of creditworthiness.
See "Loan Processing and Underwriting."
CONVENTIONAL LOANS
A Conventional Loan is a non-insured home improvement or home equity loan
typically undertaken to pay for a home improvement project, home improvement and
debt consolidation combination or a debt consolidation. Substantially all of the
Conventional Loans originated by MMC are secured by a first or junior mortgage
lien on the borrower's principal residence. Underwriting for Conventional Loans
varies according to MMC's evaluation of the borrower's credit risk and income
stability as well as the underlying collateral. MMC will rely on the underlying
collateral and equity in the property for borrowers judged to be greater credit
risks. MMC targets the higher credit quality segment of borrowers. MMC has begun
originating Conventional
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Loans through its Correspondent Division and plans to begin offering such loan
products to its Dealer Division.
MMC has focused its Conventional Loan program on that segment of the
marketplace with higher credit quality borrowers who may have limited equity in
their residence after giving effect to the amount of senior liens. The portfolio
of Conventional Loans generated through August 31, 1996 indicates on average
that the borrowers have received an "A" grade under MMC's proprietary credit
index profile, have an average debt-to-income ratio of 38% and the subject
properties are 100% owner occupied. On average, the market value of the
underlying property is $123,000 without added value from the respective home
improvement work, the amount of senior liens of $107,000 and the loan size is
$28,500. Typically, there is not enough equity in the property to cover a junior
lien in the event that a senior lender forecloses on the property. More than 99%
of the loans comprising MMC's Conventional Loan portfolio are secured by junior
liens.
TITLE I LOAN PROGRAM
The National Housing Act of 1934 (Housing Act), Sections 1 and 2(a),
authorized the creation of the FHA and the Title I credit insurance program
(Title I). Under the Housing Act, the FHA is authorized to insure qualified
lending institutions against losses on certain types of loans, including loans
to finance the alteration, repair or improvement of existing single family,
multi-family and nonresidential real property structures. Under Title I, the
payment of approximately 90% of the principal balance of a loan and certain
other amounts is insured by the United States of America in the event of a
payment default.
Title I and the regulations promulgated thereunder establish criteria
regarding (i) who may originate, acquire, service and sell Title I Loans, (ii)
Title I Loan eligibility of improvements and borrowers, (iii) the principal
amounts, terms of, and security for Title I Loans, (iv) the use and disbursement
of loan proceeds, (v) verification of completion of improvements, (vi) the
servicing of Title I Loans in default and (vii) the processing of claims for
Title I insurance.
The principal amount of a secured Title I Loan may not exceed $25,000, in
the case of a loan for the improvement of a single family structure, and
$60,000, in the case of a loan for the improvement of a multi-family structure.
Loans up to a maximum of $7,500 in principal amount may qualify as unsecured
Title I Loans.
Title I Loans are required to bear fixed rates of interest and, with
limited exceptions, be fully amortizing with equal weekly, bi-weekly,
semi-monthly or monthly installment payments. Title I Loan terms may not be less
than 6 months nor more than 240 months in the case of secured Title I Loans or
120 months in the case of unsecured Title I Loans. Subject to other federal and
state regulations, the lender may establish the interest rate to be charged in
its discretion.
Title I generally provides for two types of Title I Loans, direct loans
(Direct Title I Loans) and dealer loans (Dealer Title I Loans). Direct Title I
Loans are made directly by a lender to the borrower and there is no
participation in the loan process by the contractor, if any, performing the
improvements. In the case of Dealer Title I Loans, the Dealer, a contractor
performing the improvements, assists the borrower in obtaining the loan,
contracts with the borrower to perform the improvements, executes a retail
installment contract with the borrower and, upon completion of the improvements,
assigns the retail installment contract to the Title I lender. Each Dealer must
be approved by the Title I lender in accordance with HUD requirements. Direct
Title I Loans are closed by the lender in its own name with the proceeds being
disbursed directly to the borrower prior to completion of the improvements. The
borrower is generally required to complete the improvements financed by a Direct
Title I Loan within six months of receiving the proceeds. In the case of Dealer
Title I Loans, the lender is required to obtain a completion certificate from
the borrower certifying that the improvements have been completed prior to
disbursing the proceeds to the Dealer.
The FHA charges a lender an annual fee equal to 50 basis points of the
original principal balance of a loan for the life of the loan. A Title I lender
or Title I sponsored lender is permitted to require the borrower to pay the
insurance premium with respect to the loan. In general, the borrowers pay the
insurance premiums with respect to Title I Loans originated through the
Company's Correspondents but not with respect to Title I
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Loans originated through MMC's Dealers. Title I provides for the establishment
of an insurance coverage reserve account for each lender. The amount of
insurance coverage in a lender's reserve account is equal to 10% of the original
principal amount of all Title I Loans originated or purchased and reported for
insurance coverage by the lender less the amount of all insurance claims
approved for payment. The amount of reimbursement to which a lender is entitled
is limited to the amount of insurance coverage in the lender's reserve account.
LENDING OPERATIONS
MMC has two principal divisions for the origination of loans, the
Correspondent Division and the Dealer Division. The Correspondent Division
represents MMC's largest source of loan originations. Through its Correspondent
Division, MMC originates loans through a nationwide network of Correspondents
including financial intermediaries, mortgage companies, commercial banks and
savings and loan institutions. MMC typically originates loans from
Correspondents on an individual loan basis, pursuant to which each loan is pre-
approved by MMC and is purchased immediately after the closing. The
Correspondent Division conducts operations from its headquarters in Atlanta,
Georgia, with a Vice President of Operations responsible for underwriting and
processing and five account executives supervised by the Vice
President -- National Marketing responsible for developing and maintaining
relationships with Correspondents. At August 31, 1996, the Company had a network
of approximately 310 active Correspondents.
In addition to purchasing individual Direct Title I Loans and Conventional
Loans, from time to time the Correspondent Division purchases portfolios of
loans from Correspondents. In March 1994, MMC purchased a portfolio of Direct
Title I Loans originated by another financial institution, which consisted of
211 loans with an aggregate remaining principal balance of $1.4 million.
The Dealer Division originates Dealer Title I Loans through a network of
Dealers, consisting of home improvement construction contractors approved by the
Company, by acquiring individual retail installment contracts (Installment
Contracts) from Dealers. An Installment Contract is an agreement between the
Dealer and the borrower pursuant to which the Dealer performs the improvements
to the property and the borrower agrees to pay in installments the price of the
improvements. Before entering into an Installment Contract with a borrower, the
Dealer assists the borrower in submitting a loan application to MMC. If the loan
application is approved, the Dealer enters into an Installment Contract with the
borrower, the Dealer assigns the Installment Contract to MMC upon completion of
the home improvements and MMC, upon receipt of the requisite loan documentation
(described below) and completion of a satisfactory telephonic interview with the
borrower, pays the Dealer pursuant to the terms of the Installment Contract. The
Dealer Division maintains 13 branch offices located in Montvale, New Jersey;
Kansas City, Missouri; Las Vegas, Nevada; Austin, Texas; Oklahoma City,
Oklahoma; Seattle, Washington; Waterford, Michigan; Columbus, Ohio; Elmhurst,
Illinois; Philadelphia, Pennsylvania; Denver, Colorado; Woodbridge, Virginia;
and Bowie, Maryland through which it conducts its marketing to Dealers in the
state in which the branch is located as well as certain contiguous states. The
Dealer Division is operated with a Vice President of Operations responsible for
loan processing and underwriting, two regional managers, and 13 field
representatives supervised by the Vice President -- National Marketing who are
responsible for marketing to Dealers. At August 31, 1996, MMC had a network of
approximately 435 active Dealers doing business in 32 states. MMC intends to
commence offering Conventional Loans through its Dealer Division.
Correspondents and Dealers qualify to participate in MMC's programs only
after a review by MMC's management of their reputations and expertise, including
a review of references and financial statements, as well as a personal visit by
one or more representatives of MMC. Title I requires MMC to reapprove its
Dealers annually and to monitor the performance of those Correspondents that are
sponsored by MMC. MMC's compliance function is performed by a director of
compliance and loan administration, whose staff performs periodic reviews of
portfolio loans and Correspondent and Dealer performance and may recommend to
senior management the suspension of a Correspondent or a Dealer. MMC believes
that its system of acquiring loans through a network of Correspondents and
Dealers and processing such loans through a centralized loan processing facility
has (i) assisted MMC in minimizing its level of capital investment and fixed
overhead costs and (ii) assisted MMC in realizing certain economies of scale
associated with evaluating and acquiring loans.
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MMC does not believe that the loss of any particular Correspondent or Dealer
would have a material adverse effect upon MMC. See "Loan Processing and
Underwriting."
MMC pays its Correspondents premiums on the loans it purchases based on the
credit score of the borrower and the interest rate on the respective loan.
Additional premiums are paid to Correspondents based on the volume of loans
purchased from such Correspondents in a monthly period. During fiscal 1996 MMC
originated $94.2 million of loans from Correspondents and paid total premiums of
$2.8 million or 3% of such loans.
None of MMC's arrangements with its Dealers or Correspondents is on an
exclusive basis. Each relationship is documented by either a Dealer Purchase
Agreement or a Correspondent Purchase Agreement. Pursuant to a Dealer Purchase
Agreement, MMC may purchase from a Dealer loans that comply with the Company's
underwriting guidelines at a price acceptable to MMC. With respect to each loan
purchased, the Dealer makes customary representations and warranties regarding,
among other things, the credit history of the borrower, the status of the loan
and its lien priority if applicable, and agrees to indemnify MMC with respect to
such representations and warranties. Pursuant to a Correspondent Purchase
Agreement, MMC may purchase loans through a Correspondent, subject to receipt of
specified documentation. The Correspondent makes customary representations and
warranties regarding, among other things, the Correspondent's corporate status,
as well as regulatory compliance, good title, enforceability and payments and
advances of the loans to be purchased. The Correspondent covenants to, among
other things, keep MMC information confidential, provide supplementary
information, maintain government approvals with respect to Title I Loans and to
refrain from certain solicitations of MMC's borrowers. The Correspondent also
agrees to indemnify MMC for misrepresentations or non-performance of its
obligations.
MMC originates and acquires a limited variety of loan products, including:
(i) fixed rate, secured Title I Loans, secured by single family residences, with
terms and principal amounts ranging from 60 to 240 months and approximately
$3,000 to $25,000, respectively; and (ii) fixed rate, unsecured Title I Loans
with terms and principal amounts ranging from 36 to 120 months and approximately
$2,500 to $7,500, respectively. As part of MMC's strategic plan, MMC has
commenced originating non-FHA insured Conventional Loans utilizing its
established network of Correspondents.
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The following table sets forth certain data regarding loan applications
processed and loans originated by MMC during the periods indicated:
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YEAR ENDED AUGUST 31,
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1996 1995 1994
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Loan Applications:
Number processed............. 42,236 27,608 3,512
Number approved.............. 20,910 15,956 1,984
Approval ratio............... 49.5% 57.8% 56.5%
Loan Originations:
Principal amount of loans:
Correspondents:
Title I................... $ 82,596,197 59.3% $63,792,680 72.7% $5,251,647 64.3%
Conventional.............. 11,582,108 8.3 -- -- -- --
------------ ----- ----------- ----- ---------- -----
Total
Correspondents..... 94,178,305 67.6 63,792,680 72.7 5,251,647 64.3
============ ===== =========== ===== ========== =====
Dealers...................... 45,188,721 32.4 23,957,829 27.3 1,492,318 18.3
Bulk purchase................ -- -- -- -- 1,420,150 17.4
------------ ----- ----------- ----- ---------- -----
Total................ $139,367,026 100.0% $87,750,509 100.0% $8,164,115 100.0%
============ ===== =========== ===== ========== =====
Number of loans:
Correspondents:
Title I................... 4,382 50.9% 3,437 59.1% 338 47.4%
Conventional.............. 392 4.6 -- -- -- --
------------ ----- ----------- ----- ---------- -----
Total
Correspondents..... 4,774 55.5 3,437 59.1 338 47.4
============ ===== =========== ===== ========== =====
Dealers...................... 3,836 44.5 2,381 40.9 164 23.0
Bulk purchase................ -- -- -- -- 211 29.6
------------ ----- ----------- ----- ---------- -----
Total................ 8,610 100.0% 5,818 100.0% 713 100.0%
============ ===== =========== ===== ========== =====
Average principal balance of
loans........................ $ 16,187 $ 15,083 $ 11,450
Weighted-average interest rate
on loans originated.......... 14.03% 14.55% 14.18%
Weighted-average term on loans
originated (months).......... 198 188 175
</TABLE>
LOAN PROCESSING AND UNDERWRITING
MMC's loan application and approval process generally is conducted over the
telephone with applications usually received at MMC's centralized processing
facility from Correspondents and Dealers by facsimile transmission. Upon receipt
of an application, the information is entered into MMC's system and processing
begins. All loan applications are individually analyzed by employees of MMC at
its loan processing headquarters in Atlanta, Georgia.
MMC has developed a proprietary credit index profile (CIP) as a statistical
credit based tool to predict likely future performance of a borrower. A
significant component of this customized system is the credit evaluation score
methodology developed by FICO, a consulting firm specializing in creating
default predictive models through a high number of variable components. The
other components of the CIP include debt to income analysis, employment
stability, self employment criteria, residence stability and occupancy status of
the subject property. By utilizing both scoring models in tandem, all applicants
are considered on the basis of their ability to repay the loan obligation while
allowing MMC to maintain its risk based pricing for each loan.
Based upon FICO score default predictors and MMC's internal CIP score,
loans are classified by MMC into gradations of descending credit risks and
quality, from "A" credits to "D" credits, with subratings within those
categories. Quality is a function of both the borrowers creditworthiness and the
extent of the value of the
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<PAGE> 10
collateral, which is typically a second lien on the borrower's primary
residence. "A+" credits generally have a FICO score greater than 680. An
applicant with a FICO score of less than 620 would be rated a "C" credit unless
the loan-to-value ratio was 75% or less which would raise the credit risk to MMC
to a "B" or better depending on the borrower's debt service capability.
Depending on loan size, typical loan-to-value ratios for "A" and "B" credits
range from 90% to 125%, while loan-to-value ratios for "C" and "D" credits range
from 60% up to 90% with extraordinary compensating factors.
MMC's underwriters review the applicant's credit history, based on the
information contained in the application as well as reports available from
credit reporting bureaus and MMC's CIP score, to determine the applicant's
acceptability under MMC's underwriting guidelines. Based on the underwriter's
approval authority level, certain exceptions to the guidelines may be made when
there are compensating factors subject to approval from a corporate officer. The
underwriter's decision is communicated to the Correspondent or Dealer and, if
approved, fully explains the proposed loan terms. MMC endeavors to respond to
the Correspondent or Dealer on the same day the application is received.
MMC issues a commitment to purchase a pre-approved loan upon the receipt of
a fully completed loan package. Commitments indicate loan amounts, fees, funding
conditions, approval expiration dates and interest rates. Loan commitments are
generally issued for periods of up to 45 days in the case of Correspondents and
90 days in the case of Dealers. Prior to disbursement of funds, all loans are
carefully reviewed by funding auditors to ensure that all documentation is
complete, all contingencies specified in the approval have been met and the loan
is closed in accordance with Company and regulatory procedures.
CONVENTIONAL LOANS
MMC has implemented policies for its Conventional Loan program that are
designed to minimize losses by adhering to high credit quality standards or
requiring adequate loan-to-value levels. MMC will only make Conventional Loans
to borrowers with an "A" or "B" credit grade using the CIP. Through August 31,
1996, MMC's portfolio of Conventional Loans originated through its Correspondent
Division had been evaluated as an "A" credit risk and had a weighted-average (i)
FICO score of 661, (ii) gross debt to income ratio of 38%, (iii) interest rate
of 14% and (iv) loan-to-value ratio of 110%, as well as an average loan amount
of $28,569. Substantially all of the Conventional Loans originated to date by
MMC are secured by first or second mortgage liens on single family, owner
occupied properties.
Terms of Conventional Loans made by MMC, as well as the maximum
loan-to-value ratios and debt service to income coverage (calculated by dividing
fixed monthly debt payments by gross monthly income), vary depending upon the
Company's evaluation of the borrower's creditworthiness. Borrowers with lower
creditworthiness generally pay higher interest rates and loan origination fees.
As part of the underwriting process for Conventional Loans, MMC generally
requires an appraisal of the collateral property as a condition to the
commitment to purchase. MMC requires independent appraisers to be state licensed
and certified. MMC requires that all appraisals be completed within the Uniform
Standards of Professional Appraisal Practice as adopted by the Appraisal
Standards Board of the Appraisal Foundation. Prior to originating a loan, MMC
audits the appraisal for accuracy and to insure that the appraiser used
sufficient care in analyzing data to avoid errors that would significantly
affect the appraiser's opinion and conclusion. This audit includes a review of
economic demand, physical adaptability of the real estate, neighborhood trends
and the highest and best use of the real estate. In the event the audit reveals
any discrepancies as to the method and technique that are necessary to produce a
credible appraisal, MMC will perform additional property data research or may
request a second appraisal to be performed by an independent appraiser selected
by MMC in order to substantiate further the value of the subject property.
MMC also requires a title report on all subject properties securing its
loans to verify property ownership, lien position and the possibility of
outstanding tax liens or judgments. In the case of larger loan amounts or first
liens, MMC requires a full title insurance policy in compliance with the
American Land Title Association.
10
<PAGE> 11
TITLE I LOANS
The Title I Loans originated by MMC are executed on forms meeting FHA
requirements as well as federal and state regulations. Loan applications and
Installment Contracts are submitted to MMC's processing headquarters for credit
verification. The information provided in loan applications is first verified
by, among other things, (i) written confirmations of the applicant's income and,
if necessary, bank deposits, (ii) a formal credit bureau report on the applicant
from a credit reporting agency, (iii) a title report, (iv) if necessary, a real
estate appraisal and (v) if necessary, evidence of flood insurance. Appraisals
for Title I Loans, when necessary, are generally prepared by preapproved
independent appraisers that meet MMC's standards for experience, education and
reputation. Loan applications are also reviewed to ascertain whether or not they
satisfy MMC's underwriting criteria, including loan-to-value ratios (if
non-owner occupied), borrower income qualifications, employment stability,
purchaser requirements and necessary insurance and property appraisal
requirements. MMC will make Title I Loans to borrowers with an "A" to "C" credit
grade based on CIP score and lien position. Since the implementation of the CIP
scoring system in February 1996, through August 31, 1996, MMC's portfolio of
Title I Loans originated through its Correspondent and Dealer Divisions had been
evaluated as a "C+" and "B" credit risk, respectively, and had a
weighted-average FICO score of 637 and 645, respectively. MMC's underwriting
guidelines for Title I Loans meet FHA's underwriting criteria. Completed loan
packages are sent to MMC's underwriting department for predisbursement auditing
and funding.
Subject to underwriting approval of an application forwarded to MMC by a
Dealer, MMC issues a commitment to purchase an Installment Contract from a
Dealer upon MMC's receipt of a fully completed loan package and notice from the
borrower of satisfactory work completion. Subject to underwriting approval of an
application forwarded to MMC by a Correspondent, MMC issues a commitment to
purchase a Title I Loan upon MMC's receipt of a fully completed and closed loan
package.
MMC's underwriting personnel review completed loan applications to verify
compliance with MMC's underwriting standards, FHA requirements and federal and
state regulations. In the case of Title I Loans being acquired from Dealers, MMC
conducts a prefunding telephonic interview with the property owner to determine
that the improvements have been completed in accordance with the terms of the
Installment Contract and to the owner's satisfaction. MMC utilizes a nationwide
network of independent inspectors to perform on-site inspections of improvements
within the time frames specified by the Title I program.
Since MMC does not currently originate any Title I Loans with an original
principal balance in excess of $25,000, the FHA does not individually review the
Title I Loans originated by MMC.
QUALITY CONTROL
MMC employs various quality control personnel and procedures in order to
insure that loan origination standards are adhered to and regulatory compliance
is maintained while substantial growth is experienced in the servicing
portfolio.
In accordance with MMC's policy, the quality control department reviews a
statistical sample of loans closed each month. This review is generally
completed within 60 days of funding and circulated to appropriate department
heads and senior management. Finalized reports are maintained in MMC's files for
a period of two years from completion. Typical review procedures include
reverification of employment and income, re-appraisal of the subject property,
obtaining separate credit reports and recalculation of debt-to-income ratios.
The statistical sample is intended to cover 10% of all new loan originations
with particular emphasis on new Correspondents and Dealers. Emphasis will also
be placed on those loan sources where higher levels of delinquency are
experienced, physical inspections reveal a higher level of non-compliance, or
payment defaults occur within the first six months of funding. On occasion, the
quality control department may review all loans generated from a particular loan
source in the event an initial review determines a higher than normal number of
exceptions. The account selection of the quality control department is also
designed to include a statistical sample of loans by each underwriter and each
funding auditor and thereby provide management with information as to any
aberration from Company policies and procedures in the loan origination process.
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<PAGE> 12
Under the direction of the Vice President of Credit Quality and Regulatory
Compliance, a variety of review functions are accomplished. On a daily basis, a
sample of recently approved loans are reviewed to insure compliance with
underwriting standards. Particular attention is focused on those underwriters
who have developed a higher than normal level of exceptions. In addition to this
review, MMC has developed a staff of post-disbursement review auditors which
reviews 100% of recently funded accounts, typically within two weeks of funding.
All credit reports are analyzed, debt-to-income ratios recalculated,
contingencies monitored and loan documents inspected. Exception reports are
forwarded to the respective Vice Presidents of Production as well as senior
management. MMC also employs a Physical Inspection Group that is responsible for
monitoring the inspection of all homes which are the subject of home improvement
loans. Noncompliance is tracked by loan source and serves as another method of
evaluating a loan source relationship.
MMC has expended substantial amounts in developing its quality control and
compliance department. MMC recognizes the need to monitor its operations
continually as it experiences substantial growth. Feedback from these
departments provides senior management with the information necessary to take
corrective action when appropriate, including the revision and expansion of its
operating policies and procedures.
LOAN PRODUCTION TECHNOLOGY SYSTEMS
MMC utilizes a sophisticated computerized loan origination tracking system
that allows it to monitor the performance of Dealers and Correspondents and
supports the marketing efforts of the Dealer and Correspondent Divisions by
tracking the marketing activities of field sales personnel. The system automates
various other functions such as Home Mortgage Disclosure Act and HUD reporting
requirements and routine tasks such as decline letters and the flood
certification process. The system also affords management access to a wide range
of decision support information such as data on the approval pipeline, loan
delinquencies by source, and the activities and performance of underwriters and
funders. MMC uses intercompany electronic mail, as well as an electronic-mail
link with its affiliate, PEC, to facilitate communications and has an electronic
link to PEC that allows for the automated transfer of accounts to PEC's
servicing system.
MMC is enhancing this system to provide for the automation of the loan
origination process as well as loan file indexing and routing. These
enhancements will include electronic routing of loan application facsimile
transmissions, automated credit report inquiries and consumer credit scoring
along with on-screen underwriting and approval functions. Where feasible the
system will interface with comparable systems of MMC's Dealers and
Correspondents. MMC expects that these enhancements will (i) increase loan
production efficiencies by minimizing manual processing of loan documentation,
(ii) enhance the quality of loan processing by use of uniform electronic images
of loan files and (iii) facilitate loan administration and collections by
providing easier access to loan account information. The implementation of these
enhancements is expected to be substantially completed prior to December 1996.
These enhancements to improve loan production systems are expected to cost
approximately $50,000 and will be funded from MMC's normal operating cash flows.
LOAN SERVICING
MMC's strategy has been to retain the servicing rights associated with the
loans it originates. MMC's loan servicing activities include responding to
borrower inquiries, processing and administering loan payments, reporting and
remitting principal and interest to the whole loan purchasers who own interests
in the loans and to the trustee and others with respect to securitizations,
collecting delinquent loan payments, processing Title I insurance claims,
conducting foreclosure proceedings and disposing of foreclosed properties and
otherwise administering the loans. MMC's various loan sale and securitization
agreements allocate a portion of the difference between the stated interest rate
and the interest rate passed through to purchasers of its loans to servicing
revenue. Servicing fees are collected by MMC out of monthly loan payments. Other
sources of loan servicing revenues include late charges and miscellaneous fees.
MMC uses a sophisticated computer based mortgage servicing system that it
believes enables it to provide effective and efficient administering of
Conventional and Title I Loans. The servicing system is an on-line real time
system developed and maintained by MMC's affiliate, PEC. It provides payment
processing and cashiering functions, automated payoff statements, on-line
collections, statement and notice mailing along with a full range of investor
reporting
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<PAGE> 13
requirements. MMC has entered into a sub-servicing agreement with PEC for the
use of the system and continuous support. The monthly investor reporting package
includes a trial balance, accrued interest report, remittance report and
delinquency reports. Formal written procedures have been established for payment
processing, new loan set-up, customer service, and tax and insurance monitoring.
MMC is a HUD approved lender and a FNMA approved seller/servicer. As such,
it is subject to a thorough due diligence review of its policies, procedures,
and business, and is qualified to underwrite, sell and service Title I Loans on
behalf of the FHA and FNMA.
MMC's loan collection functions are organized into two areas of operation:
routine collections and management of nonperforming loans.
Routine collection personnel are responsible for collecting loan payments
that are less than 60 days contractually past due and providing prompt and
accurate responses to all customer inquiries and complaints. These personnel
report directly to MMC's Vice President of Loan Administration. Borrowers are
contacted on the due date for each of the first six payments in order to
encourage continued prompt payment. Generally, after six months of seasoning,
collection activity will commence if a loan payment has not been made within
five days of the due date. Borrowers usually will be contacted by telephone at
least once every five days and also by written correspondence before the loan
becomes 60 days delinquent. With respect to loan payments that are less than 60
days late, routine collections personnel utilize a system of mailed notices and
telephonic conferences for reminding borrowers of late payments and encouraging
borrowers to bring their accounts current. Installment payment invoices and
return envelopes are mailed to each borrower on a monthly basis. MMC has
bilingual customer service personnel available.
Once a loan becomes 30 days past due, a collection supervisor generally
analyzes the account to determine the appropriate course of remedial action. On
or about the 45th day of delinquency, the supervisor determines if the property
needs immediate inspection to determine if it is occupied or vacant. Depending
upon the circumstances surrounding the delinquent account, a temporary
suspension of payments or a repayment plan to return the account to current
status may be authorized by the Vice President of Loan Administration. In any
event, it is MMC's policy to work with the delinquent customer to resolve the
past due balance before Title I claim processing or legal action is initiated.
Nonperforming loan management personnel are responsible for collecting
severely delinquent loan payments (over 60 days late), filing Title I insurance
claims or initiating legal action for foreclosure and recovery. Operating from
MMC's headquarters in Atlanta, Georgia, collection personnel are responsible for
collecting delinquent loan payments and seeking to mitigate losses by providing
various alternatives to further actions, including modifications, special
refinancing and indulgence plans. Title I insurance claim personnel are
responsible for managing Title I insurance claims, utilizing a claim management
system designed to track insurance claims for Title I Loans so that all required
conditions precedent to claim perfection are met. In the case of Conventional
Loans, a foreclosure coordinator will review all previous collection activity,
evaluate the lien and equity position and obtain any additional information as
necessary. The ultimate decision to foreclose, after all necessary information
is obtained, is made by an officer of MMC. Foreclosure regulations and practices
and the rights of the owner in default vary from state to state, but generally
procedures may be initiated if: (i) the loan is 90 days (120 days under
California law) or more delinquent; (ii) a notice of default on a senior lien is
received; or (iii) MMC discovers circumstances indicating potential loss
exposure.
Net loan servicing income was $3.3 million and $873,000 for the years ended
August 31, 1996 and 1995, respectively, constituting 13.4% and 6.4%,
respectively, of MMC's total revenues in such periods. As of August 31, 1996,
MMC had increased the size of the loan portfolio it services to approximately
$214.2 million from approximately $92.3 million as of August 31, 1995, an
increase of approximately $121.9 million or 132.1%. MMC's loan servicing
portfolio is subject to reduction by normal amortization, prepayment of
outstanding loans and defaults.
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<PAGE> 14
The following table sets forth certain information regarding MMC's loan
servicing for the periods indicated (thousands of dollars):
<TABLE>
<CAPTION>
YEAR ENDED AUGUST 31,
--------------------------------
1996 1995 1994(1)
-------- ------- -------
<S> <C> <C> <C>
Servicing portfolio at beginning of year...... $ 92,286 $ 8,026 $ --
Additions to servicing portfolio.............. 139,367 87,751 8,164
Reductions in servicing portfolio(2).......... (17,464) (3,491) (138)
-------- ------- ------
Servicing portfolio at end of year............ $214,189 $92,286 $8,026
======== ======= ======
Servicing portfolio (end of year):
Company-owned loans......................... $ 4,698 $ 3,720 $1,471
Sold loans.................................. 209,491 88,566 6,555
-------- ------- ------
Total............................... $214,189 $92,286 $8,026
======== ======= ======
</TABLE>
- ---------------
(1) MMC commenced its Title I lending operations in March 1994.
(2) Reductions result from scheduled payments, prepayments and write-offs during
the period.
The following table sets forth the delinquency and Title I insurance claims
experience of loans serviced by MMC as of the dates indicated (thousands of
dollars):
<TABLE>
<CAPTION>
YEAR ENDED AUGUST 31,
---------------------------------
1996 1995 1994
-------- ------- ------
<S> <C> <C> <C>
Delinquency period(2)
31-60 days past due........................ 2.17% 2.58% 2.06%
61-90 days past due........................ 0.85 0.73 0.48
91 days and over past due.................. 4.53(3) 0.99 0.36
91 days and over past due, net of claims
filed(4)................................ 1.94 0.61 0.26
Claims filed with HUD(5)..................... 2.59 0.38 0.10
Number of Title I insurance claims........... 255 23 1
Total servicing portfolio at end of period... $214,189 $92,286 $8,026
Amount of FHA insurance available(6)......... $ 21,205 $ 9,552 $ 813
Amount of FHA insurance available as a
percentage of loans serviced (end of
year)...................................... 9.90%(6) 10.35% 10.13%
Losses on liquidated loans(7)................ $ 32 $ 16.8 $ --
</TABLE>
- ---------------
(1) MMC commenced originating loans in March 1994.
(2) Represents the dollar amount of delinquent loans as a percentage of total
dollar amount of loans serviced by MMC (including loans owned by MMC) as of
the date indicated.
(3) During the year ended August 31, 1996, the processing and payment of claims
filed with HUD was delayed.
(4) Represents the dollar amount of delinquent loans net of delinquent Title I
Loans for which claims have been filed with HUD and payment is pending as a
percentage of total dollar amount of loans serviced by MMC (including loans
owned by MMC) as of the date indicated.
(5) Represents the dollar amount of delinquent Title I Loans for which claims
have been filed with HUD and payment is pending as a percentage of total
dollar amount of loans serviced by MMC (including loans owned by MMC) as of
the date indicated.
(6) If all claims with HUD had been processed as of period end, the amount of
FHA insurance available would have been reduced to $16,215,000, which as a
percentage of loans serviced would have been 7.8%.
(7) A loss is recognized upon receipt of payment of a claim or final rejection
thereof. Claims paid in a period may relate to a claim filed in an earlier
period. Since MMC commenced its Title I lending operations in
14
<PAGE> 15
March 1994, there has been no final rejection of a claim by the FHA.
Aggregate losses on liquidated Title I Loans related to 83 of the 338 Title
I insurance claims made by MMC since commencing operations through August
31, 1996. Losses on liquidated loans will increase as the balance of the
claims are processed by HUD. MMC has received an average payment from HUD
equal to 90% of the outstanding principal balance of such Title I Loans,
plus appropriate interest and costs.
MMC has received an average amount equal to 96.9% of the outstanding
principal balance of Title I Loans for which claims have been made, each payment
including certain interest and costs. The processing and payment of claims filed
with HUD have been delayed for a number of reasons including (i) furloughs
experienced by HUD personnel in December 1995 and January 1996, (ii) the growth
in the volume of Title I Loans originated from approximately $750 million in
1994 to $1.3 billion in 1995 without a corresponding increase in HUD personnel
to service claims and (iii) the transition of processing operations to regional
centers during the second and third quarters of 1996. It is expected that once
appropriate staffing and training have been completed at HUD regional centers,
the time frame for payment of HUD claims will be significantly shortened.
SALE OF LOANS
MMC customarily sells the loans it originates to third party purchasers or,
in the case of a third party purchaser not eligible to own a Title I Loan, sells
Title I Loan participation certificates backed by Title I Loans. Whether MMC
sells a loan or a loan participation, MMC typically retains the right to service
the loans for a servicing fee. MMC typically sells loans for an amount
approximating the then remaining principal balance. The purchasers are entitled
to receive interest at yields below the stated interest rates of the loans. In
connection with such sales, MMC is typically required to deposit into a reserve
account the excess servicing spread received by it, less its servicing fee, up
to a specified percentage of the principal balance of the loans, to fund
shortfalls in collections that may result from borrower defaults. To date, the
purchasers in whole loan sales have been two banks and another financial
institution The following table sets forth certain data regarding Title I Loans
sold by MMC during the periods indicated (thousands of dollars):
<TABLE>
<CAPTION>
YEAR ENDED AUGUST 31,
-------------------------------
1996 1995 1994
-------- ------- ------
<S> <C> <C> <C>
Principal amount of loans sold to third party
purchasers................................... $137,908(2) $85,363 $6,555
Gain on sales of loans to third party
purchasers................................... 17,994 12,233 579
Net unrealized gain on mortgage related
securities................................... 2,697 -- --
Weighted-average stated interest rate on loans
sold to third party purchasers............... 14.09% 14.53% 14.15%
Weighted-average pass-through interest rate on
loans sold to third party purchasers......... 7.50 8.36 8.54
Weighted-average excess spread retained on
loans sold................................... 6.59 6.17 5.61
</TABLE>
- ---------------
(1) MMC commenced originating loans in March 1994.
(2) Includes $10.5 million of Conventional Loans.
At August 31, 1996 and 1995, MMC's Statement of Financial Condition
reflected excess servicing rights of approximately $12.1 million and $14.5
million, respectively. MMC also retains mortgage related securities through
securitization transactions. At August 31, 1996, MMC's Statement of Financial
Condition reflected $22.9 million of mortgage related securities. MMC derives a
significant portion of its income by realizing gains upon the sale of loans and
loan participations due to the excess servicing rights associated with such
loans. Excess servicing rights represent the excess of the interest rate payable
by a borrower on a loan over the interest rate passed through to the purchaser
of an interest in the loan, less MMC's normal servicing fee and other applicable
recurring fees. Mortgage related securities consist of certificates representing
the excess of the interest rate payable by an obligor on a sold loan over the
yield on pass-through certificates sold pursuant to a securitization
transaction, after payment of servicing and other fees. When loans are sold, MMC
recognizes as
15
<PAGE> 16
current revenue the present value of the excess servicing rights expected to be
realized over the anticipated average life of the loans sold less future
estimated credit losses relating to the loans sold. The capitalized excess
servicing rights and valuation of mortgage related securities are computed using
prepayment, default and interest rate assumptions that MMC believes are
reasonable based on experience with its own portfolio, available market data and
ongoing consultation with industry participants. The amount of revenue
recognized by the Company upon the sale of loans or loan participations will
vary depending on the assumptions utilized. The weighted-average discount rate
used to determine the present value of the balance of capitalized excess
servicing rights reflected on MMC's Statement of Financial Condition at August
31, 1996 and 1995 was approximately 12%.
Capitalized excess servicing rights are amortized over the lesser of the
estimated or actual remaining life of the underlying loans as an offset against
the excess servicing rights component of servicing income actually received in
connection with such loans. Although MMC believes that it has made reasonable
estimates of the excess servicing rights likely to be realized, the rate of
prepayment and the amount of defaults utilized by MMC are estimates and
experience may vary from its estimates. The gain recognized by the Company upon
the sale of loans will have been overstated if prepayments or defaults are
greater than anticipated. Higher levels of future prepayments would result in
capitalized excess servicing rights amortization expense exceeding realized
excess servicing rights, thereby adversely affecting MMC's servicing income and
resulting in a charge to earnings in the period of adjustment. Similarly, if
delinquencies or liquidations were to be greater than was initially assumed,
capitalized excess servicing rights amortization would occur more quickly than
originally anticipated, which would have an adverse effect on servicing income
in the period of such adjustment. MMC periodically reviews its prepayment
assumptions in relation to current rates of prepayment and, if necessary,
reduces the remaining asset to the net present value of the estimated remaining
future excess servicing income. Rapid increases in interest rates or competitive
pressures may result in a reduction of future excess servicing income, thereby
reducing the gains recognized by MMC upon the sale of loans or loan
participations in the future.
At August 31, 1996 and 1995, MMC's Statements of Financial Condition
reflected mortgage servicing rights of approximately $3.8 million and $1.1
million, respectively. The fair value of capitalized mortgage servicing rights
was estimated by taking the present value of expected net cash flows from
mortgage servicing using assumptions MMC believes market participants would use
in their estimates of future servicing income and expense, including assumptions
about prepayment, default and interest rates. Capitalized mortgage servicing
rights are amortized in proportion to and over the period of estimated net
servicing income. The estimate of fair value was based on a range of 100 to 125
basis points per year servicing fee, reduced by estimated costs of servicing,
and using a discount rate of 12% in the years ended August 31, 1996 and 1995.
MMC has developed its assumptions based on experience with its own portfolio,
available market data and ongoing consultation with industry participants.
In furtherance of MMC's strategy to sell loans through securitizations, in
March 1996 and August 1996, MMC completed its first two securitizations pursuant
to which it sold pools of $84.2 million and $48.8 million, respectively, of
Title I Loans. MMC previously reacquired at par $77.7 million and $36.2 million
of such loans, respectively. Pursuant to these securitizations, pass-through
certificates evidencing interests in the pools of loans were sold in a public
offering. MMC continues to sub-service the sold loans and is entitled to receive
from payments in respect of interest on the sold loans, a servicing fee equal to
1.25% of the balance of each loan with respect to the March transaction and 1%
with respect to the August transaction. In addition, with respect to both
transactions, MMC received certificates (carried as mortgage related securities
on MMC's statements of financial condition), representing the interest
differential, after payment of servicing and other fees, between the interest
paid by the obligors of the sold loans and the yield on the sold certificates.
MMC may be required to repurchase loans that do not conform to the
representations and warranties made by MMC in the securitization agreements.
MMC typically earns net interest income during the "warehouse" period
between the closing or assignment of a loan and its delivery to a purchaser. On
loans held for sale, MMC earns interest at long-term rates, financed by lines of
credit which bear interest at short-term interest rates. Normally, short-term
interest rates are lower than long-term interest rates and MMC earns a positive
spread on its loans held for sale. The
16
<PAGE> 17
average warehouse period for a loan ranges from 6 to 90 days, and the balance of
loans in warehouse was approximately $4.6 million and $3.7 million as of August
31, 1996 and 1995, respectively. MMC's interest income, net of interest expense
was $988,000 and $473,000 for the years ended August 31, 1996 and 1995,
respectively.
INTEREST RATE RISKS
Changes in interest rates affect MMC's business in a variety of ways,
including decreased demand for loans during periods of higher interest rates,
fluctuations in profits derived from the difference between short-term and
longterm interest rates and increases in prepayment rates during periods of
lower interest rates. The profits realized by MMC from home improvement loans
are, in part, a function of the difference between fixed long-term interest
rates, at which MMC originates its home improvement loans, and adjustable
short-term interest rates, at which MMC finances such loans until the closing of
the sale of such loans. Generally, short-term rates are lower than long-term
rates and MMC benefits from the positive interest rate differentials during the
time the loans are held by MMC pending the closing of the sale of such loans.
During the period from 1994 through the present, the interest rate differential
was high and this fact contributed significantly to MMC's net interest income.
The interest rate differential may not continue at such favorable levels in the
future.
Changes in interest rates during the period between the time an interest
rate is established on a loan and the time such loan is sold affect the revenues
realized by MMC from loans. In connection with the origination of loans, MMC
issues loan commitments for periods of up to 45 days in the case of
Correspondents and 90 days in the case of Dealers. Furthermore, the period of
time between the closing on a loan and the sale of such loan generally ranges
from 10 to 90 days. Increases in interest rates during these periods will result
in lower gains (or even losses) on sales of loans than would be recorded if
interest rates had remained stable or had declined. Changes in interest rates
after the sale of loans also affect the profits realized by MMC with respect to
loan sale transactions in which the yield to the purchaser is based on an
adjustable rate. During the years ended August 31, 1996 and 1995, MMC sold loans
under an agreement which provides for the yield to the purchaser to be adjusted
monthly to a rate equal to 200 basis points over the one-month London Interbank
Offered Rate (LIBOR). An increase in LIBOR would result in a decrease in MMC's
future income from such sold loans resulting in a charge to earnings in the
period of adjustment.
Interest rate levels also affect MMC's excess servicing spread. MMC
generally retains the servicing rights to the loans it sells. The yield to the
purchaser is generally lower than the average stated interest rates on the
loans, as a result of which MMC earns an excess servicing spread on the loans it
sells. Increases in interest rates or competitive pressures may result in
reduced servicing spreads, thereby reducing or eliminating the gains recognized
by MMC upon the sale of loans in the future.
SEASONALITY
Home improvement loan volume tracks the seasonality of home improvement
contract work. Volume tends to build during the spring and early summer months,
particularly with regard to pool installations. A decline is typically
experienced in late summer and early fall until temperatures begin to drop. This
change in seasons precipitates the need for new siding, window and insulation
contracts. Peak volume is experienced in November and early December and
declines dramatically from the holiday season through the winter months. Debt
consolidation and home equity loan volume are not impacted by seasonal climate
changes and, with the exclusion of the holiday season, tend to be stable
throughout the year.
PREFERRED EQUITIES CORPORATION
GENERAL
PEC acquires, develops and converts rental and condominium apartment
buildings and hotels for sale as timeshare interests and engages in the retail
sale of land. PEC's strategy is to acquire properties in desirable destination
resort areas that offer a range of recreational activities and amenities. PEC
markets and sells timeshare interests in its resorts in Las Vegas and Reno
Nevada; Honolulu, Hawaii; Brigantine, New Jersey;
17
<PAGE> 18
Steamboat Springs, Colorado; and Indian Shores near St. Petersburg, Florida; as
well as land in Nevada and Colorado. PEC recently acquired properties in
Orlando, Florida; Steamboat Springs, Colorado; and Las Vegas, Nevada to be
converted and sold as timeshare interests. In recent years, several major
lodging, hospitality and entertainment companies, including The Walt Disney
Company, Hilton Hotels Corporation, Marriott Ownership Resorts, Inc. and Hyatt
Corporation, among others, have commenced developing and marketing timeshare
interests in resort properties. The Company believes that the entry into the
timeshare industry of certain of these large and well-known lodging, hospitality
and entertainment companies has contributed to the growth and acceptance of the
industry. In order to enhance its competitive position, in April 1995 PEC
entered into a strategic alliance with Hospitality Franchise Systems, Inc. (HFS)
pursuant to which PEC was granted a ten-year (including a renewal option)
exclusive license to operate both its existing and future timeshare properties
under the name "Ramada Vacation Suites." The American Resort Development
Association estimates that approximately 1.65 million families in the United
States own timeshare interests in resorts worldwide and that sales of timeshare
interests in the United States aggregated approximately $1.8 billion in 1994.
TIMESHARE PROPERTIES AND SALES
PEC acquires, develops and converts rental and condominium apartment
buildings and hotels for sale as timeshare interests. PEC's strategy is to
acquire properties in desirable destination resort areas that offer a range of
recreational activities and amenities. The timeshare interests offered by PEC in
its resorts other than in Hawaii generally consist of undivided fee interests in
the land and facilities comprising the property or an undivided fee interest in
a particular unit, pursuant to which the owner acquires the perpetual right to
weekly occupancy of a residence unit each year. In its resort in Hawaii, PEC
offers "right-to-use" interests, pursuant to which the owner has occupancy
rights for one week each year until December 31, 2009, the last full year of the
underlying land lease for the resort property. During fiscal 1996, 1995, and
1994, PEC sold 6,982, 5,365, and 5,441 timeshare interests, respectively, at
prices ranging from $3,950 to $23,950.
In order to enhance its competitive position, in April 1995, PEC entered
into a strategic alliance pursuant to which PEC was granted a ten-year
(including a renewal option) exclusive license to operate both its existing and
future timeshare properties under the name "Ramada Vacation Suites." PEC has
renamed its timeshare resorts. The Company believes that this affiliation has
enabled it to capitalize on the Ramada reputation, name recognition and customer
profile, which closely matches PEC's customer profile. The arrangement provides
for the payment by PEC of an initial access fee of $1 million, which has been
paid, and monthly recurring fees equal to 1% of PEC's Gross Sales (as defined)
each month through January 1996 and 1.5% of PEC's Gross Sales each month
commencing in February 1996. The initial term of the arrangement is 5 years and
PEC has the option to renew the arrangement for an additional term of 5 years,
if PEC has met certain conditions, including the addition of at least 20,000
timeshare interests during the initial term and the payment of minimum annual
fees. In addition to the grant of the license, the arrangement provides for the
establishment of joint marketing programs. The Company believes it has benefited
from the use of the Ramada name, but is unable to quantify the amount of such
benefit.
PEC currently operates timeshare resorts in Las Vegas and Reno, Nevada;
Honolulu, Hawaii; Brigantine, New Jersey; Steamboat Springs, Colorado; and
Indian Shores, Florida; and recently purchased an additional property in
Orlando, Florida and Steamboat Springs, Colorado. PEC is considering the
purchase of additional properties for use in its timeshare operations.
PEC's Ramada Vacation Suites at Las Vegas, formerly known as The Grand
Flamingo Club, includes 30 buildings with a total of 429 studio units and 1 and
2 bedroom units which have been converted for sale as 21,879 timeshare
interests, of which 4,212 remained available for sale as of August 31, 1996. The
resort is in close proximity to the strip in Las Vegas and features swimming
pools and other amenities. PEC is in the process of converting additional
adjacent properties it owns. PEC has recently completed the expansion of the
common areas to include an expanded lobby, convenience store and expanded sales
facilities. At August 31, 1996, a total of 5 buildings containing 64 units were
under conversion to timeshare interests.
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<PAGE> 19
The Ramada Vacation Suites at Reno, formerly known as the Reno Spa Resort,
consists of a 95-unit hotel that has been converted for sale as 4,845 timeshare
interests, of which 626 remained available for sale as of August 31, 1996. The
resort features an indoor swimming pool, exercise facilities, sauna, jacuzzi and
sundeck.
PEC's White Sands Waikiki is an 80-unit hotel consisting of three buildings
that have been converted for sale as 4,160 timeshare interests, of which 467
remained available for sale as of August 31, 1996. The hotel is currently being
renamed Ramada Vacation Suites at Honolulu. The resort is within walking
distance of a public beach and features a swimming pool and jacuzzi. PEC holds
the buildings, equipment and furnishings under a land lease expiring in March
2010, under which PEC makes annual rental payments of approximately $192,000.
The Ramada Vacation Suites on Brigantine Beach consists of a 91-unit hotel
and a 17-unit three story building, formerly known as the Brigantine Inn and the
Brigantine Villas, respectively, that have been converted for sale as 5,508
timeshare interests, of which 519 remained available for sale as of August 31,
1996. The resort is situated on beachfront property in close proximity to
Atlantic City, New Jersey and features an enclosed swimming pool, cocktail
lounge, bar and restaurant.
The Ramada Vacation Suites at Steamboat Springs consists of 60 one and two
bedroom units, which have been converted for sale as 3,060 timeshare interests.
Of these, 1,813 remained available for sale as of August 31, 1996. PEC acquired
this condominium resort in 1994 and completed the conversion in 1995. PEC has
constructed a 5,500-square foot amenities building at this facility which
features a lobby, front desk, spa and sauna.
The Ramada Vacation Suites at Indian Shores, formerly known as the Aloha
Bay Apartments, consists of a two building complex, that has been recently
converted into a total of 32 one and two bedroom units to be sold as 1,632
timeshare interests. The Resort is located on the intercoastal waterway and is
in close proximity to Tampa, Florida. The timeshare interests became available
for sale upon completion of improvements and registration with the state of
Florida, which occurred in September, 1996.
The Ramada Vacation Suites of Orlando, formerly known as Ramada Suites at
Tango Bay, consists of a 7 building complex, that upon conversion will consist
of a total of 102 units to be sold as 5,202 timeshare interests. The resort is
in Orlando, Florida. The timeshare interests will be available for sale upon
completion of the first phase of improvements and registration with the state of
Florida, which is expected to be completed by the summer of 1997.
The Ramada Vacation Suites -- Hilltop, formerly known as The Overlook
Lodge, is a 117-room complex complete with indoor swimming pool, restaurant,
cocktail lounge and meeting room facilities. Upon conversion, the complex will
consist of 56 one and two-bedroom units to be sold as 2,856 timeshare interests.
The resort is located in Steamboat Springs, Colorado, in close proximity to the
area's ski slopes and attractions. The timeshare interests will be available for
sale upon completion of improvements and registration with the state of
Colorado, which is expected to be completed by the fall of 1997.
19
<PAGE> 20
The following table set forth certain information regarding the timeshare
interests at the Company's resort properties:
<TABLE>
<CAPTION>
STEAMBOAT
LAS VEGAS RENO WAIKIKI BRIGANTINE SPRINGS TOTAL
--------- ----- ------- ---------- --------- ------
<S> <C> <C> <C> <C> <C> <C>
Maximum number of timeshare interests...... 21,879 4,845 4,160 5,508 3,060 39,452
Net number of timeshare interests sold
through August 31, 1996.................. 17,667 4,219 3,693 4,989(1) 1,247 31,815
Number of timeshare interests available for
sale at August 31, 1996.................. 4,212 626 467 519 1,813 7,637
Percent sold through August 31, 1996....... 81% 87% 89% 91% 41% 81%
Number of timeshare interests sold during
the year ended August 31, 1996........... 4,068 585 648 90 1,591 6,982
Number of timeshare interests reacquired
during the year ended August 31, 1996
through:
Contract cancellations................... 694 213 122 89 98 1,216
Exchanges(3)............................. 2,003 391 350 81 480 3,305
Acquired for unpaid maintenance fees..... 173 44 160 27 -- 404
------- ----- ----- ------ ------ ------
Total number of timeshare interests
reacquired.......................... 2,870 648 632 197 578 4,925
------- ----- ----- ------ ------ ------
Net number of timeshare interests sold
(reacquired) during the year ended August
31, 1996................................. 1,198 (63) 16 (107) 1,013 2,057
Additional timeshare interests under
development(2)........................... 3,624 -- -- -- -- --
Sales prices of timeshare interests
available at August 31, 1996 range
From..................................... $ 6,150 6,250 3,950 5,150 6,950 N/A
To....................................... $15,000 9,850 5,950 15,450 23,950 N/A
</TABLE>
- ---------------
(1) 4,823 timeshare interests were sold by the prior developer.
(2) PEC recently purchased additional units to be converted to timeshare
interests, and are not included above. In Nevada, the addition was 64 units
to be converted into 3,264 timeshare interests. In Florida, the addition was
134 units to be converted into 6,834 timeshare interests. In Colorado, the
addition was 56 units to be converted into 2,856 timeshare interests.
(3) These exchanges are primarily related to customers exchanging and/or
upgrading their current property to generally higher quality and higher
priced units.
For the fiscal years ended August 31, 1996, 1995, and 1994 PEC's
consolidated revenue from sales of timeshare interests was $27.8 million, $20.7
million and $19.5 million, respectively, representing approximately 47.5%, 37.7%
and 43.1% of total revenues, respectively.
RCI EXCHANGE NETWORK
The attractiveness of timeshare interest ownership in resorts is enhanced
significantly by the availability of exchange networks allowing owners to
exchange their occupancy right in the resort in which they own an interest for
an occupancy right in another participating network resort. Several companies,
including Resorts Condominiums International (RCI), provide broad based
timeshare interest exchange networks, and PEC has qualified its resort
properties for participation in the RCI network.
RCI has a total of more than 2,983 participating resort facilities located
worldwide. Approximately 41.8% of the participating facilities are located in
the United States and Canada. PEC and the Owner's Association of each of PEC's
timeshare resorts have entered into an agreement with RCI pursuant to which
purchasers of timeshare interests in PEC's resorts may apply for membership in
the RCI exchange network. Under the terms of these agreements, RCI agrees to
make its exchange program available to PEC's customers who
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<PAGE> 21
apply for membership. RCI and the Association agree to promote RCI's program,
and to honor qualified exchanges by members from other participating resorts.
The initial five-year terms of the agreements are automatically renewable for
additional five-year terms, unless either party gives the other party at least
180 days written notice prior to the expiration of the then current term. Either
party may terminate the agreement upon a breach of the agreement by the other
party. Membership in RCI entitles PEC's customers, based on availability,
trading potential (which is based on their timeshare interval), and the payment
of a variable exchange fee to RCI, to exchange their occupancy right in the
resort in which they own an interest for an occupancy right at the same or a
different time in another participating resort of similar trading potential. The
cost of the annual subscription renewal fee in RCI, which is at the option and
expense of the timeshare interest owner, is approximately $67 per year.
OWNERS' ASSOCIATIONS AND PROPERTY MANAGEMENT
PEC's resort properties require ongoing management services. Independent
not-for-profit corporations known as Owners' Associations have been established
to administer each of PEC's resorts other than the resort in Honolulu. PEC's
resort in Honolulu is administered by the White Sands Resort Club, a division of
PEC together with the Owners' Associations (Associations). Owners of timeshare
interests in each of these resorts are responsible for the payment of annual
assessment fees to the respective Association, which are intended to fund all of
the operating expenses at the resort facilities and accumulate reserves for
replacement of furnishings, fixtures and equipment, and building maintenance.
Annual assessment fees for 1996 ranged from $258 to $445. PEC has in the past
financed budget deficits of the Associations, but is not obligated to do so in
the future. During fiscal 1996, PEC did not finance any budget deficits for the
Associations, since the Associations had an aggregate excess of $538,000 of fees
received compared to expenses paid. The deficit and/or excess position of the
Associations vary primarily due to the timing of major improvement expenditures.
The aggregate amount of budget deficits financed by PEC was $1.1 million and
$429,000 during fiscal 1995 and 1994, respectively.
If the owner of a timeshare interest defaults in the payments of the annual
assessment fee, the Association may impose a lien on the related timeshare
interest. PEC has agreed to pay to the Associations the annual assessment fees
of timeshare interest owners who are delinquent with respect to such fees, but
have paid PEC in full for their timeshare interest. In exchange for the payment
by PEC of such fees, the Associations assign their liens for non-payment on the
respective timeshare interests to PEC. In the event the timeshare interest
holder does not satisfy the lien after having an opportunity to do so, PEC
typically acquires a quitclaim deed or forecloses on and acquires the timeshare
interest for the amount of the lien and any foreclosure costs.
PEC has entered into management arrangements with the Associations pursuant
to which PEC receives annual management and administrative fees in exchange for
providing or arranging for various property management services, such as
bookkeeping, staffing, budgeting, maintenance, and housekeeping services. The
management arrangements are typically for initial terms ranging from three to
five years, and automatically renew for successive additional one year terms
unless canceled by the Association. No management arrangement has been canceled
to date. The Company believes that proper management is important for
maintaining customer satisfaction and protecting PEC's investment in its
inventory of unsold timeshare interests.
PEC's intent and goal is to manage these properties until all timeshare
interests are sold and the receivables generated from such sales have been paid.
However, due to cancellations, exchanges and upgrades, none of the Associations
are likely to realize a 100% occupancy rate for an extended period of time. The
continued management of these properties preserves the integrity of the property
and the portfolio performance on an on-going basis, beyond the end of the sales
period.
LAND SALES
PEC is engaged in the retail sale of land in Nevada and Colorado for
residential, commercial, industrial and recreational use. PEC acquires lots and
large tracts of unimproved land and then subdivides the land into
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<PAGE> 22
lots and parcels for retail sale. Residential lots range in size from
one-quarter acre to one and one-half acres, while commercial and industrial lots
vary in size. PEC's residential lots range in price from $11,500 to $46,500,
commercial lots range in price from $17,000 to $76,500 and industrial lots range
in price from $16,750 to $45,750. Improvements such as roads and utilities and,
in some cases, amenities are typically part of the development program in
Nevada. During fiscal 1996, 1995 and 1994, PEC sold 1,617, 1,467 and 1,699
residential lots, and 30, 51 and 61 commercial and industrial lots,
respectively. PEC has a continuing program to plat the properties that it owns.
Purchasers of lots and parcels frequently exchange their property after the
initial purchase for other property interests offered by PEC. Additionally, PEC
is required from time to time to cancel the purchase of lots and parcels as a
result of payment defaults or customer cancellations following inspections of
the property and pursuant to contractual provisions.
A substantial portion of PEC's sales of retail lots and land parcels have
been in its Calvada subdivisions, containing approximately 30,000 lots in the
Pahrump Valley, Nye County, Nevada, located approximately 60 miles from Las
Vegas. The lots are designated single family residential, multiple family
residential, mobile home, hotel/motel, industrial or commercial. PEC owns a
public utility company that provides water and sewer service to portions of the
subdivisions and two golf courses that are available to property owners and the
public. The community of Pahrump has a population estimated at approximately
23,000 and contains an urgent care medical facility, shopping, fast food
restaurants, hotel/casino facilities and several schools.
The following table illustrates certain statistics regarding the Pahrump
Valley subdivisions:
<TABLE>
<S> <C>
Number of acres acquired since 1969................................. 18,614
Number of lots platted.............................................. 29,246
Net number of lots sold through August 31, 1996..................... 28,970
Percent of lots sold through August 31, 1996........................ 99%
Number of platted lots available for sale at August 31, 1996........ 305
Number of acres available for platting.............................. 205
Number of lots to be platted........................................ 581
FOR THE YEAR ENDED AUGUST 31, 1996:
Number of lots sold................................................. 1,648
Number of lots canceled............................................. 452
Number of lots exchanged............................................ 710
------
Number of lots sold, net of cancellations and exchanges............. 486
======
</TABLE>
Central Nevada Utilities Company, a wholly-owned subsidiary of PEC,
operates a public sewer and water utility for portions of PEC's Nevada
subdivisions and certain other properties located within that subsidiary's
certificated service area (which is subject to the regulation of the Nevada
Public Service Commission).
PEC also sells larger unimproved tracts of land in Colorado. PEC has
acquired unimproved land in Huerfano County, Colorado, which is being sold for
recreational use in parcels of at least 35 acres and at prices ranging from
$11,000 to $42,750 depending on location and size. These parcels are sold
without any planned improvements and without water rights, which have been
reserved by PEC. Substantially all of the parcels have been sold, with
approximately 120 parcels remaining in inventory.
PEC has also acquired improved and unimproved land in Park County,
Colorado, which is being sold for recreational use in parcels typically ranging
in size from five to nine acres or larger and at prices ranging from $12,000 to
$29,995. These parcels are sold without any planned improvements, except for a
recreational facility which includes a basketball court, baseball field and
picnic facilities.
22
<PAGE> 23
The following table illustrates certain statistics regarding the parcels in
Huerfano and Park Counties, Colorado:
<TABLE>
<S> <C>
Number of acres acquired since 1969................................. 51,474
Number of parcels platted........................................... 2,952
Net number of parcels sold through August 31, 1996.................. 2,718
Percent of parcels sold through August 31, 1996..................... 92%
Number of platted parcels available for sale at August 31, 1996..... 234
FOR THE YEAR ENDED AUGUST 31, 1996:
Number of parcels sold.............................................. 870
Number of parcels canceled.......................................... 276
Number of parcels exchanged......................................... 454
------
Number of lots sold, net of cancellations and exchanges............. 140
======
</TABLE>
For the fiscal years ended August 31, 1996, 1995 and 1994, PEC's net
revenue from land sales was approximately $18 million, $20.8 million and $13.5
million, respectively, representing approximately 30.7%, 38% and 29.9% of total
revenues, respectively.
TRUST ARRANGEMENTS
Title to certain of PEC's resort properties and land parcels in Huerfano
County, Colorado is held in trust by trustees in order to meet regulatory
requirements applicable at the time of commencement of sales. In connection with
sales of timeshare interests pursuant to "right-to-use" or installment sales
contracts, title to certain of PEC's resort properties in the States of Nevada
and Hawaii is held in trust by trustees in order to meet requirements of certain
state regulatory authorities. Prior to 1988, PEC sold timeshare interests in
certain of its resorts in the State of Nevada pursuant to "right-to-use"
contracts and continues in other resorts to sell under installment sales
contracts under which the purchaser does not receive a deed until the purchase
price is paid in full. In addition, PEC offers "right-to-use" interests in its
resort in Hawaii, since it is on leased property. In connection with the
registration of the sale of such timeshare interests, the Department of Real
Estate of the state of Nevada and the Department of Commerce and Consumer
Affairs of the state of Hawaii required that title to the related resorts be
placed in trust.
CUSTOMER FINANCING
PEC provides financing to virtually all the purchasers of its timeshare
interests, retail lots and land parcels, most of whom make a down payment equal
to at least 10% of the purchase price. The financing is generally evidenced by
non-recourse installment sale contracts as well as notes secured by deeds of
trust. The term of the financing generally ranges from two to ten years with
principal and interest payable monthly in level payments. Interest rates are
fixed and generally range from 0% to 16% per year based on prevailing market
rates and the amount of the down payment made relative to the sales price. PEC
has a sales program whereby no stated interest is charged on those sales where
the aggregate down payment is at least 50% of the purchase price and the balance
is payable in 24 or fewer monthly payments. PEC believes its financing is
attractive to purchasers who find it convenient to handle all facets of the
purchase through a single source. At August 31, 1996, PEC had a serviced
portfolio of 18,408 notes receivable relating to sales of timeshare interests
and land, which receivables had an aggregate outstanding principal balance of
$120.5 million, a weighted-average maturity of approximately 6.6 years and a
weighted-average interest rate of 11.5%.
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<PAGE> 24
PEC has financing arrangements with four institutional lenders for the
financing of customer receivables, which provide for borrowings of up to an
aggregate of $109.5 million. These lines of credit bear interest at variable
rates tied to the prime rate and are secured by timeshare and land receivables
and inventory. At August 31, 1996, an aggregate of $59.3 million was outstanding
under such lines of credit and $43.2 million was available for borrowing. PEC
periodically sells its timeshare and land receivables to various third party
purchasers and uses a portion of the sales proceeds to reduce the outstanding
balances of its lines of credit, thereby increasing the borrowing availability
under such lines by the amount of prepayment. The sales have been for yields to
the purchaser less than the weighted-average yield on the receivables, with PEC
entitled to retain the difference. The sales agreements generally provide for
PEC to continue servicing the sold receivables, and require that PEC repurchase
or replace accounts that have become more than 90 days contractually delinquent,
or as to which certain warranties and representations are determined to be
incorrect. In addition, the sales agreements generally require the maintenance
of cash reserve accounts for losses and contain minimum net worth requirements
and other covenants, the non-compliance with which would allow the purchaser to
replace PEC as the servicer. The sales agreements for timeshare receivables
contain covenants that generally require PEC to use its best efforts to remain
the manager of the related resorts, and to cause the homeowners associations to
maintain appropriate insurance and pay real estate taxes. Performance by PEC of
such covenants generally are guaranteed by the Company. The following table sets
forth the principal balances of receivables sold by PEC in the periods indicated
(thousands of dollars):
<TABLE>
<CAPTION>
YEAR ENDED AUGUST 31,
- -------------------------------
1996 1995 1994
- ------- ------- -------
<S> <C> <C>
$16,003 $32,517 $23,993
</TABLE>
At August 31, 1996, PEC was contingently liable to replace or repurchase
receivables sold with recourse in the aggregate amount of $69.6 million, if and
as such receivables become delinquent. PEC generally writes off or fully
reserves all receivables that are more than 90 days delinquent. The following
table sets forth information with respect to receivables owned and sold that
were more than 60 but less than 90 days delinquent as of the dates indicated
(thousands of dollars):
<TABLE>
<CAPTION>
AUGUST 31,
------------------------------------------------------------
1996 1995 1994 1993 1992
-------- -------- -------- -------- --------
<S> <C> <C> <C> <C> <C>
60-day delinquent................... $ 2,547 $ 2,330 $ 2,144 $ 2,930 $ 3,749
Total receivables................... $128,299 $120,675 $109,360 $103,280 $101,234
60-day delinquency percentage....... 1.99% 1.93% 1.96% 2.84% 3.70%
</TABLE>
PEC provides an allowance for cancellation at the time it recognizes
revenues from sales of timeshare interests, which PEC believes, based on its
experience and its analysis of economic conditions, will be adequate to absorb
losses on receivables that become uncollectible. Upon the sale of the
receivables, the allowance related to those receivables is reduced and the
future estimated contingency for notes receivables sold with recourse is
appropriately increased.
MARKETING
PEC markets timeshare interests and land through on-site and off-site sales
offices. PEC's sales staff of 339 persons receive commissions based on net sales
volume. PEC maintains fully-staffed on-site sales offices at its timeshare
properties in Las Vegas and Reno, Nevada, and Steamboat Springs, Colorado, as
well as the Las Vegas principal offices, and at its land projects in Nevada and
Colorado. At its other timeshare properties, PEC maintains smaller onsite sales
offices staffed with one to two sales persons. PEC also maintains off-site sales
offices in West Covina, California; San Diego, California; Dallas, Texas; and
Denver, Colorado. PEC is exploring additional locations for offsite sales
offices. PEC's marketing efforts are targeted primarily at tourists meeting its
customer profile. Currently, approximately 63% of sales are made through the Las
Vegas sales office. One of the principal sales techniques utilized by PEC in Las
Vegas is to offer pre-screened potential customers a gift such as show tickets
in exchange for attending PEC's sales presentations. The marketing techniques
utilized at PEC's sales offices at locations other than Las Vegas include (i)
exhibition booths located at shows, fairs and other attractions, that generate
inquiries from prospective customers, whom PEC
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<PAGE> 25
then contacts by telephone, (ii) referrals from existing customers, (iii)
limited direct mail programs, and (iv) brokers specializing in lead generation.
Various premiums and inducements are offered to prospective customers to obtain
their attendance at sales presentations, primarily the offer of short term
accommodations at certain of PEC's timeshare resorts.
As part of its marketing strategy, PEC maintains an internal exchange
program. This program enables owners of PEC's timeshare interests to exchange
their occupancy right in the resort in which they own an interest for an
occupancy right at the same or a different time in another of PEC's timeshare
resorts. In addition, PEC has a sales program pursuant to which purchasers of
its timeshare interests, retail lots and land may exchange their equity
interests in one property for an interest in another of PEC's properties. For
example, a purchaser of a timeshare interest in one of PEC's timeshare resorts
may exchange his equity interest for an interest in a different unit within the
same resort, for an interest in one of PEC's other resorts or for a retail lot
or land parcel.
The agreement of sale for a timeshare interest or land may be rescinded
within various statutory rescission periods. For land sales made at a location
other than the property, the customer may generally cancel the contract within a
specified period, usually five months from the date of purchase, provided that
the contract is not in default, and provided the customer has completed a
developer guided inspection and tour of the subject property first, and then
requests the cancellation. At August 31, 1996, $131,975 of recognized sales
remained subject to such cancellation. If a customer defaults after all
rescission and cancellation periods have expired, all payments are generally
retained by PEC, and the customer forfeits all rights to the property.
SEASONALITY
Sales of timeshare interests and land are seasonal. For the fiscal years
ended August 31, 1996, 1995 and 1994 quarterly sales as a percentage of annual
sales, for each of the fiscal quarters averaged: quarters ended November
30 -- 25%, quarters ended February 28 -- 20.3%, quarters ended May 31 -- 28.9%,
and quarters ended August 31 -- 25.9%. The majority of the Company's customers
are tourists. The Company's major marketing area, Las Vegas, Nevada, reaches
peaks of tourist activity at periods different from the Company's other major
marketing areas, Reno, Nevada, Southern California, Atlantic City, New Jersey,
Denver and Park and Huerfano Counties, Colorado, which are more active in summer
than in winter. The Company's other major marketing area, Honolulu, Hawaii, is
not subject to seasonality as are the two new resorts opening in fiscal 1997 in
Florida. The Company is not dependent upon a limited number of customers whose
loss would have a materially adverse effect on the Company.
COMPETITION
The consumer finance, timeshare and real estate industries are highly
competitive. Competitors in the home improvement and debt consolidation loan
business include mortgage banking companies, commercial banks, credit unions,
thrift institutions, credit card issuers and finance companies. Competitors in
the timeshare and real estate business include hotels, other timeshare
properties and real estate properties. Certain of the Company's competitors are
substantially larger and have more capital and other resources than the Company.
MMC faces substantial competition within both the home improvement and debt
consolidation loan industry. The home improvement and debt consolidation loan
industry is dominated by widely diversified mortgage banking companies,
commercial banks, savings and loan institutions, credit card companies,
financial service affiliates of dealers and unregulated financial service
companies, many of which have substantially greater personnel and financial
resources than those of MMC. At present, these types of competitors dominate the
home improvement and debt consolidation loan industry; however, no one lender or
group of lenders dominates the industry. According to a report issued by HUD,
MMC was the fourth largest lender of Title I Loans, based on volume of loans
originated, for the quarter ended June 30, 1996. Due to the variance in the
estimates of the size of the conventional home improvement loan market, MMC is
unable to accurately estimate its competitive position in that market. MMC
believes that Greentree Financial Corp., The Money Store, First Plus Financial
Inc., Associates First Capital Corporation and Empire Funding Corp. are some of
its largest direct competitors. MMC competes principally by providing prompt,
professional service to its Correspondents and Dealers and, depending on
circumstances, by providing competitive lending rates.
Competition can take many forms including convenience in obtaining a loan,
customer service, marketing and distribution channels, amount and term of the
loan, and interest rates. In addition, the current level of
25
<PAGE> 26
gains realized by MMC and its existing competitors on the sale of loans could
attract additional competitors into this market with the possible effect of
lowering gains on future loan sales owing to increased loan origination
competition.
PEC's timeshare plans compete directly with many other timeshare plans,
some of which are in facilities located in Las Vegas, Reno, Lake Tahoe,
Honolulu, Atlantic City, Orlando, Tampa, and Steamboat Springs. In recent years,
several major lodging, hospitality and entertainment companies have begun to
develop and market timeshare properties. In addition, PEC competes with
condominium projects and with traditional hotel accommodations in these areas.
Certain of these competing projects and accommodations are larger and more
luxurious than PEC's facilities. There are currently available approximately
95,000 hotel and motel rooms in Las Vegas, Nevada, 36,000 in Honolulu, Hawaii,
20,600 in Washoe County, Nevada, which includes Reno and Lake Tahoe, 23,400 in
Atlantic City, New Jersey and 1,366 in Steamboat Springs, Colorado.
ENVIRONMENTAL REGULATION
Under various federal, state and local environmental laws, ordinances and
regulations, a current or previous owner or operator of real estate may be
required to investigate and clean up hazardous or toxic substances or chemical
releases at such property, and may be held liable to a governmental entity or to
third parties for property damage, personal injury and investigation and cleanup
costs incurred by such parties in connection with the contamination. Such laws
typically impose cleanup responsibility and liability without regard to whether
the owner knew of or caused the presence of the contaminants, and the liability
under such laws has been interpreted to be joint and several unless the harm is
divisible and there is a reasonable basis for allocation of responsibility. The
costs of investigation, remediation or removal of such substances may be
substantial, and the presence of such substances, or the failure to properly
remediate such property, may adversely affect the owner's ability to sell or
rent such property or to borrow using such property as collateral. Persons who
arrange for the disposal or treatment of hazardous or toxic substances also may
be liable for the costs of removal or remediation of such substances at the
disposal or treatment facility, whether or not the facility is owned or operated
by such person. In addition, the owner or former owners of a site may be subject
to common law claims by third parties based on damages and costs resulting from
environmental contamination emanating from a site.
GOVERNMENT REGULATION
The Company's consumer finance, timeshare and real estate operations are
subject to extensive regulation, suspension and licensing by federal and state
authorities. The following is a summary of the regulations applicable to the
Company.
MMC's consumer lending activities are subject to the Federal
Truth-in-Lending Act and Regulation Z (including the Home Ownership and Equity
Protection Act of 1994), ECOA, the Fair Credit Reporting Act of 1970, as
amended, RESPA and Regulation X, the Home Mortgage Disclosure Act, the Federal
Debt Collection Practices Act and the Housing Act, as well as other federal and
state statutes and regulations affecting MMC's activities. Failure to comply
with these requirements can lead to loss of approved status, termination or
suspension of servicing contracts without compensation to the servicer, demands
for indemnifications or mortgage loan repurchases, certain rights of rescission
for mortgage loans, class action lawsuits and administrative enforcements
actions.
TITLE I LOAN AND CONSUMER FINANCING
MMC presently is subject to the rules and regulations of, and examinations
by, HUD, FHA and other federal and state regulatory authorities with respect to
originating, underwriting, funding, acquiring, selling and servicing consumer
and mortgage loans. In addition, there are other federal and state statutes and
regulations affecting such activities. These rules and regulations, among other
things, impose licensing obligations on the Company, establish eligibility
criteria for loans, prohibit discrimination, provide for inspection and
appraisals of properties, require credit reports on prospective borrowers,
regulate payment features and, in some cases, fix maximum interest rates, fees
and loan amounts. MMC is required to submit annual audited financial
26
<PAGE> 27
statements to various governmental regulatory agencies that require the
maintenance of specified net worth levels. MMC's affairs are also subject to
examination, at all times, by the Federal Housing Commissioner to assure
compliance with FHA regulations, policies and procedures. For more information
regarding regulation of MMC under Title I, see "Title I Loan Program."
MMC is a HUD approved Title I mortgage lender and is subject to the
supervision of HUD. MMC is also a FNMA approved seller/servicer and is subject
to the supervision of FNMA. In addition, MMC's operations are subject to
supervision by state authorities (typically state banking or consumer credit
authorities), many of which generally require that MMC be licensed to conduct
its business. This normally requires state examinations and reporting
requirements on an annual basis.
The Federal Consumer Credit Protection Act (FCCPA) requires a written
statement showing an annual percentage rate of finance charges and requires that
other information be presented to debtors when consumer credit contracts are
executed. The Fair Credit Reporting Act requires certain disclosures to
applicants concerning information that is used as a basis for denial of credit.
ECOA prohibits discrimination against applicants with respect to any aspect of a
credit transaction on the basis of sex, marital status, race, color, religion,
national origin, age, derivation of income from public assistance program, or
the good faith exercise of a right under the FCCPA.
The interest rates which MMC may charge on its loans are subject to state
usury laws, which specify the maximum rate which may be charged to consumers. In
addition, both federal and state truth-in-lending regulations require that MMC
disclose to its customers prior to execution of the loans, all material terms
and conditions of the financing, including the payment schedule and total
obligation under the loans. MMC believes that it is in compliance in all
material respects with such regulations.
TIMESHARE REGULATION
Nevada Revised Statutes Chapter 119A requires the Company to give each
customer a Public Offering Statement that discloses all aspects of the timeshare
program, including the terms and conditions of sale, the common facilities, the
costs to operate and maintain common facilities, the Company's history and all
services and facilities available to the purchasers. Section 514E of Hawaii
Revised Statutes provides for similar information to be provided to all
prospective purchasers through the use of the Hawaii Disclosure Statement.
Section 11000, et seq., of the California Business and Professions Code also
provides for similar information to be provided to all prospective purchasers
through the use of an Out-of-State Time Share Permit issued by the California
Department of Real Estate. Section 45 of the New Jersey Statutes Annotated
provides for similar information to be provided to all prospective purchasers
through the use of a Public Offering Statement. Title 12, Article 61 of the
Colorado Revised Statutes provides for similar information to be provided to all
prospective purchasers, in their contracts of sales or by separate written
documents. Nevada and Colorado require a five day rescission period for all
timeshare purchasers. The rescission period required by Hawaii and New Jersey is
seven days. The rescission period required by Florida is ten days. The
rescission period in California for out-of-state sales is five days. The Nevada,
California, New Jersey, Hawaii, Colorado and Florida timeshare statutes have
stringent restrictions on sales and advertising practices and require the
Company to utilize licensed sales personnel.
The Company believes that it has made all required filings with state, city
and county authorities and is in material compliance with all state and local
regulations governing sales of timeshare interests. The Company believes that
such regulations have not had a material adverse effect on any phase of the
Company's operations, including the over-all cost of acquiring property.
Compliance with or changes in official interpretations of regulations might,
however, impose additional compliance costs on the Company that cannot be
predicted.
REAL ESTATE REGULATION
The real estate industry is subject to extensive regulation. The Company is
subject to compliance with various federal, state and local environmental,
zoning and other statutes and regulations regarding the acquisition,
subdivision, development and sale of real estate and various aspects of its
financing operations.
27
<PAGE> 28
The Interstate Land Sales Full Disclosure Act establishes strict guidelines with
respect to the subdivision and sale of land in interstate commerce. HUD has
enforcement powers with respect to this statute. In many instances, (e.g.,
Huerfano County, Colorado land sales) the Company has been exempt from HUD
registration requirements because of the size or number of the subdivided
parcels and the limited nature or type of its offerings. The Company registers
its timeshare properties with various state agencies. The Company must disclose
financial information concerning the property, evidence of title, a description
of the intended manner of offering, proposed advertising materials, and must
bear the costs of such registration, which include legal and filing fees.
The Company believes that it is in compliance in all material respects with
all applicable federal, state and local regulations. The Company believes that
such regulations have not had a material adverse effect on any phase of its
operations. Compliance with future changes in regulations might, however, impose
additional compliance costs on the Company that cannot be predicted.
The city and county governments in areas where the Company operates have
enacted licensing and other ordinances that affect timeshare projects.
EMPLOYEES
As of August 31, 1996, the Company had 1,433 employees, of whom 1,190 were
full-time employees and 243 were part-time employees. Of these, 166 were
employed full-time in consumer finance activities, including 6 executive
officers, 74 managerial and staff professional personnel, 13 marketing and sales
specialists and 73 general administrative and support personnel and loan
processors, and 1,256 were employed in timeshare and real estate activities,
including 661 sales and marketing officers and personnel, 213 general and
administrative officers, managers and support staff, 382 hotel personnel, and 11
utility company personnel. MMC had 170 employees at August 31, 1995. At that
date, PEC had 1,263 employees including senior management. None of the Company's
employees are represented by a collective bargaining unit. The Company believes
that its relations with its employees are satisfactory.
28
<PAGE> 29
ITEM 3. LEGAL PROCEEDINGS
In the matter of the PEC Apartment Subsidiaries litigation previously
reported upon, an order for judgment of $3,346,000 was rendered against PEC on
its limited guaranty, in connection with the defendants' counterclaim. Pursuant
to a stipulation between the parties dated as of May 15, 1995, PEC paid the
amount of $2,900,000 on June 15, 1995 in full settlement of this matter. Because
the reserve recorded in the financial statements of the Company exceeded the
amount of the settlement, the Company recognized a gain on discontinued
operations of $1,323,000.
On July 5, 1995, Pahrump Valley Vineyards, Inc. filed a complaint in the
5th Judicial District Court, Nye County, Nevada, against CNUC, a subsidiary of
PEC. The plaintiff claimed compensatory damages in excess of $25,000 in each of
4 counts alleging trespass, nuisance, negligence and breach of contract for the
alleged supplying of contaminated water by CNUC to the plaintiff, and also
prayed for punitive damages in excess of $25,000. Following discovery, PEC's
insurance carrier settled the case by payment of $35,000 to the plaintiffs.
Following the Company's November 10, 1995 announcement disclosing certain
accounting adjustments, an action was filed on November 13, 1995, in the United
States District Court, District of Nevada by Christopher Dunleavy, as a
purported class action against the Company, certain of the Company's officers
and directors and the Company's independent auditors. The complaint alleges,
among other things, that the defendants violated Section 10(b) of the Securities
Exchange Act of 1934 and Rule 10b-5 thereunder in connection with the
preparation and issuance of certain of the Company's financial reports issued in
1994 and 1995, including certain financial statements reported on by the
Company's independent auditors. The complaint also alleges that one of the
director defendants violated the federal securities laws by engaging in "insider
trading." The named plaintiff seeks to represent a class consisting of
purchasers of the Company's Common stock between January 14, 1994 and November
9, 1995, and seeks damages in an unspecified amount, costs, attorney's fees and
such other relief as the court may deem just and proper. The Company believes
that it has substantial defenses to the action and that the likelihood of a
material liability being incurred by the Company is remote.
On November 16, 1995, a second action was filed in the United States
District Court for the District of Nevada by Alan Peyser as a purported class
action against the Company and certain of its officers and directors, which was
served on the Company on December 20, 1995. The complaint alleges, among other
things, that the defendants violated the federal securities laws by making
statements and issuing certain financial reports in 1994 and 1995 that
overstated the Company's earnings and business prospects. The named plaintiff
seeks to represent a class consisting of purchasers of the Company's common
stock between November 28, 1994 and November 9, 1995. The complaint seeks
damages in an unspecified amount, cost, attorney's fees and such other relief as
the Court may deem just and proper. The Company believes that it has substantial
defenses to the action and that the likelihood of a material liability being
incurred by the Company is remote.
On or about June 10, 1996, the Dunleavy Action and Peyser Action were
consolidated under the caption "In re Mego Financial Corp. Securities
Litigation," Master File No. CV-9-95-01082-LD (RLJ), pursuant to a stipulation
by the parties. On or about July 26, 1996, Michael Nadler filed a motion in the
above matter requesting that he be added as a class representative and that his
attorney be added as additional counsel for the class. On or about August 26,
1996, a Motion in Opposition to the motion to add a class representative was
filed by the Company and certain other defendants. Neither motion has been heard
or decided by the court. The Company presently cannot predict the outcome or
estimated loss with respect to this matter.
In the general course of business the Company, at various times, has been
named in other lawsuits. The Company believes that it has meritorious defenses
to these lawsuits and that resolution of these matters will not have a material
adverse affect on the business or financial condition of the Company.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted to a vote of the Company's security holders
during the fourth quarter of the fiscal year ended August 31, 1996.
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<PAGE> 30
PART II
ITEM 6. SELECTED CONSOLIDATED FINANCIAL DATA
The selected financial data set forth below have been derived from the
consolidated financial statements of the Company. The consolidated financial
statements as of August 31, 1996, 1995, and 1994 and for each of the three years
in the period ended August 31, 1996 have been audited by Deloitte & Touche LLP,
independent auditors, and are included elsewhere herein. The consolidated
financial statements as of August 31, 1993 and 1992 and for each of the two
years in the period ended August 31, 1993 have been audited by Deloitte & Touche
LLP, independent auditors, and are not included herein.
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<PAGE> 31
The selected financial information set forth below should be read in
conjunction with the consolidated financial statements, the related notes and
Management's Discussion and Analysis of Financial Condition and Results of
Operations included elsewhere herein (thousands of dollars, except per share
amounts):
CONSOLIDATED SELECTED FINANCIAL DATA(1)(2)
<TABLE>
<CAPTION>
YEAR ENDED AUGUST 31,
-------------------------------------------------
1996 1995 1994(3) 1993(3) 1992(3)
-------- -------- ------- ------- -------
<S> <C> <C> <C> <C> <C>
INCOME STATEMENT DATA:
REVENUES:
Timeshare interest sales, net..................................... $ 27,778 $ 20,682 $19,521 $21,735 $14,621
Land sales, net (including housing sales)......................... 17,968 21,017 14,049 14,255 13,818
Gain on sale of notes receivable.................................. 19,110 13,819 1,454 631 --
Net unrealized gain on mortgage related securities................ 2,697 -- -- -- --
Interest income................................................... 8,698 8,179 8,368 9,094 10,159
Financial income.................................................. 3,892 1,149 -- -- --
Other(4).......................................................... 6,652 6,714 5,484 4,357 4,459
-------- -------- ------- ------- -------
Total revenues............................................. 86,795 71,560 48,876 50,072 43,057
-------- -------- ------- ------- -------
COSTS AND EXPENSES:
Cost of sales(5).................................................. 8,099 7,749 6,992 8,548 6,449
Commissions and selling........................................... 30,351 23,690 18,949 20,079 16,432
Depreciation and amortization..................................... 1,920 1,534 1,208 980 938
Provision for credit losses....................................... 1,510 864 96 -- --
Interest expense.................................................. 8,597 6,961 4,836 4,441 4,780
General and administrative........................................ 28,300 19,323 13,282 10,027 9,794
Payments to assignors............................................. -- 7,252 8,526 4,632 3,325
-------- -------- ------- ------- -------
Total costs and expenses................................... 78,777 67,373 53,889 48,707 41,718
INCOME (LOSS) BEFORE INCOME TAXES................................... 8,018 4,187 (5,013) 1,365 1,339
INCOME TAXES........................................................ 3,167 3,293 761 2,218 2,382
-------- -------- ------- ------- -------
INCOME (LOSS) FROM CONTINUING OPERATIONS............................ 4,851 894 (5,774) (853) (1,043)
GAIN ON DISCONTINUED OPERATIONS, NET OF INCOME TAXES OF $450(6)..... -- 873 -- -- --
-------- -------- ------- ------- -------
NET INCOME (LOSS)................................................... 4,851 1,767 (5,774) (853) (1,043)
MINORITY INTEREST IN INCOME OF 80%-OWNED SUBSIDIARY................. -- -- -- 126 63
CUMULATIVE PREFERRED STOCK DIVIDENDS(7)............................. 240 360 360 -- --
-------- -------- ------- ------- -------
NET INCOME (LOSS) APPLICABLE TO COMMON STOCK........................ $ 4,611 $ 1,407 $(6,134) $ (979) $(1,106)
======== ======== ======= ======= =======
EARNINGS (LOSS) PER SHARE(8):
PRIMARY:
Income (loss) from continuing operations, net of minority
interest...................................................... $ .24 $ .03 $ (.34) $ (.06) $ (.07)
Income from discontinued operations............................. -- .05 -- -- --
-------- -------- ------- ------- -------
Net income (loss)............................................... $ .24 $ .08 $ (.34) $ (.06) $ (.07)
======== ======== ======= ======= =======
Weighted-average number of shares outstanding (in thousands).... 19,087 18,087 17,820 17,145 16,701
======== ======== ======= ======= =======
FULLY DILUTED(9):
Income from continuing operations, net of minority interest..... $ .24 $ .02
Income from discontinued operations............................. -- .05
-------- --------
Net income (loss)............................................... $ .24 $ .07
======== ========
Weighted-average number of shares outstanding (in thousands).... 19,087 18,939
======== ========
BALANCE SHEET DATA:
Total assets...................................................... $165,597 $112,757 $88,302 $91,153 $88,937
Total liabilities................................................. 130,055 81,175 68,779 66,144 65,412
Minority interest................................................. -- -- -- -- 1,619
Subordinated debt................................................. 9,691 9,352 -- -- --
Redeemable preferred stock........................................ -- 3,000 3,000 3,000 --
Total stockholders' equity........................................ 25,851 19,230 16,523 22,009 21,906
</TABLE>
- ---------------
(1) At August 31, 1993, effective September 1, 1992, the Company adopted the
provisions of SFAS 109, requiring an asset/liability approach for financial
accounting and reporting of income taxes. See Note 20 of Notes to
Consolidated Financial Statements.
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<PAGE> 32
(2) The income statement data and balance sheet data herein for the five fiscal
years are not necessarily indicative of the results to be expected in the
future. Certain reclassifications have been made to conform prior years with
the current presentation.
(3) The Company has restated certain of its previously issued financial
statements; including for the year ended August 31, 1994, upon which its
independent auditors had rendered unqualified opinions. The financial data
presented herein includes those restatements.
(4) Other revenues include amortization of negative goodwill, incidental
operations, management fees from owners' associations and other fees.
(5) Direct cost of sales includes costs of sales of timeshare interests, land,
housing and incidental operations.
(6) A gain on discontinued operations of $873,000 after deducting $450,000 of
tax was recognized in fiscal 1995. See Notes 20 and 21 of Notes to
Consolidated Financial Statements.
(7) See Note 17 of Notes to Consolidated Financial Statements.
(8) No cash dividends per common share were declared during the five fiscal
years included herein.
(9) Fully diluted earnings per share are not presented for the fiscal years
ended August 31, 1994, 1993, and 1992 because the effect would have been
anti-dilutive.
OTHER DATA(1)
<TABLE>
<CAPTION>
YEAR ENDED AUGUST 31,
-----------------------------------------------
1996 1995 1994 1993 1992
------- ------- ------- ------- -------
<S> <C> <C> <C> <C> <C>
OPERATING INCOME (LOSS) BY SUBSIDIARIES:
MMC(2):
Revenues:
Gain on sale of loans............................................. $17,994 $12,233 $ 579 $ -- $ --
Net unrealized gain on mortgage related securities................ 2,697 -- -- -- --
Interest income, net of interest expense.......................... 988 473 172 -- --
Loan servicing income............................................. 3,348 873 -- -- --
------- ------- ------- ------- -------
Total revenues...................................................... 25,027 13,579 751 -- --
Total costs and expenses............................................ 13,872 7,660 2,262 -- --
------- ------- ------- ------- -------
Operating income (loss)............................................. $11,155 $ 5,919 $(1,511) $ -- $ --
======= ======= ======= ======= =======
PEC:
Revenues:
Timeshare and land sales, net..................................... $45,746 $41,494 $33,055 $34,933 $28,439
Gain on sale of receivables....................................... 1,116 1,586 875 631 --
Interest income................................................... 6,560 6,838 7,914 8,238 8,175
Other(3).......................................................... 7,196 6,886 5,514 5,414 4,459
------- ------- ------- ------- -------
Total revenues...................................................... 60,618 56,804 47,358 49,216 41,073
Total costs and expenses............................................ 59,281 48,498 41,807 43,628 37,918
------- ------- ------- ------- -------
Operating income.................................................... $ 1,337 $ 8,306 $ 5,551 $ 5,588 $ 3,155
======= ======= ======= ======= =======
INCOME STATEMENT DATA:
Consolidated operating income from subsidiaries....................... $12,492 $14,225 $ 4,040 $ 5,588 $ 3,155
Payments to assignors................................................. -- (7,252) (8,526) (4,632) (3,325)
Other income (expense), net(4)........................................ (4,474) (2,786) (527) 409 1,509
------- ------- ------- ------- -------
Income (loss) from continuing operations before income taxes.......... 8,018 4,187 (5,013) 1,365 1,339
Income taxes.......................................................... 3,167 3,293 761 2,218 2,382
------- ------- ------- ------- -------
Income (loss) from continuing operations.............................. 4,851 894 (5,774) (853) (1,043)
Income from discontinued operations................................... -- 873 -- -- --
------- ------- ------- ------- -------
Income (loss) before minority interest................................ 4,851 1,767 (5,774) (853) (1,043)
Minority interest in income of 80%-owned subsidiary................... -- -- -- 126 63
------- ------- ------- ------- -------
Net income (loss)..................................................... 4,851 1,767 (5,774) (979) (1,106)
Cumulative preferred stock dividends.................................. 240 360 360 -- --
------- ------- ------- ------- -------
Net income (loss) applicable to common stock.......................... $ 4,611 $ 1,407 $(6,134) $ (979) $(1,106)
======= ======= ======= ======= =======
</TABLE>
- ---------------
(1) The Company restated certain of its previously issued financial statements;
including for the year ended August 31, 1994, upon which its independent
auditors had rendered an unqualified opinion. The financial data presented
in this table includes those restatements.
(2) MMC commenced originating loans in March 1994.
32
<PAGE> 33
(3) Includes housing sales revenues in fiscal 1995, 1994, and 1993 of $205,000,
$515,000 and $1.1 million, respectively.
(4) The "other income (expense), net" line on this table primarily represents
interest income from short-term investments and amortization of negative
goodwill related to the parent only (Mego Financial) interest expense
related to subordinated debt incurred by Mego Financial, and various
corporate general and administrative costs incurred by Mego Financial such
as legal, audit fees, and public company compliance costs. The following
table breaks out these amounts by year and indicates the line item heading
on the Consolidated Statements of Operations (thousands of dollars):
<TABLE>
<CAPTION>
1996 1995 1994 1993 1992
------- ------- ------- ----- ------
<S> <C> <C> <C> <C> <C>
Other income (expense), net (D)
A) Interest and amortization of negative goodwill........ $ 34 $ 191 $ 514 $ 856 $1,984
B) Interest expense...................................... (1,695) -- -- -- --
C) General and administrative expense.................... (2,813) (2,977) (1,041) (447) (475)
------- ------- ------- ----- ------
Total.......................................... $(4,474) $(2,786) $ (527) $ 409 $1,509
======= ======= ======= ===== ======
</TABLE>
- ---------------
A) Included in "Interest Income" on the Consolidated Statements of
Operations.
B) Included in "Interest Expense" on the Consolidated Statements of
Operations.
C) Included in "General and Administrative" on the Consolidated Statements
of Operations.
D) All items relate to the parent only -- Mego Financial.
33
<PAGE> 34
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
The following discussion and analysis should be read in conjunction with
the Consolidated Financial Statements, including the notes thereto, contained
elsewhere herein.
GENERAL
The business of the Company, after the acquisition of PEC (see
"Business -- Purchase of Preferred Equities Corporation") and the commencement
of operations of MMC (see "Business of MMC"), is primarily the business of
generating consumer receivables by marketing timeshare interests, retail lots
and land parcels and generating home improvement loans; and collecting the
related notes receivable and loans. For additional information regarding the
Company's business segments, see Note 25 of Notes to Consolidated Financial
Statements and Item 1. Business.
MMC
MMC began originating loans on March 1, 1994 and, accordingly, MMC's
results of operations for the years ended August 31, 1996 and 1995 include full
years' of operations, while results for the year ended August 31, 1994 include
only six months of loan originations.
MMC recognizes revenue from the gain on sale of loans, interest income and
servicing income. Interest income, net, represents the interest received on
loans in MMC's portfolio prior to their sale, net of interest paid under its
credit agreements. MMC continues to service all loans sold to date. Net loan
servicing income represents servicing fee income and other ancillary fees
received for servicing loans less the amortization of capitalized mortgage
servicing rights. Mortgage servicing rights are amortized over the estimated
life of the future net servicing fee income.
MMC sells its loans through whole loan sales to third party purchasers,
retaining the right to service the loans and to receive any amounts in excess of
the guaranteed yield to the purchasers. In addition, MMC has commenced the sale
of loans through securitizations. Certain of the regular interests of the
related securitizations are sold, with the interest only and residual class
securities retained by MMC.
Gain on sale of loans includes the gain on sale of mortgage related
securities and loans held for sale. The gain on sale of mortgage related
securities is determined by an allocation of the cost of the securities based on
the relative fair value of the securities sold and the securities retained. MMC
generally retains an interest only strip security and residual interest
security. The fair value of the interest only strip and residual interest
security is the present value of the estimated cash flows to be received after
considering the effects of estimated prepayments and credit losses, net of FHA
insurance recoveries. The net unrealized gain on mortgage related securities
represents the difference between the allocated cost basis of the securities and
the estimated fair value.
As the holder of the residual securities, MMC is entitled to receive
certain excess cash flows. These excess cash flows are calculated as the
difference between (a) principal and interest paid by borrowers and (b) the sum
of (i) pass-through interest and principal to be paid to the holders of the
regular securities and interest only securities, (ii) trustee fees, (iii)
third-party credit enhancement fees, (iv) servicing fees and (v) estimated loan
pool losses. MMC's right to receive the excess cash flows is subject to the
satisfaction of certain reserve requirements which are specific to each
securitization and are used as a means of credit enhancement.
MMC carries interest only and residual securities at fair value. As such,
the carrying value of these securities is affected by changes in market interest
rates and prepayment and loss experiences of these and similar securities. MMC
estimates the fair value of the interest only and residual securities utilizing
prepayment and credit loss assumptions MMC believes to be appropriate for each
particular securitization. To MMC's knowledge, there is no active market for the
sale of these interest only and residual securities. The range of values
attributable to the factors used in determining fair value is broad. Although
MMC believes that it has made reasonable estimates of the fair value of the
mortgage related securities, the rate of prepayments and default rates utilized
are estimates, and actual experience may vary from its estimates.
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<PAGE> 35
The present value of expected net cash flows from the sale of loans is
recorded at the time of sale as excess servicing rights and mortgage related
securities. Excess servicing rights are amortized as a charge to income, as
payments are received on the retained interest differential over the estimated
life of the underlying loans. The expected cash flows used to determine the
excess servicing rights asset and mortgage related securities have been reduced
for potential losses, net of FHA insurance recoveries, under recourse provisions
of the sales agreements. The allowance for credit losses on loans sold with
recourse represents MMC's estimate of losses to be incurred in connection with
the recourse provisions of the sales agreements.
To determine the fair value of the mortgage servicing rights and excess
servicing rights, MMC projects net cash flows expected to be received over the
life of the loans. Such projections assume certain servicing costs, prepayment
rates and credit losses. These assumptions are similar to those used by MMC to
value the residual securities. As of August 31, 1996, mortgage servicing rights
totaled $3.8 million, excess servicing rights totaled $12.1 million and mortgage
related securities totaled $22.9 million for MMC.
There can be no assurance that MMC's estimates used to determine the fair
value of mortgage and excess servicing rights will remain appropriate for the
life of the loans. If actual loan prepayments or credit losses exceed MMC's
estimates, the carrying value of MMC's mortgage and excess servicing rights may
have to be written down through a charge against earnings. MMC will not write up
such assets to reflect slower than expected prepayments, although slower
prepayments may increase future earnings as MMC will receive cash flows in
excess of those anticipated.
MMC discounts cash flows on its loan sales at the rate it believes an
independent third-party purchaser would require as a rate of return. The cash
flows were discounted to present value using discount rates which averaged 12%
for the years ended August 31, 1996, 1995, and 1994. MMC has developed its
assumptions based on experience with its own portfolio, available market data
and ongoing consultation with its financial advisors.
The weighted-average discount rate used to determine the present value of
the balance of capitalized excess servicing rights and capitalized mortgage
servicing rights reflected on MMC's Statement of Financial Condition at August
31, 1996 and 1995 was approximately 12%. Capitalized excess servicing rights are
amortized over the lesser of the estimated or actual remaining life of the
underlying loans as an offset against the excess servicing rights component of
servicing income actually received in connection with such loans.
Although MMC believes that it has made reasonable estimates of the fair
value of the mortgage related securities, the excess servicing rights and
mortgage servicing rights likely to be realized, the rate of prepayment and the
amount of defaults utilized by MMC are estimates and actual experience may vary
from its estimates. The gain recognized by MMC upon the sale of loans and
unrealized gain on mortgage related securities will have been overstated if
prepayments or defaults are greater than anticipated. Higher levels of future
prepayments could result in excess servicing rights and mortgage servicing
rights amortization expense exceeding realized excess servicing rights and
mortgage servicing rights, thereby adversely affecting MMC's servicing income
and resulting in a charge to earnings in the period of adjustment. Similarly, if
delinquencies or liquidations were to be greater than initially assumed, excess
servicing rights and mortgage servicing rights amortization would occur more
quickly than originally anticipated, which would have an adverse effect on loan
servicing income in the period of such adjustment. MMC periodically reviews its
prepayment assumptions in relation to current rates of prepayment and, if
necessary, reduces the remaining asset to the net present value of the estimated
remaining future excess servicing rights. Rapid increases in interest rates or
competitive pressures may result in a reduction of excess servicing income
recognized by MMC upon the sale of loans in the future, thereby reducing the
gains recognized by MMC upon such sales. Higher levels of prepayments than
initially assumed would result in a charge to earnings in the period of
adjustment.
Increases in interest rates or higher than anticipated rates of loan
prepayments or credit losses on the underlying loans of MMC's mortgage related
securities or similar securities may require MMC to write down the value of such
mortgage related securities and result in a material adverse impact on MMC's
results of operations and financial condition. MMC is not aware of an active
market for the mortgage related securities, excess servicing rights or mortgage
servicing rights.
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<PAGE> 36
MMC continues to implement its business growth strategy through both
product line and geographic diversification and expansion of its Correspondent
and Dealer operations, in an effort to increase both loan origination volume and
servicing volume. Implementation of this strategy has increased MMC's total
assets through growth in excess servicing rights, mortgage servicing assets and
mortgage related securities and has been funded through increased borrowings.
While this growth has increased MMC's revenues through increased gain on sales
of loans, loan servicing income and net interest income, it has also increased
the general and administrative expense and provision for credit losses
associated with the growth in loans originated and serviced. Continued increases
in MMC's total assets and increasing earnings can continue only so long as
origination volumes continue to exceed paydowns of loans serviced and previous
period origination volumes. Additionally, the fair value of mortgage related
securities, mortgage servicing rights and excess servicing rights owned by MMC
may be adversely affected by changes in the interest rate environment which
could affect the discount rate and prepayment assumptions used to value the
assets. Any such adverse change in assumptions could have a material adverse
effect on MMC's results of operations and financial condition.
Although MMC's loans are generally secured by liens on real property,
because of the relatively high loan-to-value ratio ("LTV") of most of MMC's
loans, generally the collateral for such loans will not be sufficient to cover
the principal amount of the loans in the event of default. MMC relies
principally on the creditworthiness of the borrower and to a lesser extent on
the underlying collateral for repayment of its conventional loans, and on FHA
insurance with respect to Title I Loans. As a result, many of MMC's loans equal
or exceed the value of the mortgaged properties. Upon the occurrence of a
default by a borrower, MMC currently evaluates the cost effectiveness of
foreclosing on the property. To the extent that borrowers with high LTVs default
on their loan obligations, MMC is less likely to use foreclosure as a means to
mitigate its losses. Under these circumstances, losses would be charged to MMC's
allowance for credit losses on loans sold and held for sale, except to the
extent that FHA insurance proceeds are available to offset such losses. If MMC
is required to absorb losses on such loans in excess of its allowances, it could
have a material adverse effect on the Company's financial position and results
of operations.
PEC
PEC recognizes revenue primarily from sales of timeshare interests in
resort areas and land, gain on sale of receivables and interest income. PEC also
sells its consumer receivables while generally retaining the servicing rights.
Revenue from sales of timeshare interests and land is recognized after the
requisite rescission period has expired and at such time as the purchaser has
paid at least 10% of the sales price for sales of timeshare interests and 20% of
the sales price for land sales. Land sales typically meet these requirements
within eight to ten months from closing, and sales of timeshare interests
typically meet these requirements at the time of sale. The sales price, less a
provision for cancellation is recorded as revenue and the allocated cost related
to such net revenue of the timeshare interest or land parcel is recorded as
expense in the year that revenue is recognized. When revenue related to land
sales is recognized, the portion of the sales price attributable to uncompleted
required improvements, if any, is deferred.
Notes receivable with payment delinquencies of 90 days or more have been
considered in determining the allowance for cancellation. Cancellations occur
when the note receivable is determined to be uncollectible and the related
collateral, if any, has been recovered. Cancellation of a note receivable in the
year the revenue is recognized is accounted for as a reversal of the revenue.
Cancellation of a note receivable subsequent to the year the revenue was
recognized is charged to the allowance for cancellation.
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 generally retains the servicing rights and
participation in certain cash flows from the sold notes receivable. PEC
generally sells its notes receivable at par value.
The present value of expected net cash flows from the sale of notes
receivable are recorded at the time of sale as excess servicing rights. Excess
servicing rights are amortized as expense, as payments are received on the
retained interest differential over the estimated life of the underlying notes
receivable. Excess servicing
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<PAGE> 37
rights are recorded at the lower of unamortized cost or estimated fair value.
The expected cash flows used to determine the excess servicing rights asset have
been reduced for potential losses under recourse provisions of the sales
agreements. The future estimated contingency for notes receivable sold with
recourse represents PEC's estimate of losses to be incurred in connection with
the recourse provisions of the sales agreements and is shown separately as a
liability in the Company's Consolidated Statements of Financial Condition.
In discounting cash flows related to notes receivable sales, 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 in financial income. The cash flows were discounted
to present value using discount rates which averaged 15% in both fiscal 1996 and
fiscal 1995. PEC has developed its assumptions based on experience with its own
portfolio, available market data and ongoing consultation with its investment
bankers.
In determining expected cash flows, management considers economic
conditions at the date of sale. In subsequent periods, these estimates may be
revised as necessary using the original discount rate, and any losses arising
from prepayment and loss experience will be recognized as realized.
Provision for cancellation 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. PEC records a
provision for cancellations at the time revenue is recognized, based on
historical experience and current economic factors. The related allowance for
cancellation represents PEC's estimate of the amount of its probable future
credit losses on the recognized notes receivable which may become uncollectible.
The allowance for cancellations is reduced by actual cancellations experienced,
including cancellations related to previously sold notes receivable which were
reacquired pursuant to the recourse obligations discussed herein. Such allowance
is also reduced to establish the liability for future estimated cancellation as
notes receivable are sold. 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, current economic conditions which may affect the purchasers' ability
to pay, the changes in collateral values, the estimated value of inventory that
may be reacquired, and overall portfolio quality. Changes in the allowance as a
result of such reviews are included in the provision for cancellations.
Recourse to PEC on sales of notes receivable is governed by the agreements
between the purchasers and PEC. The future estimated contingency for notes
receivable sold with recourse represents PEC's estimate of its probable future
credit losses to be incurred over the lives of the notes receivable. A liability
for future estimated contingency for notes receivable sold with recourse was
established at the time of each sale based upon PEC's analysis of all probable
losses resulting from PEC's recourse obligations under each agreement of sale.
For notes receivable sold after September 30, 1992, the liability is determined
in accordance with Emerging Issues Task Force (EITF) Issue No. 92-2, on a
"discounted to present value" basis using an interest rate equivalent to the
risk-free market rate for securities with a duration similar to that estimated
for the underlying notes receivable. For notes receivable sold prior to
September 30, 1992, the liability remains on a non-discounted basis.
Fees for servicing notes receivable originated or acquired by PEC and sold
with servicing rights retained are generally based on a stipulated percentage of
the outstanding principal balance of such notes receivable and are recognized
when earned. Interest received on notes receivable sold, less amounts paid to
investors, is reported as financial income. Capitalized excess servicing rights
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 excess servicing rights and interest on cash funds.
Total costs and expenses consist primarily of commissions and selling
expenses, general and administrative expenses, direct costs of sales of
timeshare interests and land, depreciation and amortization and interest
expense. Commissions and selling costs directly attributable to unrecognized
sales are accounted for as deferred selling costs until such time as the sale is
recognized. The Company incurs a portion of operating
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<PAGE> 38
expenses of the timeshare owners' associations based on ownership of unsold
timeshare interests at each of the respective timeshare properties. These costs
are referred to as "association assessments" and are included in the
Consolidated Statements of Operations in general and administrative expense.
Management fees received from the associations are included in other revenues.
These fees are not deemed to be a result of a separate revenue generating line
of business; it is part of the support of the timeshare business and is actually
a reduction of the expense the registrant incurs to fulfill obligations
regarding timeshares.
REAL ESTATE RISK
Real estate development involves significant risks, including risks that
suitable properties will not be available at reasonable prices, that
acquisition, development and construction financing may not be available on
favorable terms or at all, that infrastructure and construction costs may exceed
original estimates, that construction may not be completed on schedule, and that
upon completion of construction and improvements, properties may not be sold on
favorable terms or at all. In addition, PEC's timeshare activities, as well as
its ownership, improvement, subdivision and sale of land, are subject to
comprehensive federal, state and local laws regulating environmental and health
matters, protection of endangered species, water supplies, zoning, land
development, land use, building design and construction and other matters. Such
laws and difficulties in obtaining, or the failure to obtain, the requisite
licenses, permits, allocations, authorizations and other entitlements pursuant
to such laws can adversely impact the development and completion of PEC's
projects. The enactment of "slow-growth" or "no-growth" initiatives in any area
where PEC sells land or timeshares could also delay or preclude entirely the
development of such properties.
RESTATEMENT AND SEC INVESTIGATION
As previously reported, the Company has restated certain of its previously
issued financial statements, including for the year ended August 31, 1994, upon
which its independent auditors had rendered unqualified opinions. As a result of
the restatement of the Company's financial statements and certain trading in its
common stock, the Securities and Exchange Commission has commenced a formal
investigation to determine, among other things, whether the Company, and/or its
officers and directors, violated applicable federal securities laws in
connection with the preparation and filing of the Company's previously issued
financial statements or such trading. Possible penalties for violation of
federal securities laws include civil remedies, such as fines and injunctions,
as well as criminal sanctions.
CERTAIN PAYMENTS AND AMORTIZATION OF NEGATIVE GOODWILL
In connection with the assignment to the Company in 1988 by affiliates of
certain officers and directors of the Company (Assignors) of the right to
acquire PEC, the Company became obligated to make quarterly payments to the
Assignors equal to 63% of the cash balances of PEC, during the 7 year period
ended January 31, 1995, that could be used to pay a dividend without violating
PEC's loan agreements. Accrual of amounts owed under such assignment agreement
to the Assignors ended on January 31, 1995, when their right to the accrual
expired, at which time PEC owed the Assignors $13.3 million. On March 2, 1995,
$10 million of such amount was converted to Subordinated debt. See Note 22 of
Notes to the Consolidated Financial Statements for further discussion. At the
time of the acquisition of PEC, the underlying book value of the net assets
acquired exceeded the purchase price paid by the Company by $42.3 million
resulting in the creation of negative goodwill in that amount (Revaluation
Adjustment). Of this amount $20 million was not amortized but was instead
reduced as additional payments were accrued to the Assignors. Amounts accrued to
the Assignors in excess of $20 million were expensed as such accruals were made.
The amortization of the remaining $22.3 million of the Revaluation Adjustment
was directly affected by the level of collections of the receivables of PEC
included in the acquired assets. As proceeds of these receivables were
collected, through installment payments or sale, a portion of the Revaluation
Adjustment included as a contra account in notes receivable was recorded to
income as amortization of negative goodwill, which amortization was completed at
February 28, 1995. The Company also amortizes over a five-year period ending
February 1998, negative goodwill related to the excess of the underlying book
value over the purchase price paid in 1993 for the acquisition of the minority
interest of Vacation Spa Resorts, Inc. (VSR), formerly an 80%-owned subsidiary.
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The Consolidated Financial Statements of the Company accordingly reflect
amortization of a portion of the Revaluation Adjustment (Revaluation
Amortization), amortization of the negative goodwill associated with the
acquisition of the VSR minority interest and accrual of payments to Assignors.
RESULTS OF OPERATIONS
Year Ended August 31, 1996 Compared to Year Ended August 31, 1995
MMC
MMC originated $139.4 million of loans during fiscal 1996 compared to $87.8
million of loans during fiscal 1995, an increase of 58.8%. The increase is a
result of the overall growth in MMC's business, including an increase in the
number of active Correspondents and Dealers and an increase in the number of
states served. At August 31, 1996, MMC had approximately 310 active
Correspondents and 435 active Dealers, compared to approximately 150 active
Correspondents and 170 active Dealers at August 31, 1995. Of the $139.4 million
of loans originated in fiscal 1996, $11.6 million were conventional loans. MMC
did not originate conventional loans in fiscal 1995.
The following table sets forth certain data regarding loans originated by
MMC during fiscal 1996 and 1995 (thousands of dollars):
<TABLE>
<CAPTION>
YEAR ENDED AUGUST 31,
------------------------------------------------
1996 1995
---------------------- ---------------------
<S> <C> <C> <C> <C>
Loan Originations:
Principal amount of loans:
Correspondents:
Title I.................................... $ 82,596,197 59.3% $63,792,680 72.7%
Conventional............................... 11,582,108 8.3 -- --
------------ ----- ----------- -----
Total Correspondents.................. 94,178,305 67.6 63,792,680 72.7
------------ ----- ----------- -----
Dealers -- Title I............................ 45,188,721 32.4 23,957,829 27.3
------------ ----- ----------- -----
Total................................. $139,367,026 100.0% $87,750,509 100.0%
============ ===== =========== =====
Number of loans:
Correspondents:
Title I.................................... 4,382 50.9% 3,437 59.1%
Conventional............................... 392 4.6 -- --
------------ ----- ----------- -----
Total Correspondents.................. 4,774 55.5 3,437 59.1
------------ ----- ----------- -----
Dealers -- Title I............................ 3,836 44.5 2,381 40.9
------------ ----- ----------- -----
Total................................. 8,610 100.0% 5,818 100.0%
============ ===== =========== =====
</TABLE>
See Notes 4 and 7 of Notes to Consolidated Financial Statements for further
discussion.
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<PAGE> 40
Total revenues increased 84.3% to $25 million for fiscal 1996 from $13.6
million for fiscal 1995. The increase was primarily the result of the increased
volume of loans originated and the sale of such loans. The following table sets
forth the principal balance of loans sold or securitized and related gain on
sale data for fiscal 1996 and 1995 (thousands of dollars):
<TABLE>
<CAPTION>
YEAR ENDED AUGUST
31,
--------------------
1996 1995
-------- -------
<S> <C> <C>
Loans Sold:
Title I Loans......................................................... $127,414 $85,363
Conventional.......................................................... 10,494 --
-------- -------
Total......................................................... $137,908 $85,363
======== =======
Gain on sale of loans................................................... $ 17,994 $12,233
Net unrealized gain on mortgage related securities...................... 2,697 --
-------- -------
Gain on sale of loans and unrealized gain on mortgage related
securities............................................................ $ 20,691 $12,233
-------- -------
Gain on sale of loans as a percentage of principal balance of loans
sold.................................................................. 13.0% 14.3%
======== =======
Gain on sale of loans and unrealized gain on mortgage related securities
as a percentage of principal balance of loans sold.................... 15.0% 14.3%
======== =======
</TABLE>
See Note 4 of Notes to Consolidated Financial Statements for further
discussion.
The percentage of gain on sale of loans can vary for several reasons,
including the relative amounts of conventional and Title I Loans, each of which
type of loan has different (i) estimated pre-payment rates, (ii)
weighted-average interest rates, (iii) weighted-average maturities, and (iv)
estimated future default rates. Also, typically the gain on sale of loans
through securitizations is higher than whole loan sales.
During 1996 the gain on sale of loans and unrealized gain on mortgage
related securities as a percentage of principal balance of loans sold increased
to 15.0% during 1996 as compared to 14.3% during 1995, primarily due to improved
interest rate spreads in MMC's sales and securitizations during fiscal 1996 as
compared to fiscal 1995. The weighted-average discount rate used in the
determination of gain on sale for MMC was 12%.
Loan servicing income increased 283.5% to $3.3 million for fiscal 1996 from
$873,000 for fiscal 1995. The increase was primarily the result of a 61.6%
increase in the amount of loan sale activity in fiscal 1996 with the servicing
rights retained by MMC, to $137.9 million for fiscal 1996 from $85.4 million for
fiscal 1995.
Interest income on loans held for sale and mortgage related securities, net
of interest expense, increased 108.9% to $988,000 during fiscal 1996 from
$473,000 during fiscal 1995. The increase was primarily the result of the
increase in the average size of the portfolio of loans held for sale, and the
increased mortgage related securities portfolio.
MMC intends to consider strategies to mitigate the interest rate risks
associated with the loan origination/warehousing function, funding its portfolio
of mortgage related securities, excess servicing rights, mortgage servicing
rights, and valuation of these assets. Implementation of interest rate risk
management strategies may decrease spreads, decrease gain on sale of loans, or
otherwise decrease revenues from that which might otherwise occur in a stable
interest rate environment without such strategies in place. MMC intends to
thoroughly analyze the cost of such strategies compared to the risks which would
be mitigated prior to implementation of any strategy.
The provision for credit losses increased 74.8% to $1.5 million for fiscal
1996 from $864,000 for fiscal 1995. The increase in the provision was directly
related to the increase in volume of loans originated in fiscal 1996 compared to
fiscal 1995. The provision for credit losses is based upon periodic analysis of
the portfolio, economic conditions and trends, historical credit loss
experience, borrowers' ability to repay, collateral values, and estimated FHA
insurance recoveries on loans originated and sold. As MMC increases its mix of
conventional loan originations as compared to Title I loan originations, the
provision for credit losses as a percentage of loans originated can be expected
to increase due to the increased credit risk associated with
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<PAGE> 41
conventional loans. Servicing costs on a per loan basis may also increase as
problem conventional loans may require greater costs to service.
Total general and administrative expenses increased 90.2% to $11.8 million
for fiscal 1996 from $6.2 million for fiscal 1995. The increase was primarily a
result of increased payroll related to the hiring of additional underwriting,
loan processing, administrative, loan quality control and other personnel in
contemplation of the expansion of MMC's business and costs related to the
opening of additional offices.
Payroll and benefits expense increased 39.3% to $5 million for fiscal 1996
from $3.6 million for fiscal 1995. The number of employees increased from 105 as
of fiscal year end 1995 to 170 as of fiscal year end 1996, due to increased
staff necessary to support the business expansion and improve quality control.
Commissions and selling expenses increased 264.7% to $2 million for fiscal
1996 from $552,000 for fiscal 1995 while loan originations increased by $51.6
million from fiscal 1995 to 1996. The sales network expanded to substantially
all states, adding new personnel and offices to further the loan origination
growth strategy.
Professional services increased 313.6% to $732,000 for fiscal 1996 from
$177,000 for fiscal 1995 due primarily to increased audit and legal services and
consultation fees.
FHA insurance increased 147.6% to $572,000 for fiscal 1996 from $231,000
for fiscal 1995. The increase was primarily attributable to the increased volume
of loan originations and loans serviced.
Other general and administrative expenses increased 190.7% to $2.1 million
for fiscal 1996 from $713,000 for fiscal 1995 primarily due to increased
expenses related to expansion of facilities and increased communications
expense. MMC is enhancing its loan production systems. These enhancements are
expected to cost approximately $50,000 and will be funded from MMC's normal
operating cash flow.
Income before income taxes increased 88.5% to $11.2 million for fiscal 1996
from $5.9 million for fiscal 1995.
As a result of the foregoing, MMC's net income increased 90% to $6.9
million for fiscal 1996 from $3.6 million for fiscal 1995.
PEC
Total revenues for PEC increased 6.7% or $3.8 million during fiscal 1996
compared to fiscal 1995 primarily due to an increase in timeshare sales to $27.8
million in fiscal 1996 from $20.7 million in fiscal 1995.
Timeshare interests and land sales, net, increased to $45.7 million in
fiscal 1996 from $41.5 million in fiscal 1995, an increase of 10.2%. Gross sales
of timeshare interests increased to $33.2 million in fiscal 1996 from $26.3
million in fiscal 1995, an increase of 26.3%. Net sales of timeshare interests
increased to $27.8 million from $20.7 million, an increase of 34.3%. The
provision for cancellation represented 16.3% and 21.3% of gross sales of
timeshare interests for the years ended August 31, 1996 and 1995, respectively.
The decrease in the provision for cancellation was primarily due to an
improvement in historical performance of cancellations, resulting in a lower
allowance requirement. The number of cancellations during fiscal 1996 was 1,216
compared to 1,030 during fiscal 1995. The number of exchanges, which are
generally made for upgrades, during fiscal 1996 was 3,305 compared to 2,373
during fiscal 1995.
Gross sales of land decreased to $22.3 million in fiscal 1996 from $24.7
million in fiscal 1995, a decrease of 9.6%. Net sales of land decreased to $18
million in fiscal 1996 from $20.8 million in fiscal 1995, a decrease of 13.7%.
The provision for cancellation represented 19.6% and 15.8% of gross sales of
land for the years ended August 31, 1996 and 1995, respectively. The 1996
decrease in land sales was the result of PEC shifting its emphasis as part of
its strategic plan from sales of land to sales of timeshare interests due both
to its diminishing inventory of land available for sale and its increasing
inventory of timeshare interests from the opening of new timeshare resorts. The
shift from land sales to timeshare sales was caused primarily by the reduction
of PEC's current land inventory which has not been fully replenished with
additional land due to the general unavailability of suitable land at acceptable
prices.
PEC's gain on sale of receivables decreased to $1.1 million for fiscal 1996
from $1.6 million for fiscal 1995. This decrease resulted from sales of
timeshare receivables and land receivables decreasing to $16 million
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<PAGE> 42
in fiscal 1996 from $32.5 million in fiscal 1995. PEC periodically sells
receivables in order to reduce the outstanding balances under its lines of
credit.
PEC's interest income decreased to $6.6 million in fiscal 1996 from $6.8
million for fiscal 1995, primarily due to a relatively flat interest rate
environment combined with a decrease in the average balance of notes receivable
outstanding.
Financial income increased to $544,000 in fiscal 1996 from $276,000 in
fiscal 1995, an increase of 97.1%. The increase is a result of the increased
number of loans serviced by PEC, generating increased servicing fees.
Revenues from incidental operations decreased to $3 million in fiscal 1996
from $3.6 million in fiscal 1995, a decrease of 17.3%, primarily due to a
decrease in utility fees partially offset by an increase in golf fee revenue.
Other revenues increased to $3.7 million in fiscal 1996 from $2.8 million in
fiscal 1995, an increase of 31.3% primarily due to increased rental income from
offices in PEC's corporate buildings.
As a result of the foregoing, total PEC revenues increased to $60.6 million
during fiscal 1996 from $56.8 million during fiscal 1995.
Total costs and expenses increased to $59.3 million for fiscal 1996 from
$48.5 million for fiscal 1995, an increase of 22.2%. The increase resulted
primarily from an increase in commission and selling expenses to $30.4 million
from $23.7 million, an increase of 28.1%; an increase in general and
administrative costs to $13.7 million from $11.2 million, an increase of 21.7%,
and an increase in direct costs of timeshare interest sales to $4 million from
$3 million, an increase of 34.3%. PEC's selling expenses increased primarily as
a result of costs relating to the establishment of new marketing programs and
strategies designed to increase sales of timeshare interests, market research
costs, additional staffing, increased advertising costs, costs associated with
the re-naming of PEC's timeshare resorts to Ramada Vacation Suites and
additional sales offices. The increase in general and administrative costs is
primarily due to increases in payroll related to hiring of additional
administrative personnel, maintenance fees related to unsold timeshare
inventory, owners' association costs, and professional fees. The increase in
direct costs of timeshare interest sales is primarily due to the increased
volume of sales. As a percentage of gross sales of timeshare interests and land,
commission and selling expenses relating thereto increased to 54.7% in fiscal
1996 from 46.5% in fiscal 1995, and cost of sales increased to 10.5% in fiscal
1996 from 10.1% in fiscal 1995. Sales prices of timeshare interests are
typically lower than those of land while selling costs are generally the same
for timeshare interests and land; accordingly, PEC generally realizes lower
profit margins from sales of timeshare interests than sales of land.
Depreciation expense increased to $1.5 million in fiscal 1996 from $1.1
million in fiscal 1995, an increase of 34.9%. The increase is a result of the
additions made to property and equipment during fiscal 1996. Property and
equipment, net of accumulated depreciation increased to $19.4 million at August
31, 1996 from $12.3 million at August 31, 1995, an increase of 58.3%.
Interest expense increased to $5.6 million in fiscal 1996 from $4.7 million
in fiscal 1995, an increase of 20.1%. The increase is a result of an increase in
outstanding balances of notes payable including two additional lines of credit.
As a result of the foregoing, PEC's income before income taxes decreased to
$1.3 million in fiscal 1996 from $8.3 million in fiscal 1995, a decrease of
83.9%. The decrease is largely due to the increase of commissions and selling
expense and in general and administrative expense, together with a decrease in
land sales.
COMPANY
Income from continuing operations increased $4 million to $4.9 million in
fiscal 1996 from $894,000 in fiscal 1995, due principally to an increase of $3.3
million in MMC net income and a decrease in payments to assignors expense to $0
in 1996 compared to $7.3 million in 1995. These were partially offset by a
decrease of $5.4 million in PEC net income, due to increased expenses related to
expansion of selling operations. See prior discussion for MMC and PEC.
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Total costs and expenses during fiscal 1996 were $78.8 million, an increase
of 16.9% over $67.4 million in fiscal 1995. Commissions and selling expenses and
general and administrative expenses increased 36.4% for fiscal 1996 compared to
1995 due primarily to the expansion of timeshare and land marketing efforts in
PEC. Additionally, Mego Financial incurs interest expense payable to assignors
and Subordinated debt. Total general and administrative expenses for Mego
Financial Corp. (parent only) were primarily comprised of professional services,
external financial reporting expenses, and regulatory and other public company
corporate expenses.
Year Ended August 31, 1995 Compared to Year Ended August 31, 1994
MMC
MMC commenced originating loans in March 1994. Total revenues increased
1,708.1% to $13.6 million for fiscal 1995 from $751,000 for fiscal 1994. The
increase was primarily the result of the increased volume of loans originated
and the sale of such loans. MMC originated $87.8 million of loans during fiscal
1995 compared to $8.2 million of loans during fiscal 1994, an increase of
974.9%. The increase was a result of the overall growth in Company's business.
At August 31, 1995, MMC had approximately 150 active Correspondents and 170
active Dealers in 34 states, compared to approximately 14 active Correspondents
and 30 active Dealers in 14 states at August 31, 1994.
The following table sets forth certain data regarding Title I Loans
originated by MMC during fiscal 1995 and 1994 (thousands of dollars):
<TABLE>
<CAPTION>
YEAR ENDED AUGUST 31,
----------------------------------------------
1995 1994
--------------------- --------------------
<S> <C> <C> <C> <C>
Principal amount of loans:
Correspondents.................................. $63,792,680 72.7% $5,251,647 64.3%
Dealers......................................... 23,957,829 27.3 1,492,318 18.3
Bulk purchase................................... -- -- 1,420,150 17.4
----------- ----- ---------- -----
Total................................... $87,750,509 100.0% $8,164,115 100.0%
=========== ===== ========== =====
Number of loans:
Correspondents.................................. 3,437 59.1% 338 47.4%
Dealers......................................... 2,381 40.9 164 23.0
Bulk purchase................................... -- -- 211 29.6
----------- ----- ---------- -----
Total................................... 5,818 100.0% 713 100.0%
=========== ===== ========== =====
</TABLE>
MMC sold $85.4 million in principal balance of loans during fiscal 1995,
recognizing a gain on sale of loans of $12.2 million. MMC sold $6.6 million in
principal balance of loans during fiscal 1994 recognizing a gain on sale of
loans of $579,000. As a percentage of loans sold, gain on sale of loans was
14.3% during fiscal 1995 compared to 8.8% during fiscal 1994. The increase in
gain on sale was primarily a result of increased volume of loans sold and a
wider differential between the stated interest rate on the loans and the yield
to purchasers. The weighted-average gross excess spread on sold loans was 6.2%
and 5.6% for fiscal 1995 and 1994, respectively. The weighted-average discount
rate used in the determination of the gain on sale for both periods was 12%.
Loan servicing income was $873,000 during fiscal 1995. This income was the
result of the sale of $85.4 million of Title I Loans, with the right to service
the loans being retained by MMC. MMC had no loan servicing income in fiscal 1994
because MMC did not sell any loans until August 31, 1994.
Interest income, net of interest expense, increased 175% to $473,000 during
fiscal 1995 from $172,000 during fiscal 1994. The increase was primarily the
result of the growth in the size of the portfolio of loans held for sale of
151.3% to $3.7 million at August 31, 1995 from $1.5 million at August 31, 1994.
The provision for credit losses increased 800% to $864,000 for fiscal 1995
from $96,000 for fiscal 1994 due to increased loan originations. Provision for
credit losses relating to unsold loans is recorded as expense in
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<PAGE> 44
amounts sufficient to maintain the allowance at a level considered adequate to
provide for anticipated losses resulting from liquidation of outstanding loans.
The provision for credit losses is based upon periodic analysis of the
portfolio, economic conditions and trends, historical credit loss experience,
borrowers' ability to repay, collateral values, and estimated FHA insurance
recoveries on Title I Loans.
Depreciation and amortization expense increased 196.3% to $403,000 for
fiscal 1995 from $136,000 for fiscal 1994 as a result of the purchase of
additional equipment, the expansion of MMC's facilities and additional software
development costs.
Other interest expense increased 750% to $187,000 for fiscal 1995 from
$22,000 for fiscal 1994 as a result of increased capitalized lease obligations.
Total general and administrative expenses increased 209.1% to $6.2 million
for fiscal 1995 from $2 million for fiscal 1994. The increase was primarily a
result of increased payroll related to the hiring of additional personnel in
contemplation of the expansion and projected growth of MMC's business and costs
related to the opening of additional offices. Commissions and selling expenses
increased to $552,000 for fiscal 1995 from $13,000 for fiscal 1994 due to the
expansion of the sales network and facilities to support increased loan
origination growth. Included in general and administrative expenses were
servicing fees paid to PEC in the amount of $232,000 and $13,000 for fiscal 1995
and 1994, respectively, and management fees paid to PEC in the amount of
$690,000 and $442,000 for fiscal 1995 and 1994, respectively. FHA insurance
expense increased to $231,000 for fiscal 1995 from $11,000 for fiscal 1994 due
to increased volume of Title I Loan originations.
Income (loss) before income taxes increased to income of $5.9 million for
fiscal 1995 from a loss of $1.5 million for its six months of operations in
fiscal 1994.
Effective September 1, 1994, MMC adopted SFAS 122 which requires that a
mortgage banking enterprise recognize as separate assets the rights to service
mortgage loans for others, regardless of how those servicing rights are
acquired. The effect of adopting SFAS 122 on MMC's financial statements was to
increase income before income taxes by $1.1 million for fiscal 1995.
As a result of the foregoing, net income (loss) increased to net income of
$3.6 million for fiscal 1995 from a net loss of $1.5 million for fiscal 1994.
PEC
Total revenues of PEC increased 19.9% to $56.8 million for fiscal 1995 from
$47.4 million for fiscal 1994. The increase was primarily the result of
increased net land sales of $20.8 million during fiscal 1995 compared to $13.5
million during fiscal 1994, an increase of 53.8%, and an 80.4% increase in
incidental operations to $3.6 million for fiscal 1995 from $2 million in fiscal
1994.
Timeshare interests and land sales, net, increased to $41.5 million for
fiscal 1995 from $33.1 million for fiscal 1994, an increase of 25.5%. Gross
sales of timeshare interests increased to $26.3 million in fiscal 1995 from
$24.7 million in fiscal 1994, an increase of 6.5%. Net sales of timeshare
interests increased to $20.7 million in fiscal 1995 from $19.5 million in fiscal
1994, an increase of 5.9%. The provision for cancellation represented 21.3% and
20.9% of gross sales of timeshare interests for the years ended August 31, 1995
and 1994, respectively.
Gross sales of land increased to $24.7 million in fiscal 1995 from $15.4
million in fiscal 1994, an increase of 60.1%. Net sales of land increased to
$20.8 million from $13.5 million, an increase of 53.8%. The provision for
cancellation represented 15.8% and 12.3% of gross sales of land for the years
ended August 31, 1995 and 1994, respectively. The increase in sales of timeshare
interests and the increase in sales of land were primarily the result of
additional sales programs and new properties in Colorado.
Gain on sale of notes receivables increased to $1.6 million for fiscal 1995
from $875,000 for fiscal 1994, an increase of 81.3%. This increase resulted from
net sales of timeshare interest and land receivables increasing to $41.5 million
during fiscal 1995 from $33.1 million during fiscal 1994, an increase of 25.5%.
PEC periodically sells receivables in order to reduce the outstanding balances
under its lines of credit.
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<PAGE> 45
Interest income decreased to $6.8 million for fiscal 1995 from $7.9 million
for fiscal 1994, a decrease of 13.6%. This decrease resulted primarily from a
reduction in PEC's portfolio of receivables arising from sales of receivables
exceeding originations.
Income from incidental operations increased to $3.6 million for fiscal 1995
from $2 million for fiscal 1994, an increase of 80.4%. The increase was
primarily due to increased utility fees and golf fee revenue.
Total costs and expenses increased to $48.5 million for fiscal 1995 from
$41.8 million for fiscal 1994, an increase of 16%. This increase resulted
primarily from an increase in commissions and selling expenses to $23.7 million
for fiscal 1995 from $18.9 million, an increase of 25%, and an increase in cost
of sales to $5.4 million in fiscal 1995 from $4.7 million in fiscal 1994, an
increase of 16.3%. As a percentage of gross sales of timeshare interests,
housing sales, land sales, and commissions and expenses relating thereto
decreased to 46.5% for fiscal 1995 from 47.2% for fiscal 1994, and cost of sales
relating thereto decreased to 10.6% for fiscal 1995 from 11.4% for fiscal 1994.
Timeshare costs of sales increased 10.9% to $3 million for fiscal 1995 from
$2.7 million for fiscal 1994. Land sale costs increased to $2.2 million for
fiscal 1995 from $1.4 million for fiscal 1994, an increase of 50.8%. Cost of
housing sales decreased to $265,000 for fiscal 1995 from $531,000 for fiscal
1994, a decrease of 50.1%.
General and administrative costs increased 7% to $11.2 million for fiscal
1995 compared to $10.5 million for fiscal 1994, primarily due to increased
staffing and training for sales of land and timeshares and other administrative
related expansion costs.
As a result of the foregoing, PEC's income from continuing operations,
excluding income from discontinued operations, increased to $5.4 million for
fiscal 1995 from $3.7 million for fiscal 1994, an increase of 44.9%.
COMPANY
Income from continuing operations increased to $894,000 in fiscal 1995 from
a loss of $5.8 million in fiscal 1994, due principally to an increase of $5.2
million in MMC net income due to a full year of operation in 1995 compared to 6
months of operations in 1994. PEC's net income increased $2.5 million due to
increased land and timeshare sales activity.
Net timeshare and land sales increased to $41.5 million for fiscal 1995
compared to $33.1 million for fiscal 1994, due to increased marketing efforts,
expansion of marketing areas and focus on increasing volume. Net timeshare and
land inventories increased 50.8% or $8.5 million during fiscal 1995 compared to
fiscal 1994. See prior discussion for MMC and PEC.
Amortization of negative goodwill decreased to $216,000 for fiscal 1995,
from $472,000 for fiscal 1994, a decrease of 54.2%. Included in such
amortization was $170,000 and $420,000 in fiscal 1995 and 1994, respectively
relating to the purchase of PEC in 1988, with $50,000 in both fiscal 1995 and
fiscal 1994 relating to the acquisition of the minority interest in Vacation Spa
Resorts.
As a result of the foregoing, total revenues increased to $71.6 million for
fiscal 1995, from $48.9 million for fiscal 1994, an increase of 46.4%.
Gain on discontinued operations occurred as a result of an order for
judgment against the Company in litigation involving certain subsidiaries of PEC
in the amount of $3.4 million, which amount was settled for $2.9 million in May
1995 and paid in June 1995. Excess of liability over assets of discontinued
operations (a provision for loss) had been provided in the amount of $4.2
million, which was adjusted to reflect the actual loss, resulting in a gain on
discontinued operations of $1.3 million during fiscal 1995.
Total costs and expenses increased to $67.4 million for fiscal 1995 from
$53.9million for fiscal 1994, an increase of 25%. This increase is primarily the
result of an increase in the operations of MMC and an increase in commissions
and selling expenses resulting from a higher volume of sales of timeshare
interests and land during the 1995 period.
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<PAGE> 46
Payments to assignors decreased to $7.3 million for fiscal 1995 from $8.5
million for fiscal 1994, a decrease of 14.9%. Accrual of amounts payable to
assignors ceased on January 31, 1995.
As a result of the foregoing, net income from continuing operations
increased to $894,000 for fiscal 1995 from a net loss of $5.8 million for fiscal
1994.
LIQUIDITY AND CAPITAL RESOURCES
Cash and cash equivalents for the Company was $3.2 million at August 31,
1996 compared to $7.3 million at August 31, 1995.
The Company's principal cash requirements relate to loan originations, the
acquisition of timeshare properties and land, and the payment of commissions and
selling expenses in connection with timeshare and land sales. MMC and PEC each
require continued access to sources of debt financing and sales in the secondary
market of loans and receivables, respectively.
MMC -- Dependence On Securitization Transactions
The values of and markets for the sale of MMC's loans are dependent upon a
number of factors, including general economic conditions, interest rates and
government regulations. Adverse changes in those factors may affect MMC's
ability to originate or sell loans in the secondary market for acceptable prices
within reasonable time frames. The ability of MMC to sell loans in the secondary
market is essential for continuation of MMC's loan origination activities. A
reduction in the size of the secondary market for home improvement loans would
adversely affect MMC's ability to sell its loans in the secondary market with a
consequent adverse impact on MMC's profitability and future originations.
MMC entered into its first two securitization transactions, which involve
the pooling and sale of loans, in March 1996 and August 1996 and intends to
continue to sell loans through securitization transactions from time to time as
opportunities arise. Pursuant to these securitizations, pass-through
certificates evidencing interests in the pools of loans were sold in public
offerings. There can be no assurance that MMC will be able to securitize its
loan production efficiently. Securitization transactions may be affected by a
number of factors, some of which are beyond MMC's control, including, among
other things, conditions in the securities markets in general, conditions in the
asset-backed securitization market, the conformity of loan pools to rating
agency requirements and, to the extent that monoline insurance is used, the
requirements of such insurers. Adverse changes in the securitization market
could impair MMC's ability to originate and sell loans through securitizations
on a favorable or timely basis. Any such impairment could have a material
adverse effect upon MMC's results of operations and financial condition.
Furthermore, MMC's quarterly operating results can fluctuate significantly as a
result of the timing and level of securitizations.
MMC -- Negative Cash Flow
As a result of the substantial growth in loan originations, MMC has
operated since March 1994, and expects to continue to operate for the
foreseeable future, on a negative cash flow basis. During the year ended August
31, 1996, MMC operated on a negative cash flow basis using $15.3 million in
operations that was funded primarily from borrowings, due primarily to an
increase in loans originated and MMC's sale of loans. In connection with whole
loan sales and securitizations, MMC recognizes a gain on sale of the loans upon
the closing of the transaction and the delivery of the loans, but does not
receive the cash representing such gain until it receives the excess servicing
spread, which is payable over the actual life of the loans sold. MMC incurs
significant expenses in connection with securitizations and incurs tax
liabilities as a result of the gain on sale. MMC must maintain external sources
of cash to fund its operations and pay its taxes and therefore must maintain
warehouse lines of credit and other external funding sources. If the capital
sources of MMC were to decrease, the rate of growth of MMC would be negatively
affected.
The pooling and servicing agreements relating to MMC's securitizations
require MMC to build overcollateralization levels through retention within each
securitization trust of excess servicing distributions and application thereof
to reduce the principal balances of the senior interests issued by the related
trust or
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<PAGE> 47
cover interest shortfalls. This retention causes the aggregate principal amount
of the loans in the related pool to exceed the aggregate principal balance of
the outstanding investor certificates. Such over-collateralization amounts serve
as credit enhancement for the related trust and therefore are available to
absorb losses realized on loans held by such trust. MMC continues to be subject
to the risks of default and foreclosure following the sale of loans through
securitizations to the extent excess servicing distributions are required to be
retained or applied to reduce principal or cover interest shortfalls from time
to time. Such retained amounts are predetermined by the entity issuing the
guarantee of the related senior interests and are a condition to obtaining
insurance and an AAA/Aaa rating thereon. In addition, such retention delays cash
distributions that otherwise would flow to MMC through its retained interest,
thereby adversely affecting the flow of cash to MMC.
MMC's cash requirements arise from loan originations, payments of operating
and interest expenses and deposits to reserve accounts related to loan sale
transactions. Loan originations are initially funded principally through MMC's
$20 million warehouse line of credit pending the sale of loans in the secondary
market. Substantially all of the loans originated by MMC are sold. Net cash used
in MMC's operating activities for the years ended August 31, 1995 and 1996 was
approximately $11.8 million and $15.3 million, respectively. This use was funded
primarily from the reinvestment of proceeds from the sale of loans in the
secondary market totaling approximately $85 million and $135.5 million for the
years ended August 31, 1995 and 1996, respectively. The loan sale transactions
required the subordination of certain cash flows payable to MMC to the payment
of scheduled principal and interest due to the loan purchasers. In connection
with certain of such sale transactions, a portion of amounts payable to MMC from
the excess interest spread is required to be maintained in a reserve account to
the extent of the subordination requirements. The subordination requirements
generally provide that the excess interest spread is payable to the reserve
account until a specified percentage of the principal balances of the sold loans
is accumulated therein.
Excess interest spread payable to MMC is subject to being utilized first to
replenish cash paid from the reserve account to fund shortfalls in collections
of interest from borrowers who default on the payments on the loans until MMC's
deposits into the reserve account equal the specified percentage. The excess
interest required to be deposited and maintained in the respective reserve
accounts is not available to support the cash flow requirements of MMC. At
August 31, 1996, amounts on deposit in such reserve accounts totaled $4.5
million.
Adequate credit facilities and other sources of funding, including the
ability of MMC to sell loans in the secondary market, are essential for the
continuation of MMC's loan origination operations. At August 31, 1996, MMC had a
$20 million warehouse line of credit (Warehouse Line) for the financing of loan
originations which expires in August 1997. At August 31, 1996, $3.3 million was
outstanding under the Warehouse Line and $16.7 million was available. The
Warehouse Line bears interest at the prime rate plus 1% per year and is secured
by loans prior to sale. The agreement with the lender requires MMC to maintain a
minimum tangible net worth of $12.5 million plus 50% of MMC's cumulative net
income after May 1, 1996, and a minimum level of profitability of at least
$500,000 per rolling six month period. In addition, MMC had a $10 million
revolving credit facility from the same lender, with respect to which $10
million was outstanding on that date. This facility was secured by a pledge of
MMC's excess servicing rights and the interest only and residual class
certificates (Certificates) relating to securitizations carried as mortgage
related securities on MMC's statements of financial condition, payable to MMC
pursuant to its securitization agreements. The revolving loan has an 18-month
revolving credit period followed by a 30-month amortization period, and requires
MMC to maintain a minimum tangible net worth of $12.5 million plus 50% of MMC's
cumulative net income after May 1, 1996, and a minimum level of profitability of
at least $500,000 per rolling six month period. Borrowings under the revolving
loan cannot exceed the lesser of (i) 40% of MMC's excess servicing rights and
Certificates or (ii) 6 times the aggregate of the excess servicing rights and
Certificate payments actually received by MMC over the most recent 3-month
period. While MMC believes that it will be able to maintain its existing credit
facilities and obtain replacement financing as its credit arrangements mature
and additional financing, if necessary, there can be no assurance that such
financing will be available on favorable terms, or at all. At August 31, 1996,
no commitments existed for material capital expenditures.
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<PAGE> 48
From time to time, MMC has sold loans through whole loan sales. In August
1994, MMC entered into an agreement with a bank pursuant to which an aggregate
of $38.3 million in principal amount of loans had been sold at December 31,
1995, for an amount equal to their remaining principal balance and accrued
interest. Pursuant to the agreement, the purchaser is entitled to receive
interest at a rate equal to the sum of 187.5 basis points and the yield paid on
4 year Federal Government Treasury obligations at the time of the sale. MMC
retained the right to service the loans and the right to receive the difference
(Excess Interest) between the sold loans' stated interest rate and the yield to
the purchaser. MMC is required to maintain a reserve account equal to 1% of the
declining principal balance of the loans sold pursuant to the agreement funded
from the Excess Interest received by MMC less its servicing fee to fund
shortfalls in collections from borrowers who default in the payment of principal
or interest.
In April 1995, MMC entered into a continuing agreement with a financial
institution pursuant to which an aggregate of approximately $175.8 million in
principal amount of loans had been sold at August 31, 1996 for an amount equal
to their remaining principal balances. Pursuant to the agreement, the purchaser
is entitled to receive interest at a variable rate equal to the sum of 200 basis
points and the one-month LIBOR rate as in effect from time to time. MMC retained
the right to service the loans and the right to receive the Excess Interest. MMC
is required to maintain a reserve account equal to 2.5% of the proceeds received
by MMC from the sale of loans pursuant to the agreement plus the Excess Interest
received by MMC less its servicing fee to fund shortfalls in collections from
borrowers who default in the payment of principal or interest. In May 1995 and
June 1995, MMC reacquired an aggregate of approximately $25 million of such
Title I Loans for an amount equal to their remaining principal balance, which
were sold to a financial institution. In March 1996 and August 1996, MMC
reacquired an additional $77.7 million and $36.2 million, respectively, of the
Title I Loans in connection with its first two securitization transactions. In
September 1996, MMC entered into a repurchase agreement with the financial
institution pursuant to which MMC pledged the interest only certificates from
its two 1996 securitizations in exchange for a $3 million advance. In November
1996, MMC entered into an agreement with the same financial institution,
providing for the purchase of up to $2 billion of loans over a 5 year period.
Pursuant to the agreement, Mego Financial issued to the financial institution
four-year warrants to purchase 1,000,000 shares of Mego Financial's common stock
at an exercise price of $7.125 per share. The agreement also provides (i) that
so long as the aggregate principal balance of loans purchased by the financial
institution and not resold to third parties exceeds $100 million, the financial
institution shall not be obligated to purchase, and MMC shall not be obligated
to sell, loans under the agreement and (ii) that the percentage of conventional
loans owned by the financial institution at any one-time and acquired pursuant
to the agreement shall not exceed 65% of the total amount of loans owned by the
financial institution at such time and acquired pursuant to the agreement. The
value of the warrants, estimated at $3 million (0.15% of the commitment amount)
as of the commitment date, will be charged to MMC and amortized as the
commitment for the purchase of loans is utilized. The financial institution has
also agreed to provide MMC a separate one-year facility of up to $11 million,
less any amounts advanced under the repurchase agreement, for the financing of
the interest only and residual certificates from future securitizations.
In May 1995, MMC entered into an agreement with a bank pursuant to which an
aggregate of $25 million in principal amount of loans had been sold at June 30,
1995 for an amount equal to their remaining principal balance. Pursuant to the
agreement, the purchaser is entitled to receive interest at a rate equal to the
sum of 190 basis points and the yield paid on four-year Federal Government
Treasury obligations at the time of the sale. MMC retained the right to service
the loans and the right to receive the Excess Interest. The agreement requires
MMC to maintain a reserve account equal to 1% of the declining principal balance
of the loans sold pursuant to the agreement funded from the Excess Interest
received by MMC less its servicing fee to fund shortfalls in collections from
borrowers who default in the payment of principal or interest.
In furtherance of MMC's strategy to sell loans through securitizations, in
March 1996 and August 1996, MMC completed its first two securitizations pursuant
to which it sold pools of $84.2 million and $48.8 million, respectively, of
Title I Loans. MMC previously reacquired at par $77.7 million and $36.2 million
of such loans, respectively. Pursuant to these securitizations, pass-through
certificates evidencing interests in the pools of loans were sold in a public
offering. MMC continues to sub-service the sold loans and is entitled to receive
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<PAGE> 49
from payments in respect of interest on the sold loans, a servicing fee equal to
1.25% of the balance of each loan with respect to the March transaction and 1%
with respect to the August transaction. In addition, with respect to both
transactions, MMC certificates received are carried as mortgage related
securities on MMC's Statement of Financial Condition representing the interest
differential, after payment of servicing and other fees, between the interest
paid by the obligors of the sold loans and the yield on the sold certificates.
MMC may be required to repurchase loans that do not conform to the
representations and warranties made by MMC in the securitization agreements.
As further described in Management's Discussion and Analysis of Financial
Condition and Results of Operations -- Subsequent Event, in November 1996, MMC
issued 2,300,000 shares of its common stock and $40 million of 12.5% Senior
Subordinated Notes due 2001 in public offerings. MMC currently intends to use
approximately $13.2 million of the aggregate net proceeds received from the
offerings to repay amounts due to Mego Financial Corp. and PEC and approximately
$17 million to reduce the amounts outstanding under MMC's warehouse and
revolving lines of credit which currently bear interest at rates ranging from 1%
to 2% over the prime rate and which expire in August 1997 and December 1997,
respectively, and to repay $3 million under a repurchase agreement. Funds
received by Mego Financial Corp. and PEC will be used in their respective
operations. The remaining net proceeds will be used by MMC to provide capital to
originate and securitize loans. Pending such use, the net proceeds received by
the Company will be invested in high quality, short term interest-bearing
investment and deposit accounts.
PEC -- Liquidity
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, and payments of commissions and selling expenses in connection
with the sale of timeshare interests and land. Commissions and selling expenses
payable by PEC in connection with sales of timeshare interests and land
typically exceed the down payments received at the time of sale, as a result of
which PEC generates a cash shortfall. This cash shortfall and PEC's other cash
requirements are funded primarily through sales of receivables, PEC's lines of
credit in the aggregate amount of $109.5 million and cash flows from operations.
At August 31, 1996, no commitments existed for material capital expenditures.
At August 31, 1996, PEC had arrangements with 4 institutional lenders for 5
agreements for the financing of receivables in connection with sales of
timeshare interests and land and the acquisition of timeshare properties and
land, which provide for 5 lines of credit of up to an aggregate of $109.5
million. Such lines of credit are secured by timeshare and land receivables. At
August 31, 1996, an aggregate of $65.9 million was outstanding under such lines
of credit, and $43.6 million was available for borrowing. At August 31, 1996 and
1995, $65.9 million and $38.1 million, respectively, had been borrowed under
these lines. Under the terms of these lines of credit, the Company may borrow up
to a range of 75% to 85% of the balances of the pledged timeshare and land
receivables. Summarized line of credit information and accompanying notes
relating to these five lines of credit outstanding at August 31, 1996, consist
of the following (thousands of dollars):
<TABLE>
<CAPTION>
BORROWING
AMOUNT AT MAXIMUM
AUGUST 31, BORROWING REVOLVING
1996 AMOUNT EXPIRATION DATE(d) MATURITY DATE INTEREST RATE
- ---------- --------- ----------------------- ------------------- --------------
<C> <C> <S> <C> <C>
$ 47,297 $57,000 (a) December 31, 1996 September 22, 2003 Prime + 2.25%
7,821 15,000 (b) December 31, 1996 August 1, 2000 Prime + 2.5%
4,865 15,000 (c) June 27, 1998 June 27, 2005 LIBOR + 4.25%
2,925 15,000 (c) February 6, 1998 August 6, 2005 LIBOR + 4.25%
2,967 7,500 (b) December 31, 1996 June 30, 2000 Prime + 2.5%
</TABLE>
- ---------------
(a) Restrictions include PEC's requirement to maintain a tangible net worth of
at least $25 million during the borrowing term, and thereafter this
requirement is permitted to decrease to $15 million depending on the loan
balance.
49
<PAGE> 50
(b) Restrictions include PEC's requirement to maintain a tangible net worth of
$25 million during the life of the loan.
(c) Restrictions include PEC's requirement to maintain a tangible net worth of
$17 million during the life of the loan.
(d) Revolving expiration date represents the expiration of the revolving
features of the lines of credit, at which time the credit lines assume fixed
maturity.
Set forth below is a schedule of the cash shortfall arising from recognized
and unrecognized sales for the periods indicated (thousands of dollars):
<TABLE>
<CAPTION>
YEAR ENDED AUGUST 31,
--------------------------------
1996 1995 1994
-------- -------- --------
<S> <C> <C> <C>
Commissions and selling expenses attributable
to recognized and unrecognized sales......... $ 29,863 $ 23,969 $ 19,924
Less: Down payments............................ 13,231 12,796 10,792
------- ------- -------
Cash Shortfall................................. $ 16,632 $ 11,173 $ 9,132
======= ======= =======
</TABLE>
During the fiscal years ended August 31, 1996 and 1995, PEC sold notes
receivable of $16 million and $32.5 million to three major financial
institutions from which $9.7 million and $20.6 million of the proceeds were used
to pay down debt for the fiscal years ended August 31, 1996 and 1995,
respectively. The receivables which have interest rates depending on the
transaction, of 11.8% - 13.9% and 11.8% - 13.7% in 1996 and 1995, respectively,
were sold to yield returns of 8.3% - 10.6% and 8.8% - 11% in 1996 and 1995,
respectively, to the purchasers, with any excess interest received from the
obligors being payable to PEC.
At August 31, 1996, PEC was contingently liable to replace or repurchase
notes receivable sold with recourse totalling $69.6 million. PEC sells notes
receivable subject to recourse provisions as contained in each agreement. PEC is
obligated under these agreements to replace or repurchase accounts that become
over 90 days delinquent or otherwise subject to replacement or repurchase. The
repurchase provisions provides for substitution of receivables as recourse for
$67 million of sold notes receivable and cash payments for repurchase relating
to $2.5 million of sold notes receivable. At August 31, 1996 and 1995, the
undiscounted amounts of the $8.4 million and $7.1 million recourse obligations
on such notes receivable were $9.6 million and $8.1 million, respectively. PEC
periodically reviews the adequacy of this liability. These reviews take into
consideration changes in the nature and level of the portfolio, current and
future economic conditions which may affect the obligors' ability to pay, the
changes in collateral values, the estimated value of inventory that may be
reacquired, and overall portfolio quality.
Recourse to PEC on sales of notes receivable is governed by the agreements
between the purchasers and PEC. The future estimated contingency for notes
receivable sold with recourse represents PEC's estimate of its probable future
credit losses to be incurred over the lives of the notes receivable. Proceeds
from the sale of notes receivable sold with recourse were $17.1 million and
$34.1 million for the years ended August 31, 1996 and 1995, respectively. A
liability for future estimated contingency for notes receivable sold with
recourse was established at the time of each sale based upon PEC's analysis of
all probable losses resulting from PEC's recourse obligations under each
agreement of sale. For notes receivable sold after September 30, 1992, the
liability is determined in accordance with Emerging Issues Task Force (EITF)
Issue No. 92-2, on a "discounted to present value" basis using an interest rate
equivalent to the risk-free market rate for securities with a duration similar
to that estimated for the underlying notes receivable.
Company -- Liquidity
During November 1994 and January 1995, payments aggregating $1.1 million
were made to the Assignors to pay a portion of the accrued liability. At January
31, 1995, when accruals ceased, $13.3 million was payable to the Assignors. On
March 2, 1995, the Assignors agreed to defer payment of $10 million
(Subordinated Debt) of the amounts due to them pursuant to an amendment to the
Assignment and Assumption Agreement providing for the subordination of such
amounts to payment of debt for money
50
<PAGE> 51
borrowed by the Company or obligations of the Company's subsidiaries guaranteed
by the Company. Warrants to purchase 1 million shares of common stock, at an
exercise price of $4.25 per share (the closing market price per share on March
2, 1995), were granted to the Assignors in consideration of the payment deferral
and subordination. The warrants contain restrictions on transfer and are
exercisable after March 1, 1996 and until March 1, 2000. Interest on the
Subordinated Debt is to be paid semi-annually at the rate of 10% per year
starting September 1, 1995, and the Subordinated Debt is to be repaid in seven
equal semi-annual payments of $1.4 million plus interest commencing March 1,
1997. On June 14, 1995, the Company paid an aggregate of $809,000 to the
Assignors, including interest in the amount of $59,000. At August 31, 1996, $2.6
million, other than the Subordinated Debt, was payable to the Assignors, which
amount also bears interest at the rate of 10% per year. Payments to Assignors
are secured by a pledge of all of PEC's outstanding stock. During fiscal 1996,
the Company paid interest of $1,196,000 to the Assignors on Subordinated debt
and other amounts payable. See "Item 13. Certain Relationships and Related
Transactions."
During fiscal years 1996 and 1995, the Company used cash of $33.2 million
and $5.1 million, respectively, in operating activities. The increase was due
primarily to increased loan fundings by MMC.
During fiscal years 1996 and 1995, the Company used cash of $9.7 million
and $3.7 million, respectively, in investing activities, which was substantially
expended for the purchase of property and equipment.
During fiscal years 1996 and 1995, the Company provided cash of $38.8
million and $5.2 million, respectively, in financing activities as a result of
borrowings.
Capital expenditures during fiscal years 1996 and 1995 were $21.1 million
and $14 million, respectively, for the acquisition of inventory and $9.3 million
and $3.8 million, respectively, for the purchase of property and equipment. The
Company made additional capital expenditures in 1996 for the acquisition of
inventory, renovation of future timeshare inventory, refurbishment of present
timeshare inventory, and the acquisition of replacement equipment. No
commitments existed at August 31, 1996 for material capital expenditures. The
Company believes that its capital requirements will be met from cash balances,
internally generated cash, existing lines of credit, sales of receivables, and
the modification, replacement or addition to its lines of credit.
FINANCIAL CONDITION
August 31, 1996 Compared to August 31, 1995
Cash decreased 56.6% to $3.2 million at August 31, 1996 from $7.3 million
at August 31, 1995 primarily as a result of the timing of loan originations,
sales, and borrowings.
Restricted cash deposits increased 2.9% to $6.7 million at August 31, 1996
from $6.5 million at August 31, 1995 due to increased volume of loans serviced
for others pursuant to agreements which restrict a small percentage of cash
relative to the volume of loans serviced, as well as loan payments collected
from borrowers on accounts serviced for others.
51
<PAGE> 52
Notes receivable, net, increased 27% to $45.2 million at August 31, 1996
from $35.6 million at August 31, 1995 primarily as a result of MMC loan
originations increasing to $139.4 million for fiscal 1996 from $87.8 million for
fiscal 1995, and the timing of loan sales. The following table sets forth
certain data regarding loans originated by MMC during fiscal 1996 and 1995:
<TABLE>
<CAPTION>
1996 1995
---------------------- ---------------------
<S> <C> <C> <C> <C>
Principal amount of loans:
Correspondents:
Title I.................................. $ 82,596,197 59.3% $63,792,680 72.7%
Conventional............................. 11,582,108 8.3 -- --
------------ ----- ------------ -----
Total Correspondent................. 94,178,305 67.6 63,792,680 72.7
------------ ----- ------------ -----
Dealers -- Title I.......................... 45,188,721 32.4 23,957,829 27.3
------------ ----- ------------ -----
Total............................... $139,367,026 100.0% $87,750,509 100.0%
============ ===== ============ =====
Number of loans:
Correspondents:
Title I.................................. 4,382 50.9% 3,437 59.1%
Conventional............................. 392 4.6 -- --
------------ ----- ------------ -----
Total Correspondent................. 4,774 55.5 3,437 59.1
------------ ----- ------------ -----
Dealers -- Title I.......................... 3,836 44.5 2,381 40.9
------------ ----- ------------ -----
Total.................................... 8,610 100.0% 5,818 100.0%
============ ===== ============ =====
</TABLE>
Net timeshare and land sales increased to $45.7 million at August 31, 1996
from $41.5 million at August 31, 1995 which increased net notes receivable. Net
timeshare and land sales are set forth in the following table (thousands of
dollars).
<TABLE>
<CAPTION>
AUGUST 31,
-------------------
1996 1995 $ CHANGE % CHANGE
------- ------- --------- ---------
<S> <C> <C> <C> <C>
Timeshare sales, net............................... $27,778 $20,682 $ 7,096 34.3%
Land sales, net.................................... 17,968 20,812 (2,844) (13.7)
------- ------- ------ ------
Total timeshare and land sales, net...... $45,746 $41,494 $ 4,252 10.2%
======= ======= ====== ======
</TABLE>
Excess servicing rights decreased 13.9% to $14.3 million at August 31, 1996
from $16.6 million at August 31, 1995. Excess servicing rights are calculated
using prepayment, default and interest rate assumptions that the Company
believes market participants would use for similar rights. The Company believes
that the excess servicing rights recognized at the time of sale do not exceed
the amount that would be received if such rights were sold at fair market value
in the marketplace. The decrease in excess servicing rights was primarily a
result of loans sold with excess servicing rights recognized which were
reacquired and included in the fiscal 1996 securitizations as well as normal
amortization of such excess servicing rights. The excess cash flow created
through securitization which had been recognized as excess servicing rights on
loans reacquired and securitized are included in the cost basis of the mortgage
related securities. Mortgage related securities were $22.9 million at August 31,
1996 as a result of MMC's securitization transactions during fiscal 1996. There
was no corresponding asset at August 31, 1995. See Notes 8 and 9 of Notes to
Consolidated Financial Statements.
Mortgage servicing rights increased 255.7% to $3.8 million at August 31,
1996 from $1.1 million at August 31, 1995 as a result of additional sales of
mortgage originations and the resulting increase in sales of loans serviced to
$137.9 million during fiscal 1996 from $85.4 million during fiscal 1995.
Timeshare and land inventories increased 72.4% to $35.9 million at August
31, 1996 from $20.8 million at August 31, 1995 primarily in Nevada, as a result
of additional inventory previously under construction and made available for
sale in fiscal 1996.
Property and equipment, net, increased 59.8% to $20.3 million at August 31,
1996 from $12.7 million at August 31, 1995 due to increased purchases of office
equipment related to facility expansion.
52
<PAGE> 53
Notes and contracts payable increased 88.9% to $84.4 million at August 31,
1996 from $44.7 million at August 31, 1995 due to increased levels of excess
mortgage servicing rights and mortgage related securities created through loan
securitization which were available for financing to meet the Company's cash
requirements.
Accounts payable and accrued liabilities increased to $19.7 million at
August 31, 1996 from $14 million at August 31, 1995, primarily as a result of
increases in accrued payroll, interest and other unpaid operational costs.
Future estimated contingency for notes receivable sold with recourse
increased 16.2% to $9.3 million at August 31, 1996 from $8 million at August 31,
1995. Loans sold with recourse which were reacquired and included in the 1996
securitizations decreased the amount needed for this allowance while increased
loan sales increased the allowance requirements. Recourse to the Company on
sales of loans is governed by the agreements between the purchasers and the
Company. The allowance for credit losses on loans sold with recourse represents
the Company's estimate of its probable future credit losses to be incurred over
the lives of the loans considering estimated future FHA insurance recoveries on
Title I Loans. No allowance for credit losses on loans sold with recourse is
established on loans sold through securitizations, as the Company has no
recourse obligation under those securitization agreements. Estimated credit
losses on loans sold through securitizations are considered in MMC's valuation
of its residual interest securities.
Deferred income taxes payable increased 35.5% to $11 million at August 31,
1996 from $8.1 million at August 31, 1995 due to increased income.
Stockholder's equity increased 34.4% to $25.9 million at August 31, 1996
from $19.2 million at August 31, 1995 as a result of net income applicable to
common stock of $4.6 million during fiscal 1996.
August 31, 1995 Compared to August 31, 1994
Cash decreased 33.2% to $7.3 million at August 31, 1995 from $11 million at
August 31, 1994 primarily as a result of the timing of loan originations, sales
and borrowings.
Restricted cash deposits increased 760% to $6.5 million at August 31, 1995
from $752,000 at August 31, 1994, due to activity on loans serviced for others
pursuant to agreements which restrict a small percentage of cash relative to the
volume of loans serviced, as well as loan payments collected from borrowers.
Notes receivable, net, decreased 13.7% to $35.6 million at August 31, 1995
from $41.2 million at August 31, 1994 primarily due to sales of receivables
exceeding increases in newly recognized notes receivable.
Excess servicing rights increased 671.9% to $16.6 million at August 31,
1995 from $2.1 million at August 31, 1994. Excess servicing rights are
calculated using prepayment, default and interest rate assumptions that the
Company believes market participants would use for similar rights. The Company
believes that the excess servicing rights recognized at the time of sale do not
exceed the amount that would be received if such rights were sold at fair market
value in the marketplace. The increase in excess servicing rights was primarily
a result of increases in loans sold with excess servicing rights.
Mortgage servicing rights were $1.1 million at August 31, 1995 as a result
of sales of loans which resulted in an increase in the principal balance of sold
loans serviced and implementation of SFAS No. 122. There was no corresponding
asset at August 31, 1994.
Timeshare and land inventories increased to $20.8 million at August 31,
1995 from $12.1 million at August 31, 1994, an increase of 72.1%. The increase
was primarily due to the acquisition and renovation of timeshare interests.
Notes and contracts payable increased 12.3% to $44.7 million at August 31,
1995 from $39.8 million at August 31, 1994 due to increased borrowings under the
Company's lines of credit and the timing of loan sales.
Accounts payable and accrued liabilities increased 129.1% to $14 million at
August 31, 1995 from $6.1 million at August 31, 1994, primarily as a result of
increases in accrued payroll, interest and other operational costs, due to
expansion and growth of the Company.
53
<PAGE> 54
Future estimated contingency for notes receivable sold with recourse
increased 117.6% to $8 million at August 31, 1995 from $3.7 million at August
31, 1994, primarily due to increased loans sold under recourse provisions.
Recourse to the Company on sales of loans is governed by the agreements between
the purchasers and the Company. The allowance for credit losses on loans sold
with recourse represents the Company's estimate of its probable future credit
losses to be incurred over the lives of the loans, considering estimated future
FHA insurance recoveries on Title I Loans and other factors.
Payable to assignors decreased 63.8% to $2.6 million at August 31, 1995
from $7.1 million at August 31, 1994, as a result of accrued amounts payable
exceeding payments made and the reclassification of $10 million to subordinated
debt.
Excess of liability over assets of discontinued operations decreased to $0
at August 31, 1995 from $4.2 million at August 31, 1994, as a result of an order
for judgment against the Company in litigation involving certain subsidiaries of
PEC in the amount of $3.4 million, which amount was settled for $2.9 million in
May 1995 and paid in June 1995.
Deposits, which represent the cash funds received on unrecognized land
sales, increased by 63% to $3.6 million at August 31, 1996 from $2.2 million at
August 31, 1994.
Deferred income taxes payable increased 49.7% to $8.1 million at August 31,
1995 from $5.4 million at August 31, 1994 due to increased income.
Stockholder's equity increased 16.4% to $19.2 million at August 31, 1995
from $16.5 million at August 31, 1994 as a result of net income applicable to
common stock of $1.4 million and the issuance of 1,000,000 common stock warrants
valued at $1.3 million.
POSSIBLE TERMINATION OF SERVICING RIGHTS
As described in Note 10 of Notes to Consolidated Financial Statements, the
pooling and servicing agreements relating to the Company's securitization
transactions contain provisions with respect to the maximum permitted loan
delinquency rates and loan default rates, which, if exceeded, would allow the
termination of the Company's right to service the related loans. At September
30, 1996, the default rates on the pool of loans sold in the March 1996
securitization transaction exceeded the permitted limit set forth in the related
pooling and servicing agreement. Accordingly, this condition could result in the
termination of the Company's servicing rights with respect to that pool of loans
by the trustee, the master servicer or the insurance company providing credit
enhancement for that transaction. The mortgage servicing rights on this pool of
loans were approximately $1.4 million at August 31, 1996. Although the insurance
company has indicated that it, and to its knowledge, the trustee and the master
servicer has no present intention to terminate the Company's servicing rights,
no assurance can be given that one or more of such parties will not exercise its
right to terminate. In the event of such termination, there would be an adverse
effect on the valuation of the Company's mortgage servicing rights and the
results of operations in the amount of the mortgage servicing rights ($1.4
million before tax and $870,000 after tax at August 31, 1996) on the date of
termination.
SUBSEQUENT EVENT
In November 1996, MMC issued 2,300,000 shares of its common stock in a
public offering at $10.00 per share. As a result of this transaction, the
Company's ownership in MMC declined from 100% at August 31, 1996 to 81.3%. The
Company continues to have voting control on all matters submitted to
shareholders of MMC, including the election of directors and approval of
extraordinary corporate transactions. Concurrently with the common stock
offering, MMC issued $40 million of 12.5% Senior Subordinated Notes due in 2001
in a public offering. MMC currently intends to use approximately $13.2 million
of the aggregate net proceeds received from the offerings to repay amounts due
to Mego Financial Corp. and PEC and approximately $17 million to reduce the
amounts outstanding under MMC's warehouse and revolving lines of credit which
currently bear interest at rates ranging from 1% to 2% over the prime rate and
which expire in August 1997 and December 1997, respectively, and to repay $3
million under a repurchase agreement. Funds received by Mego Financial Corp. and
PEC will be used in their respective operations. The remaining net proceeds will
be
54
<PAGE> 55
used by MMC to provide capital to originate and securitize loans. Pending such
use, the net proceeds received by the Company will be invested in high quality,
short term interest-bearing investment and deposit accounts.
EFFECTS OF CHANGING PRICES AND INFLATION
The Company's operations are sensitive to increases in interest rates and
to inflation. Increased borrowing costs resulting from increases in interest
rates may not be immediately recoverable from prospective purchasers.
Inflationary increases are difficult to pass on to customers since increases in
sales prices often results in lower sales closing rates and higher
cancellations. The Company's notes receivable consist primarily of fixed-rate
long term installment contracts that do not increase or decrease as a result of
changes in interest rates charged to the Company. In addition, delinquency and
cancellation rates may be affected by changes in the national economy.
SEASONALITY
Sales of timeshare interests and land are seasonal. For the fiscal years
ended August 31, 1996, 1995 and 1994 quarterly sales as a percentage of annual
sales, for each of the fiscal quarters averaged: quarters ended November
30 -- 25%, quarters ended February 28 -- 20.3%, quarters ended May 31 -- 28.9%,
and quarters ended August 31 -- 25.9%. The majority of the Company's customers
are tourists. The Company's major marketing area, Las Vegas, Nevada, reaches
peaks of tourist activity at periods different from the Company's other major
marketing areas, Reno, Nevada, Southern California, Atlantic City, New Jersey,
Denver and Park and Huerfano Counties, Colorado, which are more active in summer
than in winter. The Company's other major marketing area, Honolulu, Hawaii, is
not subject to seasonality as are the two new resorts opening in fiscal 1997 in
Florida. The Company is not dependent upon a limited number of customers whose
loss would have a materially adverse effect on the Company.
Home improvement loan volume tracks the seasonality of home improvement
contract work. Volume tends to build during the spring and early summer months,
particularly with regard to pool installations. A decline is typically
experienced in late summer and early fall until temperatures begin to drop. This
change in seasons precipitates the need for new siding, window and insulation
contracts. Peak volume is experienced in November and early December and
declines dramatically from the holiday season through the winter months. Debt
consolidation and home equity loan volume are not impacted by seasonal climate
changes and, with the exclusion of the holiday season, tend to be stable
throughout the year.
RECENT ACCOUNTING PRONOUNCEMENTS
The Financial Accounting Standards Board (the FASB) has issued Statement
No. 121 "Accounting for the Impairment of Long-Lived Assets and for Long-Lived
Assets to be Disposed of" (SFAS 121). SFAS 121 requires that long-lived assets
and certain identifiable intangibles be reviewed for impairment whenever events
or changes in circumstances indicate that the carrying amount of an asset may
not be recoverable. SFAS 121 is effective for fiscal years beginning after
December 15, 1995. The Company does not anticipate any material effect upon
adoption on the results of operations or financial condition.
In October 1995, FASB issued SFAS No. 123, "Accounting for Stock-Based
Compensation," (SFAS 123), which establishes financial accounting and reporting
standards for stock-based employee compensation plans. This statement also
applies to transactions in which an entity issues its equity instruments to
acquire goods or services from nonemployees. Those transactions must be
accounted for based on the fair value of the consideration received or the fair
value of the equity instruments issued, whichever is more reliably measurable.
SFAS 123 is effective for fiscal years beginning December 15, 1995. The Company
intends to provide the pro forma and other additional disclosure about
stockbased employee compensation plans in its 1997 financial statements as
required by SFAS 123.
SFAS No. 125, "Accounting for Transfers and Servicing of Financial Assets
and Extinguishments of Liabilities" (SFAS 125) was issued by FASB in June 1996.
SFAS 125 provides accounting and reporting standards for transfers and servicing
of financial assets and extinguishments of liabilities. This statement also
provides consistent standards for distinguishing transfers of financial assets
that are sales from transfers that
55
<PAGE> 56
are secured borrowings. It requires that liabilities and derivatives incurred or
obtained by transferors as part of a transfer of financial assets be initially
measured at fair value. SFAS 125 also requires that servicing assets be measured
by allocating the carrying amount between the assets sold and retained interests
based on their relative fair values at the date of transfer. Additionally, this
statement requires that the servicing assets and liabilities be subsequently
measured by (a) amortization in proportion to and over the period of estimated
net servicing income and (b) assessment for asset impairment or increased
obligation based on the fair values. The statement will require that the
Company's existing and future excess servicing receivables be measured at fair
market value and be reclassified as interest only strip securities and accounted
for in accordance with SFAS 115. As required by the statement, the Company will
adopt the new requirements effective January 1, 1997. It is not anticipated that
upon implementation, the statement will have any material impact on the
financial statements of the Company, as the book value of the Company's excess
servicing rights and mortgage related securities approximates fair value. Upon
adoption of SFAS 125, the Company's subsidiary, PEC, will begin recognizing
servicing rights and notes receivable held for sale, similar to the method
currently used by MMC on mortgage servicing rights under SFAS 122. This will
have the impact of increasing the gain on sale of notes at the time of sale and
reducing future servicing fee income on PEC generated receivables sold after
January 1, 1997.
CAUTIONARY STATEMENT RELATING TO FORWARD-LOOKING STATEMENTS
The foregoing Management's Discussion and Analysis of Financial Condition
and Results of Operations contains various "forward-looking statements" within
the meaning of Section 27A of the Securities Act of 1933, as amended, and
Section 21E of the Securities Exchange Act of 1934, as amended, which represent
the Company's expectations and beliefs concerning future events, including the
sufficiency of the Company's cash flow for the Company's future liquidity and
capital resource needs. The Company cautions that these statements are further
qualified by important factors that could cause actual results to differ
materially from those in the forward-looking statements, including, without
limitation, the following: decline in demand for home improvement and debt
consolidation loans; decline in demand for timeshare interests; the effect of
general economic conditions generally and specifically changes in interest
rates; the effect of competition; the Company's dependence on the availability
to sell its loans and receivables; and the regulation of the Company by federal,
state and local regulatory authorities. Actual events or results may differ as a
result of these and other factors.
56
<PAGE> 57
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The following consolidated financial statements and supplementary data of
the Company and its subsidiaries are included herewith:
<TABLE>
<CAPTION>
PAGE
-----------
<S> <C>
Independent Auditors' Report.................................................. F-2
Consolidated Statements of Financial Condition -- August 31, 1996 and 1995.... F-3
Consolidated Statements of Operations for the years ended August 31, 1996,
1995, and 1994.............................................................. F-4 - F-5
Consolidated Statements of Stockholders' Equity for the years ended August 31,
1996, 1995, and 1994........................................................ F-6
Consolidated Statements of Cash Flows for the years ended August 31, 1996,
1995, and 1994.............................................................. F-7 - F-8
Notes to Consolidated Financial Statements for the years ended August 31,
1996, 1995, and 1994........................................................ F-9 - F-36
Independent Auditors' Report on Financial Statement Schedules................. S-1
Valuation and Qualifying Accounts for the year ended August 31, 1996.......... S-2
Valuation and Qualifying Accounts for the year ended August 31, 1995.......... S-3
Valuation and Qualifying Accounts for the year ended August 31, 1994.......... S-4
</TABLE>
All other schedules are omitted because of the absence of conditions under
which they are required or because the required information is included in the
financial statements.
57
<PAGE> 58
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, as amended, the Registrant has duly caused this Report to
be signed on its behalf by the undersigned, thereunto duly authorized.
MEGO FINANCIAL CORP.
Date: August 1, 1997 By: /s/ JEROME J. COHEN
------------------------------------
Jerome J. Cohen, President
74
<PAGE> 59
MEGO FINANCIAL CORP. AND SUBSIDIARIES
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
Independent Auditors' Report.......................................................... F-2
Financial Statements:
Consolidated Statements of Financial Condition -- August 31, 1996 and 1995.......... F-3
Consolidated Statements of Operations -- Years Ended August 31, 1996, F-4
1995 and 1994....................................................................
Consolidated Statements of Stockholders' Equity -- Years Ended August 31, F-6
1996, 1995 and 1994..............................................................
Consolidated Statements of Cash Flows -- Years Ended August 31, 1996, F-7
1995 and 1994....................................................................
Notes to Consolidated Financial Statements.......................................... F-9
</TABLE>
F-1
<PAGE> 60
INDEPENDENT AUDITORS' REPORT
To the Board of Directors and Stockholders of
Mego Financial Corp. and Subsidiaries
Las Vegas, Nevada
We have audited the accompanying statements of financial condition of Mego
Financial Corp. and its subsidiaries (the "Company") as of August 31, 1996 and
1995, and the related consolidated financial statements of operations,
stockholders' equity, and cash flows for each of the three years in the period
ended August 31, 1996. These financial statements are the responsibility of the
Company's management. Our responsibility is to express an opinion on these
financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, such consolidated financial statements present fairly, in
all material respects, the financial position of Mego Financial Corp. and
subsidiaries at August 31, 1996 and 1995, and the results of their operations
and their cash flows for each of the three years in the period ended August 31,
1996 in conformity with generally accepted accounting principles.
As discussed in Note 4 to the consolidated financial statements, in 1995
the Company adopted Statement of Financial Accounting Standards No. 122,
Accounting for Mortgage Servicing Rights effective September 1, 1994.
DELOITTE & TOUCHE LLP
Las Vegas, Nevada
October 25, 1996, except for Note 24 as to which the date is
November 22, 1996
F-2
<PAGE> 61
MEGO FINANCIAL CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
(thousands of dollars, except per share amounts)
August 31,
<TABLE>
<CAPTION>
1996 1995
-------- --------
<S> <C> <C>
ASSETS
Cash and cash equivalents.............................................. $ 3,185 $ 7,338
Restricted cash........................................................ 6,657 6,467
Notes receivable, net of allowances for cancellations, valuation
discounts, and credit losses of $12,059 and $12,312 at August 31,
1996 and 1995, respectively.......................................... 45,220 35,608
Mortgage related securities, at fair value............................. 22,944 --
Excess servicing rights................................................ 14,268 16,565
Mortgage servicing rights.............................................. 3,827 1,076
Timeshare interests held for sale...................................... 33,691 17,376
Land and improvements inventory........................................ 2,185 3,432
Other investments...................................................... 1,972 1,531
Property and equipment, net of accumulated depreciation of $13,550 and
$11,848 at August 31, 1996 and 1995, respectively.................... 20,262 12,681
Deferred selling costs................................................. 2,901 3,332
Other assets........................................................... 8,485 7,351
-------- --------
TOTAL ASSETS................................................. $165,597 $112,757
======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY
Liabilities:
Notes and contracts payable.......................................... $ 84,449 $ 44,715
Accounts payable and accrued liabilities............................. 19,662 13,998
Payable to assignors................................................. 2,579 2,579
Future estimated contingency for notes receivable sold with
recourse.......................................................... 9,332 8,030
Deposits............................................................. 2,971 3,619
Negative goodwill.................................................... 82 131
Deferred income taxes................................................ 10,980 8,103
-------- --------
Total liabilities before subordinated debt and redeemable
preferred stock............................................ 130,055 81,175
-------- --------
Subordinated debt...................................................... 9,691 9,352
-------- --------
Redeemable preferred stock, Series A, 12% cumulative preferred stock,
$.01 par value, $10 redemption value, 0 and 300,000 shares issued and
outstanding at August 31, 1996 and 1995, respectively................ -- 3,000
-------- --------
Stockholders' equity:
Preferred stock, $.01 par value (authorized -- 5,000,000 shares)..... -- --
Common stock, $.01 par value (authorized -- 50,000,000 shares; issued
and outstanding -- 18,433,121 and 18,087,556 at August 31, 1996
and 1995, respectively)........................................... 184 180
Additional paid-in capital........................................... 6,504 4,498
Retained earnings.................................................... 19,163 14,552
-------- --------
Total stockholders' equity................................... 25,851 19,230
-------- --------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY................... $165,597 $112,757
======== ========
</TABLE>
See notes to consolidated financial statements.
F-3
<PAGE> 62
MEGO FINANCIAL CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(thousands of dollars, except per share amounts)
For the years ended August 31,
<TABLE>
<CAPTION>
1996 1995 1994
------- ------- -------
<S> <C> <C> <C>
REVENUES
Timeshare interest sales, net............................... $27,778 $20,682 $19,521
Land sales, net............................................. 17,968 20,812 13,534
Housing sales............................................... -- 205 515
Gain on sale of notes receivable............................ 19,110 13,819 1,454
Net unrealized gain on mortgage related securities.......... 2,697 -- --
Interest income............................................. 8,698 8,179 8,368
Financial income............................................ 3,892 1,149 --
Amortization of negative goodwill........................... 49 216 472
Incidental operations....................................... 2,995 3,620 2,007
Other....................................................... 3,608 2,878 3,005
------- ------- -------
Total revenues...................................... 86,795 71,560 48,876
------- ------- -------
COSTS AND EXPENSES
Direct cost of:
Timeshare interest sales................................. 3,998 2,977 2,684
Land sales............................................... 1,844 2,164 1,435
Housing sales............................................ -- 265 531
Incidental operations.................................... 2,257 2,343 2,342
Commissions and selling..................................... 30,351 23,690 18,949
Depreciation and amortization............................... 1,920 1,534 1,208
Provision for credit losses................................. 1,510 864 96
Interest expense............................................ 8,597 6,961 4,836
General and administrative.................................. 28,300 19,323 13,282
Payments to assignors....................................... -- 7,252 8,526
------- ------- -------
Total costs and expenses............................ 78,777 67,373 53,889
------- ------- -------
INCOME (LOSS) BEFORE INCOME TAXES............................. 8,018 4,187 (5,013)
INCOME TAXES.................................................. 3,167 3,293 761
------- ------- -------
INCOME (LOSS) FROM CONTINUING OPERATIONS...................... 4,851 894 (5,774)
GAIN ON DISCONTINUED OPERATIONS, NET OF INCOME TAXES OF
$450........................................................ -- 873 --
------- ------- -------
NET INCOME (LOSS)............................................. 4,851 1,767 (5,774)
CUMULATIVE PREFERRED STOCK DIVIDENDS.......................... 240 360 360
------- ------- -------
NET INCOME (LOSS) APPLICABLE TO COMMON STOCK.................. $ 4,611 $ 1,407 $(6,134)
======= ======= =======
</TABLE>
See notes to consolidated financial statements.
F-4
<PAGE> 63
MEGO FINANCIAL CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS (Continued)
(thousands of dollars, except per share amounts)
For the years ended August 31,
<TABLE>
<CAPTION>
1996 1995 1994
----------- ----------- -----------
<S> <C> <C> <C>
EARNINGS (LOSS) PER COMMON SHARE:
Primary:
Income (loss) from continuing operations....... $ 0.24 $ 0.03 $ (0.34)
Income from discontinued operations............ -- $ 0.05 --
----------- ----------- -----------
Net income (loss).............................. $ 0.24 $ 0.08 $ (0.34)
=========== =========== ===========
Weighted-average number of common shares and
common share equivalents outstanding........... 19,087,387 18,087,153 17,820,170
=========== =========== ===========
Fully Diluted:
Income from continuing operations.............. $ 0.24 $ 0.02
Income from discontinued operations............ -- 0.05
----------- -----------
Net income..................................... $ 0.24 $ 0.07
=========== ===========
Weighted-average number of common shares and
common share equivalents outstanding........... 19,087,387 18,939,201
=========== ===========
</TABLE>
See notes to consolidated financial statements.
F-5
<PAGE> 64
MEGO FINANCIAL CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
(thousands of dollars, except per share amounts)
<TABLE>
<CAPTION>
COMMON STOCK
-------------------
$.01 PAR VALUE ADDITIONAL
------------------- PAID-IN RETAINED
SHARES AMOUNT CAPITAL EARNINGS TOTAL
---------- ------ ---------- ------- -------
<S> <C> <C> <C> <C> <C>
Balance at September 1, 1993................ 17,631,169 $178 $2,612 $19,219 $22,009
Issuance of common stock.................... 475,000 3 647 -- 650
Redemption of common stock.................. (19,419) (1) (61) -- (62)
Dividends on preferred stock................ -- -- -- (300) (300)
Net loss.................................... -- -- -- (5,774) (5,774)
---------- ---- ------ ------- -------
Balance at August 31, 1994.................. 18,086,750 180 3,198 13,145 16,523
Issuance of 1,000,000 common stock warrants
in connection with subordinated debt
valued at $1.30 per share................. -- -- 1,300 -- 1,300
Issuance of common stock in connection with
exercise of stock options................. 806 -- -- -- --
Dividends on preferred stock................ -- -- -- (360) (360)
Net income.................................. -- -- -- 1,767 1,767
---------- ---- ------ ------- -------
Balance at August 31, 1995.................. 18,087,556 180 4,498 14,552 19,230
Issuance of common stock in connection with
exercise of stock options................. 2,218 1 9 -- 10
Issuance of common stock in connection with
redemption of preferred stock............. 343,347 3 1,997 -- 2,000
Dividends on preferred stock................ -- -- -- (240) (240)
Net income.................................. -- -- -- 4,851 4,851
---------- ---- ------ ------- -------
Balance at August 31, 1996.................. 18,433,121 $184 $6,504 $19,163 $25,851
========== ==== ====== ======= =======
</TABLE>
See notes to consolidated financial statements.
F-6
<PAGE> 65
MEGO FINANCIAL CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(thousands of dollars)
For the years ended August 31,
<TABLE>
<CAPTION>
1996 1995 1994
--------- --------- --------
<S> <C> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income (loss).......................................... $ 4,851 $ 1,767 $ (5,774)
--------- --------- --------
Adjustments to reconcile net income (loss) to net cash used
in operating activities:
Amortization of negative goodwill....................... (49) (216) (472)
Charges to allowance for cancellation and credit
losses................................................ (6,918) (6,611) (7,909)
Provisions for cancellation and credit losses........... 11,288 10,359 7,775
Provisions for uncollectible owners' association
advances.............................................. 12 1,050 365
Cost of sales........................................... 5,842 5,406 4,650
Depreciation and amortization expense................... 1,920 1,534 1,208
Gain on sale of notes receivables....................... (1,116) (1,586) (875)
Gain on discontinued operations......................... -- (1,323) --
Increase (decrease) in future estimated contingency for
notes receivable sold with recourse................... 3,080 4,943 2,340
Additions to excess servicing rights.................... (21,242) (15,336) (1,611)
Amortization of excess servicing rights................. 2,758 917 367
Repayments of mortgage related securities............... 92 -- --
Accretion of residual interest on mortgage related
securities............................................ (243) -- --
Net unrealized gain on mortgage related securities...... (2,697) -- --
Additions to mortgage servicing rights.................. (3,306) (1,176) --
Amortization of mortgage servicing rights............... 555 100 --
Deferred income taxes................................... 2,877 2,689 761
Amortization of future estimated contingency for notes
receivable sold with recourse......................... (1,812) (1,423) (1,696)
Repayments on notes receivable, net..................... 24,499 18,137 25,057
Proceeds from sale of notes receivable.................. 152,601 119,055 31,097
Purchase of land and timeshare interests................ (20,910) (14,123) (5,782)
Changes in operating assets and liabilities:
Increase in restricted cash........................... (190) (5,715) (252)
Increase in notes receivable, net..................... (190,902) (133,147) (43,949)
Decrease (increase) in other assets................... 327 (795) (544)
Decrease (increase) in deferred selling costs......... 431 (277) (1,003)
Increase in accounts payable and accrued
liabilities........................................ 5,664 6,036 1,722
Increase (decrease) in deposits....................... (648) 1,399 802
Increase in payable to assignors...................... -- 6,100 3,927
Decrease in excess of liabilities over assets of
discontinued operations............................ -- (2,899) --
--------- --------- --------
Total adjustments.................................. (38,087) (6,902) 15,978
--------- --------- --------
Net cash provided by (used in) operating
activities.................................... (33,236) (5,135) 10,204
--------- --------- --------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchase of property and equipment......................... (9,327) (3,797) (2,573)
Proceeds from sale of property and equipment............... 19 3 150
Additions to other investments............................. (1,381) (262) (3,903)
Decreases in other investments............................. 940 350 4,111
--------- --------- --------
Net cash used in investing activities............ (9,749) (3,706) (2,215)
--------- --------- --------
</TABLE>
See notes to consolidated financial statements.
F-7
<PAGE> 66
MEGO FINANCIAL CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS (Continued)
(thousands of dollars)
For the years ended August 31,
<TABLE>
<CAPTION>
1996 1995 1994
--------- --------- --------
<S> <C> <C> <C>
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from borrowings............................... $ 201,243 $ 122,334 $ 41,040
Reduction of debt...................................... (161,510) (117,429) (45,958)
Preferred stock dividends.............................. (240) (360) (300)
Redemption of preferred stock.......................... (1,000) -- --
Redemption of common stock............................. -- -- (62)
Payments on subordinated debt.......................... (1,000) -- --
Increase in subordinated debt.......................... 1,339 652 --
--------- --------- --------
Net cash provided by (used in) financing
activities................................... 38,832 5,197 (5,280)
--------- --------- --------
NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS..... (4,153) (3,644) 2,709
CASH AND CASH EQUIVALENTS -- BEGINNING OF YEAR........... 7,338 10,982 8,273
--------- --------- --------
CASH AND CASH EQUIVALENTS -- END OF YEAR................. $ 3,185 $ 7,338 $ 10,982
========= ========= ========
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Cash paid during the year for:
Interest, net of amounts capitalized................ $ 9,136 $ 5,567 $ 4,698
========= ========= ========
Income taxes........................................ $ 25 $ 3 $ --
========= ========= ========
SUPPLEMENTAL DISCLOSURE OF NON-CASH ACTIVITIES:
The Company issued 475,000 shares of its common stock
to an unrelated entity for services rendered to Mego
Mortgage............................................ $ -- $ -- $ 650
========= ========= ========
Issuance of subordinated debt to assignors............. $ -- $ 10,000 $ --
========= ========= ========
In connection with the issuance of subordinated debt
the Company issued 1,000,000 common stock warrants
to the assignors.................................... $ -- $ 1,300 $ --
========= ========= ========
In connection with the securitization of loans and
creation of mortgage related securities, the Company
retained interest only securities and residual
interest securities................................. $ 20,096 $ -- $ --
========= ========= ========
Redemption of preferred stock through issuance of
common stock........................................ $ 2,000 $ -- $ --
========= ========= ========
</TABLE>
See notes to consolidated financial statements.
F-8
<PAGE> 67
MEGO FINANCIAL CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
For the years ended August 31, 1996, 1995, and 1994
1. NATURE OF OPERATIONS
Mego Financial Corp. (Mego) is a specialty financial services company that,
through its subsidiaries, Mego Mortgage Corporation (MMC) and Preferred Equities
Corporation (PEC), is engaged primarily in originating, selling and servicing
consumer receivables generated through home improvement loans and timeshare and
land sales. Mego Financial Corp. and its subsidiaries are herein collectively
referred to as the Company. MMC originates Title I home improvement loans (Title
I Loans) insured by the Federal Housing Administration (FHA) of the Department
of Housing and Urban Development (HUD) through a network of loan correspondents
and home improvement contractors. In May 1996, MMC commenced the origination of
conventional home improvement and home equity loans through its network of loan
correspondents. PEC markets and finances timeshare interests in select resort
areas, as well as land. By providing financing to virtually all of its
customers, PEC also originates consumer receivables that it sells and services.
Timeshare and land sales have historically accounted for most of the Company's
revenues and profits; however, since March 1994, when MMC commenced operations,
originating, selling and servicing home improvement loans have accounted for an
increasing portion of revenues and profits. Mego was incorporated under the laws
of the state of New York in 1954 under the name Mego Corp. and, in 1992, changed
its name to Mego Financial Corp. In February 1988, Mego acquired PEC, pursuant
to an assignment by the Assignors, as defined below, of their contract right to
purchase PEC. See Note 2 for further discussion.
To facilitate its sales of timeshare interests, the Company has entered
into several trust agreements. The trustees administer the collection of the
related notes receivable. The Company has assigned title to certain of its
resort properties and its interest in certain notes receivable to the trustees.
2. ACQUISITION OF PREFERRED EQUITIES CORPORATION
The acquisition of PEC on February 1, 1988, was effected pursuant to an
Assignment Agreement, dated October 25, 1987, between Mego and several
corporations (Assignors) and a related Assignment and Assumption Agreement,
(Assignment and Assumption Agreement), dated February 1, 1988, and amended on
July 29, 1988 between Mego and the Assignors (collectively, such agreements
constitute the Assignment). The acquisition of PEC was accomplished by PEC's
issuing 2 shares of its common stock to the Company for a purchase price of
approximately $50,000. Immediately prior to that time, the previously
outstanding shares held by others were surrendered and redeemed by PEC at a cost
to PEC of approximately $10,463,000 plus fees and expenses, leaving Mego with
all of the outstanding shares of PEC.
The right to purchase shares from PEC was obtained by Mego pursuant to the
Assignment, which assigned to the Company the right to purchase shares from PEC
pursuant to the Stock Purchase and Redemption Agreement, dated October 6, 1987,
between PEC and the Assignors, as amended on October 25, 1987. Consideration for
the Assignment consisted of promissory notes (Purchase Notes) from Mego to the
Assignors in the aggregate amount of $2,000,000 and additional payments to the
Assignors as described below. The Purchase Notes were paid in full prior to
August 31, 1988. After the payment of the Purchase Notes, the Assignors were
entitled to receive from the Company on a quarterly basis, as determined as of
the end of each quarter, additional payments equal in the aggregate to 63% of
PEC's consolidated unrestricted cash balances, for a period ending on January
31, 1995. The additional payments are collateralized by a pledge of PEC stock to
the Assignors.
On March 2, 1995, Mego entered into the Second Amendment to Assignment and
Assumption Agreement (Amendment) whereby the Assignors agreed to defer payment
of $10,000,000 of the amount payable to Assignors and to subordinate such
amounts in right of payment applied to debt for money borrowed by Mego or
obligations of subsidiaries guaranteed by Mego. Warrants for 1,000,000 shares of
Mego common stock, at an exercise price of $4.25 per share (the closing market
price per share on March 2, 1995) were granted to the Assignors in consideration
of the payment deferral and subordination. The warrants contain
F-9
<PAGE> 68
MEGO FINANCIAL CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
For the years ended August 31, 1996, 1995, and 1994
restrictions on transfer and are exercisable until March 1, 2000. The Amendment
calls for interest to be paid semi-annually at the rate of 10% per annum
starting September 1, 1995, and 7 equal semi-annual payments of $1,429,000 plus
interest, commencing March 1, 1997. The payments are collateralized by a pledge
of PEC stock. See Notes 16 and 22 for further discussion.
3. EXCESS OF BOOK VALUE OF NET ASSETS ACQUIRED OVER ACQUISITION COST
On February 1, 1988, the underlying book value of the net assets of PEC
exceeded Mego's acquisition cost by the amount of $42,315,000. Management
allocated the excess book value to assets existing at the acquisition date
(primarily notes receivable which mature over approximately seven to ten years),
as a revaluation adjustment. As collections are made on the receivables (either
through installment payments or upon sale of receivables), a portion of the
revaluation adjustment is recorded to income as amortization. For the fiscal
years ended August 31, 1996, 1995, and 1994, such amortization amounted to $0,
$166,000, and $422,000, respectively. The Company previously determined that
$20,000,000 of the revaluation adjustment should not be amortized. Payments to
assignors have aggregated $47,401,000 through January 31, 1995 at which time the
accrual of payments to Assignors ceased. Amounts in excess of $20,000,000 have
been expensed and $0, $7,252,000 and $8,526,000 have been included in costs and
expenses for the 12 months ended August 31, 1996, 1995 and 1994, respectively.
See Notes 2 and 22 for further discussion.
4. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Principles of Consolidation -- The accompanying consolidated financial
statements include the accounts of Mego and its subsidiaries. All significant
intercompany accounts and transactions have been eliminated in consolidation.
See Note 1 for further discussion.
Parent Company Only Basis -- At August 31, 1996 and 1995, Mego, on a
"parent company only" basis, reflected total assets of $58,708,000 and
$51,529,000, respectively, which are comprised principally of its equity
investment in subsidiaries of $46,082,000 and $41,280,000, respectively, and
liabilities of $23,166,000 and $22,947,000, respectively, excluding subordinated
debt At August 31, 1996, liabilities were comprised principally of deferred
income taxes of $11,669,000, payable to Assignors of $2,579,000, and payable to
PEC of $7,445,000, excluding subordinated debt. At August 31, 1995, liabilities
excluding subordinated debt were comprised principally of deferred income taxes
of $8,103,000, payable to Assignors of $2,579,000, and payable to PEC of
$7,741,000. At August 31, 1996 and 1995, subordinated debt of $9,691,000 and
$9,352,000, respectively, was outstanding. At August 31, 1996 and 1995, Mego had
outstanding redeemable preferred stock with an aggregate redemption price of $0
and $3,000,000, respectively. See Notes 2, 16, and 17 for further discussion.
Cash Equivalents -- Cash equivalents consist primarily of certificates of
deposit, repurchase agreements and commercial paper with original maturities of
ninety days or less.
Restricted Cash -- Restricted cash represents cash on deposit which relates
to utility subsidiary customer deposits and betterment fees; cash on deposit in
accordance with notes receivable sale agreements; and untransmitted funds
received from collection of notes receivable which have not as yet been
disbursed to the purchasers of such notes receivable in accordance with the
related sale agreements.
Notes Receivable -- Substantially all of the notes receivable generated by
MMC are held for sale and are carried at the lower of cost or market on an
aggregate basis by type of receivable. The cost basis is the outstanding
principal balance of the notes reduced by the allowances for cancellation and
credit losses and by the net deferred origination fees and certain direct
origination costs that are recognized upon sale. Loan origination fees and costs
associated with notes held for sale are deferred until the loan is sold, with no
amortization recorded in the interim period. The amounts are immaterial, and
therefore not separately disclosed since the time between origination and sale
is usually extremely short.
F-10
<PAGE> 69
MEGO FINANCIAL CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
For the years ended August 31, 1996, 1995, and 1994
Allowances for Cancellation and Credit Losses -- Provisions for
cancellation and credit losses relating to notes receivable are recorded as
expense in amounts sufficient to maintain the allowance at a level considered
adequate to provide for anticipated losses resulting from customers' failure to
fulfill their obligations under the terms of their notes receivable. The Company
records a provision for cancellations and credit loss at the time revenue is
recognized, based upon periodic analysis of the portfolio, collateral values,
estimated FHA insurance recoveries, historical credit loss experience,
borrowers' ability to repay, and current economic factors. The allowance for
cancellations and credit losses represents the Company's estimate of its
probable future credit losses to be incurred over the lives of the notes. The
allowance for cancellations and credit losses is reduced by actual cancellations
and losses 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 future estimated cancellation and credit losses as notes
receivable are sold. Recourse to the Company on sales of notes receivable is
governed by the agreements between the purchasers and the Company. No allowance
for credit losses on loans sold with recourse is established on loans sold
through securitizations, as the Company has no recourse obligation under those
securitization agreements. Estimated credit losses on loans sold through
securitizations are considered in the Company's valuation of its residual
interest securities. The Company's judgment in determining the adequacy of this
allowance is based upon a periodic review of its portfolio of notes receivable.
These reviews take into consideration changes in the nature and level of the
portfolio, current economic conditions which may affect the purchasers' ability
to pay, the changes in collateral values, the estimated value of inventory that
may be reacquired, and overall portfolio quality. Changes in the allowance as a
result of such reviews are reflected in the provision for cancellation and
credit losses.
Mortgage Related Securities -- In 1996, the Company securitized a majority
of loans originated by MMC into the form of a REMIC. A REMIC is a trust issuing
multi-class securities with certain tax advantages to investors and which
derives its cash flow from a pool of underlying mortgages. Certain of the senior
classes of the REMIC are sold, and an interest only strip and a subordinated
residual class are retained by the Company. The subordinated residual class is
in the form of residual certificates and are classified as residual interest
securities. The documents governing the Company's securitizations require the
Company to establish initial over-collateralization or build
over-collateralization levels through retention of distributions by the REMIC
trust otherwise payable to the Company as the residual interest holder. This
over-collateralization causes the aggregate principal amount of the loans in the
related pool and/or cash reserves to exceed the aggregate principal balance of
the outstanding investor certificates. Such excess amounts serve as credit
enhancement for the related REMIC trust. To the extent that borrowers default on
the payment of principal or interest on the loans, losses will reduce the
over-collateralization and cash flows otherwise payable to the residual interest
security holder to the extent that funds are available. If payment defaults
exceed the amount of over-collateralization, as applicable, the insurance policy
maintained by the related REMIC trust will pay any further losses experienced by
holders of the senior interests in the related REMIC trust. The Company does not
have any recourse obligations for credit losses in the REMIC trust. The residual
interests are amortized to operations over the contractual lives of the loans,
considering future estimated prepayments utilizing an amortization method which
approximates the level yield method.
The Company adopted Statement of Financial Accounting Standards (SFAS) No.
115, "Accounting for Certain Investments in Debt and Equity Securities" (SFAS
115) on September 1, 1995. There was no cumulative financial statement impact as
a result of adopting SFAS 115.
In accordance with the provisions of SFAS 115, the Company classifies
residual interest securities and interest only securities as trading securities
which are recorded at fair value with any unrealized gains or losses recorded in
the results of operations in the period of the change in fair value. Valuations
at origination and at each reporting period are based on discounted cash flow
analyses. The cash flows are estimated as the excess of the weighted-average
coupon on each pool of loans securitized over the sum of the pass-through
interest
F-11
<PAGE> 70
MEGO FINANCIAL CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
For the years ended August 31, 1996, 1995, and 1994
rate, servicing fees, a trustee fee, an insurance fee and an estimate of annual
future credit losses, net of FHA insurance recoveries, related to the loans
securitized, over the life of the loans. These cash flows are projected over the
life of the loans using prepayment, default, and loss assumptions that the
Company believes market participants would use for similar financial instruments
and are discounted using an interest rate that the Company believes a purchaser
unrelated to the seller of such a financial instrument would require. The
Company utilized prepayment assumptions of 14%, estimated loss factor
assumptions of 1%, and weighted-average discount rates of 12%. The valuation
includes consideration of characteristics of the loans including loan type and
size, interest rate, origination date, and term. The Company also uses other
available information such as externally prepared reports on prepayment rates
and industry default rates of the type of loan portfolio under review. To the
Company's knowledge, there is no active market for the sale of these mortgage
related securities. The range of values attributable to the factors used in
determining fair value is broad. Although the Company believes that it has made
reasonable estimates of the fair value of the mortgage related securities, the
rate of prepayments and default rates utilized are estimates, and actual
experience may vary.
Mortgage Servicing Rights -- At August 31, 1995, effective September 1,
1994, the Company adopted the provisions of SFAS No. 122 "Accounting for
Mortgage Servicing Rights, an amendment of SFAS No. 65" (SFAS 122) which
requires that a mortgage banking enterprise recognize as separate assets the
rights to service mortgage loans for others however those servicing rights are
acquired. The effect of adopting SFAS 122 on the Company's financial statements
was to increase income before income taxes by $1,076,000 for the year ended
August 31, 1995. The fair value of capitalized mortgage servicing rights is
estimated by calculating the present value of expected net cash flows from
mortgage servicing using assumptions the Company believes market participants
would use in their estimates of future servicing income and expense, including
assumptions about prepayment, default and interest rates. Mortgage servicing
rights are amortized in proportion to and over the period of estimated net
servicing income. The estimate of fair value was based on a 125 basis points per
annum servicing fee reduced by estimated costs of servicing using a discount
rate of 12% for the year ended August 31, 1996, and a 100 basis points per annum
servicing fee reduced by estimated costs of servicing using a discount rate of
12% for the year ended August 31, 1995. At August 31, 1996 and August 31, 1995,
the book value of mortgage servicing rights approximated fair value. The Company
periodically reviews mortgage servicing rights to determine impairment. This
review is performed on a disaggregated basis, based upon date of origination.
Impairment is recognized in a valuation allowance for each pool in the period of
the impairment. The Company has developed its assumptions based on experience
with its own portfolio, available market data and ongoing consultation with its
investment bankers.
Timeshare Interests Held for Sale -- Costs incurred in connection with
preparing timeshare interests for sale are capitalized and include all costs of
acquisition, renovation and furnishings. Timeshare interests held for sale are
valued at the lower of cost or net realizable value.
Land and Improvements Inventory -- Land and improvements inventory include
carrying costs capitalized during the development period and costs of
improvements incurred to date and are stated at cost, not in excess of market
value.
Property and Equipment -- Property and equipment is stated at cost and is
depreciated over its estimated useful life (generally 3-40 years) using the
straight-line method. Costs of maintenance and repairs that do not improve or
extend the life of the respective assets are recorded as expense.
Utility Accounting Policies -- The Company, through a wholly-owned
subsidiary, provides water and sewer services to customers in the Pahrump valley
of Nevada. The Company is subject to regulation by the Public Service Commission
of Nevada and the Company's accounting policies conform to generally accepted
accounting principles as applied in the case of regulated public utilities in
accordance with the accounting requirements of the regulatory authority having
jurisdiction. Contributions in aid of construction (CIAC)
F-12
<PAGE> 71
MEGO FINANCIAL CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
For the years ended August 31, 1996, 1995, and 1994
received by the Company from its customers are included as a separate liability
and amortized over the period of 9-25 years, which represents the estimated
remaining useful life of the corresponding improvements. Amortization of CIAC
reduces amortization expense. CIAC is included in accounts payable and accrued
liabilities in the amounts of $4,494,000 and $3,750,000 at August 31, 1996 and
1995, respectively. The Company excludes from the CIAC liability, a sum equal to
the income tax expense related to the receipt of CIAC funds.
Future Estimated Contingency for Notes Receivable Sold with Recourse --
Recourse to the Company on sales of notes receivable is governed by the
agreements between the purchasers and the Company. The future estimated
contingency for notes receivable sold with recourse represents the Company's
estimate of its probable future credit losses to be incurred over the lives of
the notes receivable. Proceeds from the sale of notes receivable sold with
recourse were $135,200,000, $119,055,000 and $31,097,000 for the years ended
August 31, 1996, 1995 and 1994, respectively. A liability for future estimated
contingency for notes receivable sold with recourse was established at the time
of each sale based upon the Company's analysis of all probable losses resulting
from the Company's recourse obligations under each agreement of sale. For notes
receivable sold after September 30, 1992, the liability was determined in
accordance with Emerging Issues Task Force (EITF) Issue No. 92-2, on a
"discounted to present value" basis using an interest rate equivalent to the
risk-free market rate for securities with a duration similar to that estimated
for the underlying notes receivable. For notes receivable sold prior to
September 30, 1992, the liability remains on a non-discounted basis.
Income Taxes -- The Company utilizes the provisions of SFAS No. 109,
"Accounting for Income Taxes." SFAS No. 109 requires the Company to adhere to an
asset/liability approach for financial accounting and reporting for income
taxes. Income taxes are provided for the tax effects of transactions reported in
the financial statements and consist of taxes currently due plus deferred taxes
related primarily to differences between the bases of the balance sheet for
financial and income tax reporting. The deferred tax assets and liabilities
represent the future tax return consequences of those differences, which will
either be taxable or deductible when they are recovered or settled. Deferred
taxes also are recognized for operating losses that are available to offset
future taxable income and tax credits that are available to offset future income
taxes.
Revenue and Profit Recognition -- Timeshare Interests and Land
Sales -- Sales of timeshare interests and land are recognized and included in
revenues after certain "down payment" and other "continuing investment" criteria
are met. Land sale revenues are recognized using the deposit method in
accordance with the provisions of SFAS No. 66 "Accounting for Sales of Real
Estate." The agreement for sale generally provides for a down payment and a note
secured by a deed of trust or mortgage payable to the Company in monthly
installments, including interest, over a period of up to ten years. Revenue is
recognized after the requisite rescission period has expired and at such time as
the purchaser has paid at least 10% of the sales price for sales of timeshare
interests and 20% of the sales price for land sales. Land sales usually meet
these requirements within eight to ten months from closing, and sales of
timeshare interests usually meet these requirements at the time of sale. The
sales price, less a provision for cancellation, is recorded as revenue and the
allocated cost related to such net revenue of the timeshare interest or land is
recorded as expense in the year that revenue is recognized. When revenue related
to land sales is recognized, the portion of the sales price attributable to
uncompleted required improvements, if any, is deferred.
All payments received prior to the recognition of the sale as revenue are
accounted for as deposits. Selling costs directly attributable to unrecognized
sales are accounted for as deferred selling costs until the sale is recognized.
For land sales made at a location other than at the property, the purchaser
may cancel the contract within a specified inspection period, usually five
months from the date of purchase, provided that the purchaser is not in default
under the terms of the contract. At August 31, 1996, $131,975 of recognized
sales remain subject to
F-13
<PAGE> 72
MEGO FINANCIAL CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
For the years ended August 31, 1996, 1995, and 1994
such cancellation. If a purchaser defaults under the terms of the contract,
after all rescission and inspection periods have expired, all payments are
generally retained by the Company.
If the underlying note receivable is at a "below market" interest rate, a
valuation discount is applied to the note receivable balance and amortized over
its term so that the effective yield is 8% - 12% depending on the year of sale.
Notes receivable with payment delinquencies of 90 days or more have been
considered in determining the allowance for cancellation. Cancellations occur
when the note receivable is determined to be uncollectible and related
collateral, if any, has been recovered. Cancellation of a sale in the year the
revenue is recognized is deemed to not represent a sale and is accounted for as
a reversal of the revenue with an adjustment to cost of sale. Cancellations
subsequent to the year the revenue was recognized are charged to the allowance
for cancellation.
Revenue Recognition -- Gain on Sales of Notes Receivable -- Gain on sale of
notes receivable includes the gain on sale of mortgage related securities and
the gain on sale of notes receivable. In accordance with EITF Issue No. 88-11,
the gain on sale of mortgage related securities is determined by an allocation
of the cost of the securities based on the relative fair value of the securities
sold and the securities retained. In sales of loans through securitization
transactions, the Company generally retains interest only strip securities and
residual interest securities. The fair value of the interest only strip
securities and residual interest securities is the present value of the
estimated cash flow to be received after considering the effects of estimated
prepayments and credit losses. The interest only strip securities and residual
interest securities are included in mortgage related securities in the
Consolidated Statements of Financial Condition.
Gain on sale of notes receivable includes the present value of the
differential between contractual interest rates charged to borrowers on notes
receivable sold by the Company and the interest rates to be received by the
purchasers of such notes receivable, after considering the effects of estimated
prepayments and a normal servicing fee. The Company retains certain
participations in cash flows from the sold notes receivable and generally
retains the associated servicing rights. The Company generally sells its notes
receivable at par value.
The present value of expected net cash flows from the sale of notes
receivable are recorded at the time of sale as excess servicing rights. Excess
servicing rights 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. Excess servicing rights are recorded at the lower of
unamortized cost or estimated fair value. The expected cash flows used to
determine the excess servicing rights asset have been reduced for potential
losses net of potential FHA insurance recoveries, under recourse provisions of
the sales agreements. The future estimated contingency for notes receivable sold
with recourse represents the Company's estimate of losses to be incurred in
connection with the recourse provisions of the sales agreements and is shown
separately as a liability in the Company's Consolidated Statements of Financial
Condition.
In discounting cash flows related to notes receivable sales, the Company
defers servicing income at an annual rate of 1% - 1.25%, 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 in financial income. The cash
flows were discounted to present value using discount rates which averaged
between 12% and 15% in both fiscal 1996 and fiscal 1995. The Company has
developed its assumptions based on experience with its own portfolio, available
market data and ongoing consultation with its investment bankers.
In determining expected cash flows, management considers economic
conditions at the date of sale. In subsequent periods, these estimates may be
revised as necessary using the original discount rate, and any losses arising
from prepayment and loss experience will be recognized as realized.
Interest Income -- Interest income is recorded as earned. Interest income
represents the interest earned on notes receivable, mortgage related securities,
and short term investments. In accordance with EITF Issue
F-14
<PAGE> 73
MEGO FINANCIAL CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
For the years ended August 31, 1996, 1995, and 1994
No. 89-4, the Company computes an effective yield based on the carrying amount
of each mortgage related security and its estimated future cash flow. This yield
is then used to accrue interest income on the mortgage related security.
During the period that a Title I Loan is 30 days through 270 days
delinquent, the Company accrues interest at the HUD guaranteed rate of 7% in
lieu of the contractual rate of the loan. When a Title I Loan becomes over 270
days contractually delinquent, it is placed on non-accrual status and interest
is recognized only as cash is received. Interest income on other notes
receivable greater than 90 days delinquent is generally recognized on a cash
basis.
Financial Income -- Fees for servicing notes receivable originated or
acquired by the Company and sold with servicing rights retained are generally
based on a stipulated percentage of the outstanding principal balance of such
notes receivable and are recognized when earned. Interest received on notes
receivable sold, less amounts paid to investors, is reported as financial
income. Capitalized excess servicing rights and mortgage servicing rights are
amortized systematically to reduce income to an amount representing normal
servicing income and the present value discount. Late charges and other
miscellaneous income are recognized when collected. Costs to service notes
receivable are recorded as expense when incurred.
Timeshare Owners' Associations -- The Company incurs a portion of operating
expenses of the timeshare owners' associations based on ownership of the unsold
timeshare interests at each of the respective timeshare properties. These costs
are referred to as Association Assessments and are included in the Consolidated
Statements of Operations in general and administrative expense. Management fees
received from the associations are included in other revenues. See Note 22 for
further discussion.
Organizational Costs of Mego Mortgage Corporation -- Organizational costs
associated with the organization of the operations of Mego Mortgage Corporation,
which commenced loan originations on March 1, 1994, are being amortized over a
five year period by the Company. These organizational costs are comprised of
costs to incorporate, legal, accounting and other professional fees associated
with the organization of Mego Mortgage Corporation. The amortization of these
costs is included in depreciation and amortization expense on the Consolidated
Statements of Operations. Accumulated amortization related to organizational
costs was $482,000 and $289,000 at August 31, 1996 and 1995, respectively.
Earnings (loss) per common share -- Earnings (loss) per common share are
based on the net income (loss) applicable to common stock for each period
divided by the weighted-average number of common shares and common share
equivalents outstanding during the period. Earnings per common share assuming
full dilution are computed by dividing net income applicable to common stock by
the weighted-average number of common shares plus common share equivalents using
the treasury stock method. In loss periods, anti-dilutive common share
equivalents are excluded.
Recently Issued Accounting Standards -- The Financial Accounting Standards
Board (the FASB) has issued Statement No. 121 "Accounting for the Impairment of
Long-Lived Assets and for Long-Lived Assets to be Disposed of" (SFAS 121). SFAS
121 requires that long-lived assets and certain identifiable intangibles be
reviewed for impairment whenever events or changes in circumstances indicate
that the carrying amount of an asset may not be recoverable. SFAS 121 is
effective for fiscal years beginning after December 15, 1995. The Company does
not anticipate any material effect upon adoption on results of operation or
financial condition.
In October 1995, FASB issued SFAS No. 123, "Accounting for Stock-Based
Compensation," (SFAS 123), which establishes financial accounting and reporting
standards for stock-based employee compensation plans. This statement also
applies to transactions in which an entity issues its equity instruments to
acquire goods or services from nonemployees. Those transactions must be
accounted for based on the fair value of the consideration received or the fair
value of the equity instruments issued, whichever is more
F-15
<PAGE> 74
MEGO FINANCIAL CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
For the years ended August 31, 1996, 1995, and 1994
reliably measurable. SFAS 123 is effective for fiscal years beginning after
December 15, 1995. The Company intends to provide the pro forma and other
additional disclosure about stock-based employee compensation plans in its
fiscal 1997 financial statements as required by SFAS 123.
SFAS No. 125, "Accounting for Transfers and Servicing of Financial Assets
and Extinguishments of Liabilities" (SFAS 125) was issued by FASB in June 1996.
SFAS 125 provides accounting and reporting standards for transfers and servicing
of financial assets and extinguishments of liabilities. This statement also
provides consistent standards for distinguishing transfers of financial assets
that are sales from transfers that are secured borrowings. It requires that
liabilities and derivatives incurred or obtained by transferors as part of a
transfer of financial assets be initially measured at fair value. SFAS 125 also
requires that servicing assets be measured by allocating the carrying amount
between the assets sold and retained interests based on their relative fair
values at the date of transfer. Additionally, this statement requires that the
servicing assets and liabilities be subsequently measured by (a) amortization in
proportion to and over the period of estimated net servicing income and (b)
assessment for asset impairment or increased obligation based on the fair
values. The statement will require that the Company's existing and future excess
servicing receivables be measured at fair market value and be reclassified as
interest only strip securities and accounted for in accordance with SFAS 115. As
required by the statement, the Company will adopt the new requirements effective
January 1, 1997. It is not anticipated that upon implementation, the statement
will have any material impact on the financial statements of the Company, as the
book value of the Company's excess servicing rights and mortgage related
securities approximates fair value. Upon adoption of SFAS 125, the Company's
subsidiary, PEC, will begin recognizing servicing rights and notes receivable
held for sale, similar to the method currently used by MMC with respect to
mortgage servicing rights under SFAS 122. This will have the impact of
increasing the gain on sale of notes at the time of sale and reducing future
servicing fee income from PEC generated receivables sold after January 1, 1997.
Reclassification -- Certain reclassifications have been made to conform
prior years with the current year presentation.
Use of Estimates -- The preparation of financial statements in conformity
with generally accepted accounting principles (GAAP) requires management to make
estimates and assumptions that affect the reported amounts of assets and
liabilities and disclosures of contingent assets and liabilities at the date of
the financial statements and the reported amounts of revenues and expenses
during the reporting period. Actual results could differ from those estimates.
5. FAIR VALUES OF FINANCIAL INSTRUMENTS
SFAS No. 107, "Disclosure about Fair Value of Financial Instruments" (SFAS
107), requires disclosure of estimated fair value information for financial
instruments, whether or not recognized in the Statements of Financial Condition.
Fair values are based upon estimates using present value or other valuation
techniques in cases where quoted market prices are not available. Those
techniques are significantly affected by the assumptions used, including the
discount rate and estimates of future cash flows. In that regard, the derived
fair value estimates cannot be substantiated by comparison to independent
markets and, in many cases, could not be realized in immediate settlement of the
instrument. SFAS 107 excludes certain financial instruments and all nonfinancial
instruments from its disclosure requirements. Accordingly, the aggregate fair
value amounts presented do not represent the underlying value of the Company.
F-16
<PAGE> 75
MEGO FINANCIAL CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
For the years ended August 31, 1996, 1995, and 1994
Estimated fair values, carrying values and various methods and assumptions
used in valuing the Company's financial instruments at August 31, 1996 are set
forth below (thousands of dollars):
<TABLE>
<CAPTION>
CARRYING ESTIMATED
VALUE FAIR VALUE
-------- ----------
<S> <C> <C>
Financial Assets:
Cash and cash equivalents(a)................... $ 3,185 $ 3,185
Notes receivable, net(b)....................... 45,220 46,708
Mortgage related securities(c)................. 22,944 22,944
Excess servicing rights(c)..................... 14,268 14,268
Mortgage servicing rights(c)................... 3,827 3,827
Financial Liabilities:
Notes and contracts payable(d)................. 84,449 84,449
Deposits(e).................................... 2,971 2,971
Subordinated debt(a)........................... 9,691 9,691
</TABLE>
- ---------------
(a) Carrying value was used as the estimate of fair value.
(b) Since it is the Company's business to sell loans it originates, the fair
value was estimated by using outstanding commitments from investors adjusted
for non-qualified loans and the collateral securing such loans.
(c) The fair value was estimated by discounting future cash flows of the
instruments using discount rates, default, loss and prepayment assumptions
based upon available market data, opinions from investment bankers and
portfolio experience.
(d) Notes payable generally are adjustable rate, indexed to the prime rate, or
to the 90 day London Interbank Offering Rate (LIBOR); therefore, carrying
value approximates fair value. Contracts payable represent capitalized
equipment leases with a weighted-average interest rate of 9.9%, which
approximates fair value.
(e) Deposits represent down payments received from customers prior to the
recognition of a sale under GAAP. The carrying value approximates the
estimated fair value for these deposits.
At August 31, 1996, the Company had $59,597,000 in outstanding commitments
to originate and purchase loans and no other off-balance sheet financial
instruments. A fair value of the commitments was estimated at $6,800,000 by
calculating a theoretical gain or loss on the sale of a funded loan adjusted for
an estimate of loan commitments not expected to fund, considering the difference
between investor yield requirements and the committed loan rates. The estimated
fair value is not necessarily representative of the actual gain to be recorded
on such loan sales in the future.
The fair value estimates made at August 31, 1996 were based upon pertinent
market data and relevant information on the financial instruments at that time.
These estimates do not reflect any premium or discount that could result from
the sale of the entire portion of the financial instruments. Because no market
exists for a substantial portion of the financial instruments, fair value
estimates may be based upon judgments regarding future expected loss experience,
current economic conditions, risk characteristics of various financial
instruments and other factors. These estimates are subjective in nature and
involve uncertainties and matters of significant judgment and therefore cannot
be determined with precision. Changes in assumptions could significantly affect
the estimates.
Fair value estimates are based upon existing on-and-off-balance sheet
financial instruments without attempting to estimate the value of anticipated
future business and the value of assets and liabilities that are not considered
financial instruments. For instance, the Company has certain fee-generating
business lines
F-17
<PAGE> 76
MEGO FINANCIAL CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
For the years ended August 31, 1996, 1995, and 1994
(e.g., its loan servicing operations) that were not considered in these
estimates since these activities are not financial instruments. In addition, the
tax implications related to the realization of the unrealized gains and losses
can have a significant effect on fair value estimates and have not been
considered in any of the estimates.
6. CONCENTRATIONS OF RISK
Availability of Funding Sources -- The Company funds substantially all of
the notes receivable, timeshare inventory and land inventory which it originates
or purchases with borrowings through its financing facilities and internally
generated funds. These borrowings are in turn repaid with the proceeds received
by the Company from such notes receivable through loan sales, repayments, or
securitizations. Any failure to renew or obtain adequate financing under its
financing facilities, or other borrowings, or any substantial reduction in the
size of or pricing in the markets for the Company's notes receivable, could have
a material adverse effect on the Company's operations. To the extent that the
Company is not successful in maintaining or replacing existing financings, it
would have to curtail its operations or sell assets, thereby having a material
adverse effect on the Company's results of operations and financial condition.
Dependence on Securitizations -- In 1996, the Company pooled and sold
through securitizations an increasing percentage of the loans that it
originated. The Company derives a significant portion of its income by
recognizing gains on sale of loans through securitizations which are due in part
to the fair value, recorded at the time of sale, of residual interests and
interest only securities retained. Adverse changes in the securitization market
could impair the Company's ability to sell loans through securitizations on a
favorable or timely basis. Any such impairment could have a material adverse
effect upon the Company's results of operations and financial condition.
The Company has relied on credit enhancement and over-collateralization to
achieve the "AAA/Aaa" rating for the senior interests in its securitizations.
The credit enhancement has generally been in the form of an insurance policy
issued by an insurance company insuring the timely repayment of senior interests
in each of the REMIC trusts. There can be no assurance that the Company will be
able to obtain credit enhancement in any form from the current insurer or any
other provider of credit enhancement on acceptable terms or that future
securitizations will be similarly rated. A downgrading of the insurer's credit
rating or its withdrawal of credit enhancement could have a material adverse
effect on the Company's results of operations and financial condition.
Geographic Concentrations -- The Company services notes receivable in all
50 states, the District of Columbia and Canada. At August 31, 1996, 33% of the
dollar value of notes receivable serviced had been originated in California, and
9% in Florida. No other state accounted for more than 10% of the servicing
portfolio. The risk inherent in such concentrations is dependent upon regional
and general economic stability which affects property values and the financial
stability of the borrowers. The Company's timeshare and land inventories are
concentrated in Nevada, New Jersey, Colorado, and Florida. The risk inherent in
such concentrations is in the continued popularity of these resort destinations,
which affects the marketability of the Company's products.
Credit Risk -- The Company is exposed to on-balance sheet credit risk
related to its notes receivable and mortgage related securities. The Company is
exposed to off-balance sheet credit risk related to loans which the Company has
committed to originate and loans sold under recourse provisions. The outstanding
balance of loans sold with recourse provisions totaled $134,084,000 and
$117,469,000 at August 31, 1996 and 1995, respectively.
Off-Balance Sheet Activities -- These financial instruments consist of
commitments to extend credit to borrowers and commitments to purchase loans from
others. As of August 31, 1996 and 1995, the Company had outstanding commitments
to extend credit or purchase loans in the amounts of $59,597,000 and
F-18
<PAGE> 77
MEGO FINANCIAL CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
For the years ended August 31, 1996, 1995, and 1994
$53,447,000, respectively. These commitments do not represent the expected total
cash outlay of the Company, as historically only 40% of these commitments result
in loan originations or purchases. The prospective borrower or seller is under
no obligation as a result of the Company's commitment. The Company's credit and
interest rate risk is therefore limited to those commitments which result in
note originations and purchases. The commitments are made for a specified fixed
rate of interest, therefore the Company is exposed to interest rate risk, to the
extent changes in market interest rates change prior to the origination and
prior to the sale of the loans.
Interest Rate Risk -- The Company's profitability is in part determined by
the difference, or "spread," between the effective rate of interest received on
the loans originated or purchased by the Company and the interest rates payable
under its financing facilities to fund the Company's notes receivable and
inventory held for sale and the yield required by investors on notes receivable
sales and loan securitizations. The spread can be adversely affected after a
note is originated or purchased and while it is held during the warehousing
period by increases in the interest rate demanded by investors in
securitizations or sales. In addition, because the notes originated and
purchased by the Company have fixed rates, the Company bears the risk of
narrowing spreads because of interest rate increases during the period from the
date the notes are originated or purchased until the closing of the sale or
securitization of such notes. Additionally, the fair value of mortgage related
securities, mortgage servicing rights and excess servicing rights owned by the
Company may be adversely affected by changes in the interest rate environment
which could affect the discount rate and prepayment assumptions used to value
the assets. Any such adverse change in assumptions could have a material adverse
effect on the Company's results of operations and financial condition.
7. NOTES RECEIVABLE
Notes receivable consist of the following (thousands of dollars):
<TABLE>
<CAPTION>
AUGUST 31,
-------------------
1996 1995
------- -------
<S> <C> <C>
Related to timeshare sales............................... $24,973 $20,661
Related to land sales.................................... 27,601 23,509
Related to Title I and conventional home improvement
loans.................................................. 4,705 3,750
------- -------
Total.......................................... 57,279 47,920
------- -------
Less: Allowances for cancellation and credit losses...... 11,607 11,969
Valuation discount..................................... 452 343
------- -------
12,059 12,312
------- -------
Total.......................................... $45,220 $35,608
======= =======
</TABLE>
The Company provides financing to the purchasers of its timeshare interests
and lands. This financing is generally evidenced by notes secured by deeds of
trust as well as non-recourse installment sales contracts. These notes
receivable are generally payable over a period of up to 10 years, bear interest
at rates ranging from 0% to 16% and require equal monthly installments of
principal and interest.
The Company has entered into financing arrangements with certain purchasers
of timeshare interests and lands whereby no stated interest rate is charged if
the aggregate down payment is at least 50% of the purchase price and the balance
is payable in 24 or fewer monthly payments. Notes receivable of $5,991,000 and
$6,855,000 at August 31, 1996 and 1995, respectively, made under this
arrangement are included in the table above. A valuation discount is established
to provide for an effective interest rate (currently 10%) on notes receivable
bearing no stated interest rate at the time of sale, and is applied to the
principal balance and amortized over the term of note. The effective interest
rate is based upon the economic interest rate environment and similar industry
data.
F-19
<PAGE> 78
MEGO FINANCIAL CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
For the years ended August 31, 1996, 1995, and 1994
The Company is obligated under certain agreements for the sale of notes
receivable and certain loan agreements to maintain various minimum net worth
requirements. The most restrictive of these agreements requires PEC to maintain
a minimum net worth of $25,000,000 and MMC to maintain a minimum tangible net
worth requirement of $12,500,000 plus 50% of MMC's cumulative net income since
May 1, 1996. (50% of MMC's cumulative net income for the period May 1, 1996 to
August 31, 1996 was $1.1 million.) Additionally, MMC is required to maintain a
minimum level of profitability of at least $500,000 per rolling 6 month period.
At August 31, 1996 and 1995, receivables aggregating $54,247,000 and
$41,299,000, respectively, were pledged to lenders to collateralize certain of
the Company's indebtedness. Receivables which qualify for the lenders' criteria
may be pledged as collateral whether or not such receivables have been
recognized for accounting purposes. See Note 15 for further discussion.
Allowance for Cancellation and Credit Losses -- The Company provides an
allowance for cancellation and credit losses, in an amount which in the
Company's judgment will be adequate to absorb losses on notes receivable and
after FHA insurance recoveries on the loans, that may become uncollectible. The
Company's judgment in determining the adequacy of this allowance is based on its
continual review of its portfolio which utilizes historical experience and
current economic factors. These reviews take into consideration changes in the
nature and level of the portfolio, historical rates, collateral values, and
current and future economic conditions which may affect the obligors' ability to
pay, collateral values and overall portfolio quality. Changes in the allowance
for cancellation and credit losses for notes receivable consist of the following
(thousands of dollars):
<TABLE>
<CAPTION>
YEAR ENDED AUGUST 31,
-------------------------------
1996 1995 1994
------- ------- -------
<S> <C> <C> <C>
Balance at beginning of year.................................. $19,999 $16,971 $17,744
Provisions for credit losses and cancellations................ 11,288 10,359 7,775
Amounts charged to allowance for cancellations................ (8,893) (7,331) (8,548)
Reductions due to reacquisitions and securitizations.......... (1,455) -- --
------- ------- -------
Balance at end of year.............................. $20,939 $19,999 $16,971
======= ======= =======
Allowance for cancellation and credit losses.................. $11,607 $11,969 $13,281
Future estimated contingency for notes receivable sold with
recourse.................................................... 9,332 8,030 3,690
------- ------- -------
Total............................................... $20,939 $19,999 $16,971
======= ======= =======
</TABLE>
During 1996, $113.9 million of notes receivable sold with recourse were
repurchased and securitized as further described in Note 4. Reductions due to
reacquisition and securitization represent the allowance for credit losses on
notes receivable sold with recourse transferred to the cost basis of the
mortgage related securities as a result of these transactions.
Number of Notes Receivable Accounts Serviced -- The number of notes
receivable accounts serviced at August 31, 1996 and 1995, was approximately
32,602 and 21,901, respectively. At August 31, 1996 and 1995, the amount of
notes receivable with payment delinquencies of 90 days or more was approximately
$14,561,000 and $5,254,000, respectively on serviced accounts.
F-20
<PAGE> 79
MEGO FINANCIAL CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
For the years ended August 31, 1996, 1995, and 1994
Loans serviced and originated consist of the following (thousands of
dollars):
<TABLE>
<CAPTION>
YEAR ENDED AUGUST 31,
---------------------
1996 1995
-------- --------
<S> <C> <C>
Loans originated:
Amount of Title I Loan originations.......... $127,785 $ 87,751
Amount of conventional loan originations..... 11,582 --
Notes receivable additions................... 51,535 45,396
-------- --------
Total................................ $190,902 $133,147
======== ========
Loans serviced (including notes securitized,
notes sold to investors and notes receivable
held for sale):
Title I Loans................................ $202,766 $ 92,286
Conventional loans........................... 11,423 --
Timeshare and land........................... 120,709 114,333
-------- --------
Total................................ $334,898 $206,619
======== ========
</TABLE>
8. MORTGAGE RELATED SECURITIES
Mortgage related securities consist of interest only strips and residual
interest certificates of FHA Title I Loan asset-backed securities collateralized
by loans originated, purchased and serviced by the Company.
Mortgage related securities are classified as trading securities and are
recorded at estimated fair value. Changes in the estimated fair value are
recorded in current operations. As of August 31, 1996 mortgage related
securities consist of the following (thousands of dollars):
<TABLE>
<S> <C>
Interest only securities................................... $ 4,602
Residual interest securities............................... 18,342
-------
Total............................................ $22,944
=======
</TABLE>
No mortgage related securities were owned during 1995.
Activity in mortgage related securities consist of the following for the
year ended August 31, 1996 (thousands of dollars):
<TABLE>
<S> <C>
Balance at beginning of year............................... $ --
Additions due to securitizations, at cost.................. 20,096
Net unrealized gain........................................ 2,697
Accretion of residual interest............................. 243
Principal reductions....................................... (92)
-------
Total............................................ $22,944
=======
</TABLE>
F-21
<PAGE> 80
MEGO FINANCIAL CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
For the years ended August 31, 1996, 1995, and 1994
9. EXCESS SERVICING RIGHTS
Activity in excess servicing rights consist of the following (thousands of
dollars):
<TABLE>
<CAPTION>
YEAR ENDED AUGUST 31,
--------------------------------
1996 1995 1994
-------- -------- ------
<S> <C> <C> <C>
Balance at beginning of year................. $ 16,565 $ 2,146 $ 902
Plus: Additions.............................. 21,242 15,336 1,611
Less: Amortization........................... (2,758) (917) (367)
Amounts related to loans repurchased,
securitized and transferred to mortgage
related securities......................... (20,781) -- --
-------- ------- ------
Balance at end of year............. $ 14,268 $ 16,565 $2,146
======== ======= ======
</TABLE>
As of August 31, 1996, 1995 and 1994, excess servicing rights consisted of
excess cash flows on serviced loans totaling $140,780,000, $133,284,000 and
$37,758,000, yielding weighted-average interest rates of 12.6%, 12.9% and 12.1%,
net of normal servicing and pass-through fees and weighted-average pass-through
yields to the investor of 8.6%, 8.7% and 9.2%, respectively. These loans were
sold under recourse provisions as described in Note 4 of Notes to Consolidated
Financial Statements.
During 1996, $113,917,000 of loans sold were repurchased and securitized as
further described in Note 4. Excess servicing rights related to the loans
repurchased and securitized of $20,781,000 were transferred to the cost basis of
the mortgage related securities as a result of these transactions.
Of the Title I Loans sold in the year ended August 31, 1995, $56,922,000 of
such loans were sold to a purchaser, in a series of sales commencing on April
21, 1995, under a continuing sales agreement which provides for the yield to the
purchaser to be adjusted monthly to a rate equal to 200 basis points (2%) per
annum over the one-month London Interbank Offered Rate (LIBOR). LIBOR was 5.875%
per annum at August 31, 1995. The principal balance of loans subject to the
LIBOR adjustment was $29,255,000 at August 31, 1996. The effect of an increase
or decrease in LIBOR of 100 basis points (1%) applied to those loans would be a
decrease or increase, respectively, to the Company's future pre-tax income of
approximately $956,000. For timeshare and land loans during fiscal 1996,
$12,329,000 of the total loans sold were sold to one purchaser, in a series of
sales, providing a yield to the purchaser at fixed rates, ranging from
8.3%-9.4%. Of the notes receivable sold during fiscal 1995, $17,296,000 of such
loans were sold to the same purchaser in a series of sales providing a yield to
the purchaser at fixed rates ranging from 8.8%-10%.
10. MORTGAGE SERVICING RIGHTS
Activity in mortgage servicing rights consist of the following (thousands
of dollars):
<TABLE>
<CAPTION>
YEAR ENDED AUGUST 31,
----------------------------
1996 1995 1994
------ ------ ------
<S> <C> <C> <C>
Balance at beginning of year..................... $1,076 $ -- $ --
Plus: Additions.................................. 3,306 1,176 --
Less: Amortization............................... (555) (100) --
------ ------ ------
Balance at end of year................. $3,827 $1,076 $ --
====== ====== ======
</TABLE>
The Company had no valuation allowance for mortgage servicing rights during
1996, 1995, and 1994, as the cost basis of mortgage servicing rights
approximated fair value.
The pooling and servicing agreements relating to the securitization
transactions contain provisions with respect to the maximum permitted loan
delinquency rates and loan default rates, which, if exceeded, would
F-22
<PAGE> 81
MEGO FINANCIAL CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
For the years ended August 31, 1996, 1995, and 1994
allow the termination of the Company's rights to service the related loans. At
September 30, 1996, the default rates on one pooling and servicing agreement
exceeded the permitted level. The mortgage servicing rights for this agreement
were approximately $1.4 million at August 31, 1996. In the event of such
termination, there would be an adverse effect on the valuation of the Company's
mortgage servicing rights.
11. INVENTORIES
Timeshare interests held for sale consist of the following (thousands of
dollars):
<TABLE>
<CAPTION>
AUGUST 31,
-------------------
1996 1995
------- -------
<S> <C> <C>
Timeshare interests (including capitalized interest
of $486 and $190 in 1996 and 1995, respectively)... $14,353 $ 9,689
Timeshare interests under construction (including
capitalized interest of $389 and $291 in 1996 and
1995, respectively)................................ 19,338 7,687
------- -------
Total...................................... $33,691 $17,376
======= =======
</TABLE>
At August 31, 1996 and 1995, 7,637 and 6,328 of timeshare interests,
respectively, were available for sale. The number of apartment units of 254 and
90 at August 31, 1996 and 1995, respectively, were under construction and
awaiting completion of remodeling, renovation, furnishing, conversion and
registration, representing 12,954 and 4,590, respectively, of timeshare
interests.
Land and improvements inventory consist of $2.2 million at August 31, 1996
and $3.4 million at August 31, 1995.
12. OTHER INVESTMENTS
Other investments in the following locations, at lower of cost or market,
consist of the following (thousands of dollars):
<TABLE>
<CAPTION>
AUGUST 31,
-------------------
1996 1995
------- -------
<S> <C> <C>
Water rights:
Herfano County, Colorado........................... $ 524 $ 581
Nye County, Nevada................................. 98 95
Land:
Nye County, Nevada................................. 863 525
Park County, Colorado.............................. 13 9
Clark County, Nevada................................. 51 84
Other................................................ 423 237
------- -------
Total...................................... $ 1,972 $ 1,531
======= =======
</TABLE>
F-23
<PAGE> 82
MEGO FINANCIAL CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
For the years ended August 31, 1996, 1995, and 1994
13. PROPERTY AND EQUIPMENT
Property and equipment and related accumulated depreciation, consist of the
following (thousands of dollars):
<TABLE>
<CAPTION>
AUGUST 31,
-------------------
1996 1995
------- -------
<S> <C> <C>
Water and sewer system............................... $13,752 $10,645
Furniture and equipment.............................. 6,422 4,843
Buildings............................................ 8,451 4,792
Vehicles............................................. 2,304 2,173
Recreational facilities and equipment................ 1,192 1,082
Land................................................. 1,342 689
Leasehold improvements............................... 349 305
------- -------
33,812 24,529
Less: Accumulated depreciation....................... 13,550 11,848
------- -------
Total property and equipment, net.................... $20,262 $12,681
======= =======
</TABLE>
14. OTHER ASSETS
Other assets consist of the following (thousands of dollars):
<TABLE>
<CAPTION>
AUGUST 31,
-------------------
1996 1995
------- -------
<S> <C> <C>
Other receivables.................................... $ 2,161 $ 1,251
Miscellaneous assets................................. 1,784 1,255
Deposits and impounds................................ 560 448
Licenses............................................. 1,067 1,167
Other receivables collateralized by trust deeds...... 222 235
Receivable from owners' associations (Notes 4 and
22)................................................ 623 1,188
Organizational costs of MMC.......................... 482 675
Prepaid expenses and other........................... 1,586 1,132
------- -------
Total...................................... $ 8,485 $ 7,351
======= =======
</TABLE>
15. NOTES AND CONTRACTS PAYABLE
The Company's debt including lines of credit consist of the following
(thousands of dollars):
<TABLE>
<CAPTION>
AUGUST 31,
-------------------
1996 1995
------- -------
<S> <C> <C>
Notes collateralized by receivables (a).............. $41,568 $26,785
Mortgages collateralized by real estate properties
(b)................................................ 31,078 16,525
Notes collateralized by excess servicing rights and
mortgage related securities (c).................... 10,000 --
Installment contracts and other notes payable........ 1,803 1,405
------- -------
Total...................................... $84,449 $44,715
======= =======
</TABLE>
F-24
<PAGE> 83
MEGO FINANCIAL CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
For the years ended August 31, 1996, 1995, and 1994
The details of the notes payable are summarized as follows (thousands of
dollars):
<TABLE>
<CAPTION>
AUGUST 31,
-------------------
1996 1995
------- -------
<S> <C> <C>
(A) NOTES COLLATERALIZED BY RECEIVABLES
Borrowings bearing interest at prime plus: 1% to 2.5% in 1996
including "lines of credit" (see below) and 1% to 2.5% in 1995..... $41,443 $26,595
Promissory notes payable............................................ 125 190
------- -------
Total notes collateralized by receivables...................... $41,568 $26,785
======= =======
(B) MORTGAGES COLLATERALIZED BY REAL ESTATE PROPERTIES
Mortgages collateralized by the respective underlying assets with
various repayment terms and fixed interest rates of 10% to 12.5% in
1996 and 10% in 1995 and variable rates of prime plus: 1.25% to 3%
and 90 day LIBOR plus 4.25% in 1996 and prime plus: 2.5% in 1995... $31,078 $16,525
======= =======
(C) NOTES COLLATERALIZED BY EXCESS SERVICING RIGHTS (NOTE 8) AND MORTGAGE
RELATED SECURITIES (NOTES 7 AND 9)................................... $10,000 $ --
======= =======
</TABLE>
The prime rate of interest was 8.25% and the 90 day LIBOR was 5.53% at
August 31, 1996.
Maturities -- Scheduled maturities of the Company's contracts payable,
excluding lines of credit are as follows (thousands of dollars):
<TABLE>
<CAPTION>
BALANCE 1997 1998 1999 2000 2001
----------- ----------- ----------- ----------- ----------- -----------
<S> <C> <C> <C> <C> <C>
$1,803 $721 $605 $293 $179 $5
</TABLE>
Lines of Credit -- PEC entered into 5 agreements for lines of credit not to
exceed $109,500,000 which are collateralized by security interests in timeshare
and land receivables and are guaranteed by the Company. At August 31, 1996 and
1995, an aggregate of $65,875,000 and $38,123,000 had been borrowed under such
lines of credit. Under the terms of such lines of credit, PEC may borrow up to
75% to 85% of the balances of the pledged timeshare and land receivables. MMC
entered into 2 lines of credit agreements with the same lender, not to exceed an
aggregate of $30,000,000, one of which is collateralized by security interests
in loans held for sale, and the other by excess servicing rights and mortgage
related securities.
Summarized line of credit information relating to these five lines of
credit outstanding at August 31, 1996, consist of the following (thousands of
dollars):
<TABLE>
<CAPTION>
BORROWING
AMOUNT AT
AUGUST MAXIMUM
31, BORROWING REVOLVING MATURITY INTEREST
1996 AMOUNT EXPIRATION DATE(F) DATE RATE
- --------- ------- ------------------------- ------------------ -------------
<C> <C> <S> <C> <C>
$47,297 $57,000 (a)December 31, 1996 September 22, 2003 Prime + 2.25%
7,821 15,000 (b)December 31, 1996 August 1, 2000 Prime + 2.5%
4,865 15,000 (c)June 27, 1998 June 27, 2005 LIBOR + 4.25%
2,925 15,000 (c)February 6, 1998 August 6, 2005 LIBOR + 4.25%
2,967 7,500 (b)December 31, 1996 June 30, 2000 Prime + 2.5%
3,265 20,000 (d)August 9, 1997 August 9, 1997 Prime + 1.0%
10,000 10,000 (d)(e)December 31, 1997 June 30, 2000 Prime + 2.0%
</TABLE>
- ---------------
(a) Restrictions include the Company's requirement to maintain a tangible net
worth in PEC of at least $25,000,000 during the borrowing term, and
thereafter this requirement is permitted to decrease to $15,000,000
depending on the loan balance.
F-25
<PAGE> 84
MEGO FINANCIAL CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
For the years ended August 31, 1996, 1995, and 1994
(b) Restrictions include the Company's requirement to maintain a tangible net
worth in PEC of $25,000,000 during the life of the loan.
(c) Restrictions include the Company's requirement to maintain a tangible net
worth in PEC of $17,000,000 during the life of the loan.
(d) Restrictions include the Company's requirement to maintain MMC's tangible
net worth at $12,500,000 plus 50% of MMC's cumulative net income since May
1, 1996. (50% of MMC's cumulative net income for the period May 1, 1996 to
August 31, 1996 was $1.1 million). Additionally, MMC is required to maintain
a minimum level of profitability of at least $500,000 per rolling 6 month
period.
(e) Borrowings by MMC under this facility cannot exceed the lesser of (a) 40% of
MMC's excess servicing rights and mortgage related securities or (b) six
times the aggregate of the excess servicing rights and mortgage related
securities payments actually received by the Company over the most recent 3
month period.
(f) Revolving expiration date represents the expiration dates of the revolving
features of the lines of credit, at which time the credit lines assume fixed
maturity.
At August 31, 1996 and 1995, contracts payable consisted of $932,000 and
$419,000, respectively, in obligations under lease purchase arrangements secured
by property and equipment, bearing a weighted-average interest rate of 9.48%.
16. SUBORDINATED DEBT
On March 2, 1995, Mego entered into the Amendment whereby the Assignors
agreed to defer payment of $10 million of the amount payable to assignors and to
subordinate such amounts in right of payment to debt for money borrowed by Mego
or obligations of subsidiaries guaranteed by Mego. Warrants for 1,000,000 shares
of Mego Common Stock, at an exercise price of $4.25 per share (the closing
market price per share on March 2, 1995) were granted to the Assignors in
consideration of the payment deferral and subordination. The warrants contain
restrictions on transfer and are exercisable after March 1, 1996 and until March
1, 2000. The Amendment calls for interest to be paid semi-annually at the rate
of 10% per annum starting September 1, 1995, and seven equal semi-annual
payments of $1,429,000 plus interest, commencing March 1, 1997. The effective
interest rate after considering the effect of accreted interest is 14.7%. See
Note 2 for further discussion. The following table represents subordinated debt
activity since inception (thousands of dollars):
<TABLE>
<CAPTION>
1996 1995
------- -------
<S> <C> <C>
Face amount of debt....................................... $10,000 $10,000
Less: Value of warrants issued............................ (1,300) (1,300)
------- -------
Subordinated debt -- original value....................... 8,700 8,700
Accreted interest since inception......................... 1,991 652
Less: Interest payments since inception................... (1,000) --
------- -------
Subordinated debt at August 31............................ $ 9,691 $ 9,352
======= =======
</TABLE>
The carrying value of subordinated debt approximated fair value at August
31, 1996 and 1995. See Note 5 of Notes to Consolidated Financial Statements.
17. REDEEMABLE PREFERRED STOCK
The Company had designated 300,000 shares of its 5,000,000 authorized
preferred shares as Series A, 12% Cumulative Preferred Stock, par value, $.01
per share. The remaining 4,700,000 authorized preferred
F-26
<PAGE> 85
MEGO FINANCIAL CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
For the years ended August 31, 1996, 1995, and 1994
shares have not been designated. As of August 31, 1993, the Company sold 300,000
shares of its Series A, 12% Cumulative Preferred Stock (Preferred Stock), at a
price of $10 per share. The Preferred Stock was stated at its par value of $.01
per share, and redemption value of $10 per share. The Company was obligated to
redeem 100,000 shares of Preferred Stock on August 31, 1995, at $10 per share.
In August 1995, the Company gave notice of redemption of 100,000 shares. On
September 1, 1995, after receipt of the certificates, the Company redeemed
100,000 shares of its Preferred Stock. On August 31, 1996, the holder of the
Company's 200,000 shares of outstanding 12% cumulative preferred stock with a
redemption price of $2,000,000 redeemed their shares for 343,347 shares of the
Company's common stock. The number of common shares exchanged was based upon the
10 day average closing stock price of $5.825 for the Company's common stock
immediately prior to August 31, 1996. In conjunction with the exchange, the
expiration date of the warrants outstanding to purchase 300,000 shares of the
Company's common stock at a price of $1.20, issued in conjunction with the
preferred stock, and due to expire on August 31, 1996 was extended to August 31,
1997.
18. STOCKHOLDERS' EQUITY
The Company has a stock option plan, adopted November 1993, for officers
and key employees which provides for non-qualified and qualified incentive
options. The Stock Option Committee of the Board of Directors determines the
option price (not to be less than fair market value for qualified incentive
options) at the date of grant. The options generally expire ten years from the
date of grant and are exercisable over the period stated in each option at the
cumulative rate of 20% per year commencing December 22, 1994, for three years
and the remaining 40% after December 22, 1997.
<TABLE>
<CAPTION>
RESERVE SHARES NUMBER PRICE PER SHARE
-------------- ------- ---------------
<S> <C> <C> <C>
At November 17, 1993................... 525,000 -- --
Granted to more than 10% stockholder... -- 35,000 $ 2.75
Granted to others...................... -- 355,000 $ 2.50
------ -------
At August 31, 1994..................... 525,000 390,000 $ 2.50/2.75
Exercised.............................. (2,000) (2,000)
Forfeited.............................. -- (8,000)
Granted................................ -- 85,000 $ 8.00/8.75
------ -------
At August 31, 1995..................... 523,000 465,000
Exercised.............................. (4,000) (4,000)
Forfeited.............................. -- (6,000)
Granted................................ -- 25,000 $ 5.875
------ -------
At August 31, 1996..................... 519,000 480,000 $ 2.50/8.75
====== =======
</TABLE>
The number of options exercisable under this plan at August 31, 1996, was
170,000 at a range of $2.50 to $8.75 per share.
F-27
<PAGE> 86
MEGO FINANCIAL CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
For the years ended August 31, 1996, 1995, and 1994
19. TIMESHARE INTEREST SALES AND LAND SALES
Timeshare interest sales, net -- A summary of the components of timeshare
interest sales is as follows (thousands of dollars):
<TABLE>
<CAPTION>
YEAR ENDED AUGUST 31,
-------------------------------
1996 1995 1994
------- ------- -------
<S> <C> <C> <C>
Timeshare interest sales....................... $33,178 $26,272 $24,670
Less: Provision for cancellation............... (5,400) (5,590) (5,149)
------- ------- -------
Total................................ $27,778 $20,682 $19,521
======= ======= =======
</TABLE>
Land sales, net -- A summary of the components of land sales is as follows
(thousands of dollars):
<TABLE>
<CAPTION>
YEAR ENDED AUGUST 31,
-------------------------------
1996 1995 1994
------- ------- -------
<S> <C> <C> <C>
Land sales.................................... $22,346 $24,717 $15,434
Less: Provision for cancellation.............. (4,378) (3,905) (1,900)
------- ------- -------
Total............................... $17,968 $20,812 $13,534
======= ======= =======
</TABLE>
20. INCOME TAXES
The Company files a consolidated federal income tax return with its
subsidiaries for its tax year which ends the last day of February.
The Company adopted SFAS 109 effective September 1, 1992. There was no
cumulative effect of adopting SFAS 109 on the Company's financial statements.
The estimated income tax payable as of August 31, 1996, is approximately
$1,344,000. The tax provision for 1996 consists of $290,000 current provision
and $2,877,000 deferred provision. The tax provision for 1995 consists of
$1,054,000 current provision, including the $450,000 of tax associated with
discontinued operations, and $2,689,000 deferred provision. The provision for
1994 consisted entirely of deferred provision.
Deferred income taxes reflect the net tax effects of (a) temporary
differences between the carrying amount of assets and liabilities for financial
reporting purposes and the amounts used for income tax purposes, (b) temporary
differences between the timing of revenue recognition for book purposes and for
income tax purposes, and (c) operating loss and tax credit carryforwards. The
tax effects of significant items comprising the Company's net deferred tax
liability as of August 31, 1996 and 1995 are as follows (thousands of dollars):
<TABLE>
<CAPTION>
AUGUST 31,
------------------
1996 1995
------- ------
<S> <C> <C>
Deferred tax liabilities:
Difference between book and tax carrying value of
assets............................................... $ 3,064 $3,508
Timing of revenue recognition........................... 8,348 4,606
------- -------
11,412 8,114
------- -------
Deferred tax assets:
Other................................................... 432 11
------- -------
Net deferred tax liability...................... $10,980 $8,103
======= =======
</TABLE>
F-28
<PAGE> 87
MEGO FINANCIAL CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
For the years ended August 31, 1996, 1995, and 1994
The provision for taxes as reported is different from the tax provision
computed by applying the statutory federal rate of 34%. The differences are as
follows (thousands of dollars):
<TABLE>
<S> <C> <C> <C>
Income (loss) before income taxes, including
gain on discontinued operations............... $8,018 $4,187 $(5,013)
====== ====== =======
Tax at the statutory federal rate............... $2,726 $1,424 $(1,704)
Increase (decrease) in taxes resulting from:
State income taxes, net of federal income tax
benefit....................................... 442 264 --
Payments to assignors........................... -- 813 2,218
Realization of purchase price adjustments..... -- 70 217
Amortization of negative goodwill.......... -- -- 17
Contributions in aid of construction....... 81 929 114
Preferred stock dividends.................. (82) (122) (122)
Other...................................... -- (85) 21
------ ------ -------
Total........................................... $3,167 $3,293 $ 761
====== ====== =======
</TABLE>
21. DISCONTINUED OPERATIONS
Gain on discontinued operations occurred as a result of an order for
judgment against PEC in the matter of the PEC Apartment Subsidiaries in the
amount of $3,356,000, which amount was settled for $2,900,000 on May 15, 1995,
and paid on June 15, 1995. Excess of liability over assets of discontinued
operations (a provision for loss) had been provided in the amount of $4,222,000
resulting in a gain on discontinued operations of $873,000 after deducting
$450,000 of taxes to be reflected on the income statement. See Note 23 for
further discussion.
22. RELATED PARTY TRANSACTIONS
Timeshare Owners' Associations -- Owners' Associations have been
incorporated for the Grand Flamingo, Reno Spa, Brigantine and Steamboat Springs
timesharing resorts. The respective Owners' Associations are independent
notfor-profit corporations. PEC acts as the managing agent for these Owners'
Associations and the White Sands Resort Club, which is a division of PEC
(Associations) and received management fees for its services of $2,081,000 and
$1,988,000 in 1996 and 1995, respectively. Such fees were recorded in other
revenue. The expenses of PEC for management of each timeshare resort are
incurred to preserve the integrity of the property and the portfolio performance
on an on-going basis beyond the end of the sales period. PEC does not manage
resorts of other developers and would not collect management fees or incur
expenses were it not part of the total timeshare sale package and support of the
portfolio. The owners of timeshare interests in each Association are responsible
for payment to the Associations of assessments, which are intended to fund all
of the operating expenses at each of the resort facilities. The Company's share
of the Association assessments, net of room income, was $983,000 and $56,000 for
1996 and 1995, respectively, and have been recorded as general and
administrative expense. This increase was primarily due to the newer resorts
recording a full year's operations in fiscal 1996 versus a partial year in
fiscal 1995. The Company has in the past financed budget deficits of the
Associations as is reflected in the receivable from such Associations, but is
not obligated to do so in the future.
Since January 1988, the Company has agreed to pay to the Associations the
assessments of timeshare interest owners who are delinquent with respect to
their assessments, but have paid the Company in full for their timeshare
interests. In exchange for these payments, the Associations assign their liens
for non-payment of assessments on the respective timeshare interests to the
Company. In the event the timeshare interest
F-29
<PAGE> 88
MEGO FINANCIAL CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
For the years ended August 31, 1996, 1995, and 1994
holder does not satisfy the lien after having an opportunity to do so, the
Company acquires the timeshare interest for the amount of the lien and any
foreclosure costs.
At August 31, 1996 and 1995, $623,000 and $1,188,000, respectively, was due
from Owners' Associations. These amounts are included in other assets at August
31, 1996 and 1995.
Payments to Assignors -- Certain transactions have been entered into with
the Assignors, who are affiliates of certain officers and directors of the
Company, and these transactions are more fully described in Note 2. During the
years ended August 31, 1996, 1995, and 1994, approximately $1,196,000,
$2,301,000, and $4,904,000, including interest of $1,196,000, $473,000 and
$304,000, respectively, were paid to the Assignors. See Note 16 for further
discussion.
Transactions with Management -- On September 24, 1990, Brigantine Preferred
Properties, Inc. (Properties), a Nevada Corporation that is a wholly-owned
subsidiary of the Company, entered into agreements with Brigantine Inn, Ltd., a
New Jersey Limited Partnership (Inn), and Brigantine Villas, L.P., a New Jersey
Limited Partnership (Villas), herein referred to as the Inn Agreement and the
Villas Agreement, respectively, for the acquisition of certain assets (primarily
inventory of timeshare interests and related assets) and the assumption of
certain liabilities of the Inn and Villas. Inn and Villas were in the business
of selling timeshare interests in two adjacent facilities located near Atlantic
City, New Jersey.
Goodwill of $1,837,000 associated with this transaction has been amortized
over a 3 year period ending September 30, 1993. At August 31, 1994, all of the
Company's obligations owed to the Inn and Villas had been paid in full.
During December 1992, Properties purchased approximately $6,025,000 of
timeshare receivables from Inn for a purchase price of approximately $3,524,000.
The purchase price was financed through the sale by Properties of approximately
$3,720,000 of the acquired receivables to a financial institution. In connection
with the sale, the Company guaranteed the repurchase and other obligations of
Properties and agreed to maintain a net worth of at least $22,500,000. As
collateral for its obligations under the sale agreement, Properties also pledged
approximately $750,000 of the acquired timeshare receivables to the purchaser.
The amount of the collateral required under the sale agreement reduces by
approximately 20% per year. In connection with this transaction, Properties
recorded an allowance for cancellation and a future estimated contingency for
notes receivable sold with recourse aggregating approximately $2,000,000.
PEC provides account servicing for related and non-related entities which
consists of providing billing and collection services and receiving funds. The
Company also provides the same services for MMC. Deferred servicing revenues
arise from sales of receivables with the Company becoming the servicing agent
for the purchasers. At August 31, 1996 and 1995, the Company was servicing for
these entities and for its own receivables approximately 32,602 and 21,901
accounts, respectively.
23. COMMITMENTS AND CONTINGENCIES
Future Improvements -- Central Nevada Utilities Company, (CNUC) subsidiary,
has issued performance bonds of $13,556,000 outstanding at August 31, 1996, to
ensure the completion of water, sewer and other improvements in portions of the
Calvada development areas. The cost of the improvements will be offset by the
future receipt of betterment fees and connection fees.
F-30
<PAGE> 89
MEGO FINANCIAL CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
For the years ended August 31, 1996, 1995, and 1994
Leases -- The Company leases certain real estate for sales and general and
administrative usage. The Company also leases its Hawaii real estate for
timeshare usage. Rental expense for fiscal years 1996, 1995, and 1994 was
$2,731,000, $2,446,000, and $1,865,000, respectively. Future minimum rental
payments under operating leases are set forth below (thousands of dollars):
<TABLE>
<CAPTION>
YEAR ENDING AUGUST 31,
----------------------
<S> <C>
1997........... $ 1,941
1998........... 1,830
1999........... 1,331
2000........... 1,144
2001........... 1,154
Thereafter .... 2,639
------
Total....... $10,039
======
</TABLE>
Litigation -- In the matter of the PEC Apartment Subsidiaries litigation
previously reported upon, an order for judgment of $3,346,000 was rendered
against PEC on its limited guaranty, in connection with the defendants'
counterclaim. Pursuant to a stipulation between the parties dated as of May 15,
1995, PEC paid the amount of $2,900,000 on June 15, 1995 in full settlement of
this matter. Because the reserve recorded in the financial statements of the
Company exceeded the amount of the settlement, the Company recognized a gain on
discontinued operations of $1,323,000.
On July 5, 1995, Pahrump Valley Vineyards, Inc. filed a complaint in the
5th Judicial District Court, Nye County, Nevada, against CNUC, a subsidiary of
PEC. The plaintiff claimed compensatory damages in excess of $25,000 in each of
4 counts alleging trespass, nuisance, negligence and breach of contract for the
alleged supplying of contaminated water by CNUC to the plaintiff, and also
prayed for punitive damages in excess of $25,000. Following discovery, PEC's
insurance carrier settled the case by payment of $35,000 to the plaintiffs.
Following the Company's November 10, 1995 announcement disclosing certain
accounting adjustments, an action was filed on November 13, 1995, in the United
States District Court, District of Nevada by Christopher Dunleavy, as a
purported class action against the Company, certain of the Company's officers
and directors and the Company's independent auditors. The complaint alleges,
among other things, that the defendants violated Section 10(b) of the Securities
Exchange Act of 1934 and Rule 10b-5 thereunder in connection with the
preparation and issuance of certain of the Company's financial reports issued in
1994 and 1995, including certain financial statements reported on by the
Company's independent auditors. The complaint also alleges that one of the
director defendants violated the federal securities laws by engaging in "insider
trading." The named plaintiff seeks to represent a class consisting of
purchasers of the Company's Common Stock between January 14, 1994 and November
9, 1995, and seeks damages in an unspecified amount, costs, attorney's fees and
such other relief as the court may deem just and proper. The Company believes
that it has substantial defenses to the action and that the likelihood of a
material liability being incurred by the Company is remote.
On November 16, 1995, a second action was filed in the United States
District Court for the District of Nevada by Alan Peyser as a purported class
action against the Company and certain of its officers and directors, which was
served on the Company on December 20, 1995. The complaint alleges, among other
things, that the defendants violated the federal securities laws by making
statements and issuing certain financial reports in 1994 and 1995 that
overstated the Company's earnings and business prospects. The named plaintiff
seeks to represent a class consisting of purchasers of the Company's common
stock between November 28, 1994 and November 9, 1995. The complaint seeks
damages in an unspecified amount, cost, attorney's fees and such other relief as
the Court may deem just and proper. The Company believes that it has
F-31
<PAGE> 90
MEGO FINANCIAL CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
For the years ended August 31, 1996, 1995, and 1994
substantial defenses to the action and that the likelihood of a material
liability being incurred by the Company is remote.
On or about June 10, 1996, the Dunleavy Action and Peyser Action were
consolidated under the caption "In re Mego Financial Corp. Securities
Litigation," Master File No. CV-9-95-01082-LD (RLJ), pursuant to a stipulation
by the parties. On or about July 26, 1996, Michael Nadler filed a motion in the
above matter requesting that he be added as a class representative and that his
attorney be added as additional counsel for the class. On or about August 26,
1996, a Motion in Opposition to the motion to add a class representative was
filed by the Company and certain other defendants. Neither motion has been heard
or decided by the court. The Company cannot predict the outcome or estimated
loss with respect to this matter.
In the general course of business the Company, at various times, has been
named in other lawsuits. The Company believes that it has meritorious defenses
to these lawsuits and that resolution of these matters will not have a material
adverse affect on the financial condition or results of operations of the
Company.
Contingencies -- At August 31, 1996, irrevocable letters of credit in the
amount of $2,084,000 were issued and outstanding to secure certain obligations
of the Company. These letters are collateralized by notes receivable in the
amount of $2,497,000.
License Agreement -- In April 1995, PEC entered into a strategic alliance
pursuant to which PEC was granted a ten-year (including a renewal option)
exclusive license to operate both its existing and future timeshare properties
under the name "Ramada Vacation Suites". PEC has renamed its timeshare resorts.
The arrangement provides for the payment by PEC of an initial access fee of $1
million, which has been paid, and monthly recurring fees equal to 1% of PEC's
Gross Sales (as defined) each month through January 1996 and 1.5% of PEC's Gross
Sales each month commencing in February 1996. The initial term of the
arrangement is 5 years and PEC has the option to renew the arrangement for an
additional term of 5 years.
24. SUBSEQUENT EVENTS
In September 1996, MMC received a commitment from a financial institution
providing for the purchase of up to $2 billion of loans over a 5 year period.
Upon closing of the final agreement, the Company will issue to the financial
institution 4 year warrants to purchase 1,000,000 shares of the Company's common
stock at an exercise price of $7.125 per share. The value of the warrants,
estimated at $3,000,000 (0.15% of the commitment amount) as of the commitment
date, will be recorded as a commitment fee and charged to expense as the
commitment is utilized. The financial institution has also agreed to provide MMC
a separate one year facility of up to $11,000,000, less any amounts advanced
under a separate $3,000,000 repurchase agreement, for the financing of the
interest only and residual certificates from future securitizations.
In November 1996, MMC issued 2,300,000 shares of its common stock in a
public offering at $10.00 per share. As a result of this transaction, the
Company's ownership in MMC declined from 100% at August 31, 1996 to 81.3%. The
Company continues to have voting control on all matters submitted to
shareholders of MMC, including the election of directors and approval of
extraordinary corporate transactions. Concurrently with the common stock
offering, MMC issued $40 million of 12.5% Senior Subordinated Notes due in 2001
in a public offering. MMC currently intends to use approximately $13.2 million
of the aggregate net proceeds received from the offerings to repay amounts due
to Mego Financial Corp. and PEC and approximately $17 million to reduce the
amounts outstanding under MMC's warehouse and revolving lines of credit which
currently bear interest at rates ranging from 1% to 2% over the prime rate and
which expire in August 1997 and December 1997, respectively, and to repay $3
million under a repurchase agreement. Funds received by Mego Financial Corp. and
PEC will be used in their respective operations. The remaining net proceeds will
be used by MMC to provide capital to originate and securitize loans. Pending
such use, the net proceeds received by the Company will be invested in high
quality, short term interest-bearing investment and deposit accounts.
F-32
<PAGE> 91
MEGO FINANCIAL CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
For the years ended August 31, 1996, 1995, and 1994
25. SEGMENT DATA
The Company's general business is consumer lending, however, in compliance
with SFAS 14 "Financial Reporting for Segments of a Business Enterprise,"
segment data is presented for "Mortgage operations" and "Timeshare and land
operations". The mortgage operations business segment is comprised of Mego
Mortgage Corporation financial information and the timeshare and land operations
is comprised of Preferred Equities Corporation financial data. Corporate
represents Mego Financial, the parent only financial information. Other and
intersegment eliminations, net represents elimination and reclassification
entries for consolidation purposes. The segment data tables follow (thousands of
dollars) (1):
<TABLE>
<CAPTION>
YEAR ENDED AUGUST 31,
----------------------------------
1996 1995 1994
-------- -------- --------
<S> <C> <C> <C>
REVENUES(2):
Mortgage operations(3)................... $ 25,027 $ 13,579 $ 751
Timeshare and land operations............ 60,618 56,804 47,358
-------- -------- --------
Total business segments............... 85,645 70,383 48,109
Corporate................................ 34 191 514
Other and intersegment eliminations,
net................................... 1,116 986 253
-------- -------- --------
Total............................ $ 86,795 $ 71,560 $ 48,876
======== ======== ========
</TABLE>
<TABLE>
<CAPTION>
YEAR ENDED AUGUST 31,
----------------------------------
1996 1995 1994
-------- -------- --------
<S> <C> <C> <C>
INCOME (LOSS) FROM CONTINUING OPERATIONS
BEFORE INCOME TAXES(2):
Mortgage operations...................... $ 11,155 $ 5,919 $ (1,511)
Timeshare and land operations............ 1,337 8,306 5,551
-------- -------- --------
Total business segments............... 12,492 14,225 4,040
Corporate(4)............................. (4,474) (10,038) (9,053)
-------- -------- --------
Total............................ $ 8,018 $ 4,187 $ (5,013)
======== ======== ========
</TABLE>
<TABLE>
<CAPTION>
YEAR ENDED AUGUST 31,
----------------------------------
1996 1995 1994
-------- -------- --------
<S> <C> <C> <C>
ASSETS:
Mortgage operations...................... $ 50,606 $ 24,081 $ 5,122
Timeshare and land operations............ 122,970 94,820 87,732
-------- -------- --------
Total business segments............... 173,576 118,901 92,854
Corporate................................ 21,326 18,749 5,672
Other and intersegment eliminations,
net................................... (29,305)(5) (24,893)(6) (10,224)(7)
-------- -------- --------
Total............................ $165,597 $112,757 $ 88,302
======== ======== ========
</TABLE>
F-33
<PAGE> 92
MEGO FINANCIAL CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
For the years ended August 31, 1996, 1995, and 1994
<TABLE>
<CAPTION>
AUGUST 31,
----------------------------
1996 1995 1994
------ ------ ------
<S> <C> <C> <C>
CAPITAL EXPENDITURES:
Mortgage operations......................... $ 637 $ 274 $ 263
Timeshare and land operations............... 8,690 3,523 2,310
------ ------ ------
Total business segments.................. 9,327 3,797 2,573
Corporate................................... -- -- --
------ ------ ------
Total............................... $9,327 $3,797 $2,573
====== ====== ======
</TABLE>
<TABLE>
<CAPTION>
AUGUST 31,
----------------------------
1996 1995 1994
------ ------ ------
<S> <C> <C> <C>
DEPRECIATION EXPENSE:
Mortgage operations......................... $ 394 $ 403 $ 116
Timeshare and land operations............... 1,526 1,131 1,092
------ ------ ------
Total business segments.................. 1,920 1,534 1,208
Corporate................................... -- -- --
------ ------ ------
Total............................... $1,920 $1,534 $1,208
====== ====== ======
</TABLE>
- ---------------
(1) The fiscal three year segment financial data included herein is not
necessarily indicative of current or future operations of the Company.
(2) Included in MMC's net income from operations is $1,380, $922, and $455, of
loan servicing and management services fee expense paid to PEC, which is
included in PEC's revenues. There were no material corporate allocations
made.
(3) MMC commenced originating loans in March 1994.
(4) Includes payments to assignors of $0, $7,252, and $8,526 in 1996, 1995, and
1994, respectively. Includes $1,695 of interest expense related to the
parent in 1996 and includes $2,813, $2,977 and $1,041 of parent only general
and administrative expenses in 1996, 1995, and 1994, respectively.
(5) Includes income taxes due to parent, Mego Financial, of $11,994 from Mego
Mortgage; amount due to PEC from Mego Financial of $7,445, Mego Financial's
investment in Mego Mortgage and PEC of $8,700, $819 due to PEC from Mego
Mortgage for loan servicing and management services fees, and other
eliminations.
(6) Includes income taxes due to the parent, Mego Financial, of $8,452 from Mego
Mortgage; amount due to PEC from Mego Financial of $7,741 and Mego
Financial's investment in Mego Mortgage and PEC of $8,700.
(7) Includes amount due to PEC from Mego Financial of $4,194, Mego Financial's
investment in Mego Mortgage and PEC of $5,650, and other eliminations.
26. LAND SALES
The following table reflects the maturities of receivables from land sales
for each of the five years after August 31, 1996 (thousands of dollars):
<TABLE>
<CAPTION>
1997 1998 1999 2000 2001
---- ------ ---- ---- ----
<S> <C> <C> <C> <C> <C>
Land receivables maturities......................... $670 $1,332 $314 $506 $964
</TABLE>
The range of interest rates are from 0.0% to 14.5% and the weighted-average
interest rate at August 31, 1996 was 11.4%.
F-34
<PAGE> 93
MEGO FINANCIAL CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
For the years ended August 31, 1996, 1995, and 1994
The delinquency information related to land loans at August 31, 1996 is as
follows (dollars in thousands):
<TABLE>
<CAPTION>
PRINCIPAL BALANCE % OF LOANS SERVICED
----------------- -------------------
<S> <C> <C>
30-59 days..................... $ 1,762 1.5%
60-90 days..................... 510 0.4%
Over 90 days................... 2,110 1.8%
</TABLE>
The amount of recorded expenditures for improvements were $68,000 during
fiscal 1996, and the estimated total costs and expenditures for improvements on
these loans for the next five years are deemed immaterial for disclosure
purposes at August 31, 1996. The obligations for future improvements at August
31, 1996 was $27,000.
27. QUARTERLY FINANCIAL DATA
The following tables reflect consolidated quarterly financial data for Mego
Financial Corp. for the fiscal years ended August 31, 1996 and 1995 (dollars in
thousands, except per share amounts):
<TABLE>
<CAPTION>
THREE MONTHS ENDED
------------------------------------------------------------
AUGUST 31, MAY 31, FEBRUARY 29, NOVEMBER 30,
1996 1996 1996 1995
------------ ------------ ------------ ------------
<S> <C> <C> <C> <C>
REVENUES:
Net timeshare interest and land
sales................................ $ 10,345 $ 12,449 $ 11,159 $ 11,793
Gain on sale of receivables and
mortgage related securities.......... 7,139 3,387 4,884 6,397
Interest income........................ 3,071 2,436 1,561 1,630
Financial income and other............. 1,913 3,662 2,234 2,735
----------- ----------- ----------- -----------
Total revenues............... 22,468 21,934 19,838 22,555
----------- ----------- ----------- -----------
EXPENSES:
Direct costs of timeshare interest and
land sales........................... 1,499 1,447 1,387 1,509
Operating expenses..................... 16,613 17,005 14,569 14,641
Provision for credit losses............ 695 318 200 297
Interest............................... 2,585 3,088 1,286 1,638
----------- ----------- ----------- -----------
Total expenses............... 21,392 21,858 17,442 18,085
----------- ----------- ----------- -----------
Income before income taxes............. 1,076 76 2,396 4,470
Income tax expense (benefit)........... 807 (230) 918 1,672
----------- ----------- ----------- -----------
Net income............................. 269 306 1,478 2,798
Cumulative preferred stock
dividends(1)......................... 60 40 60 80
----------- ----------- ----------- -----------
Net income applicable to common
stock................................ $ 209 $ 266 $ 1,418 $ 2,718
=========== =========== =========== ===========
EARNINGS PER SHARE:
Primary................................ $ 0.01 $ 0.01 $ 0.08 $ 0.15
=========== =========== =========== ===========
Fully-diluted.......................... $ 0.01 $ 0.01 $ 0.07 $ 0.14
=========== =========== =========== ===========
WEIGHTED-AVERAGE NUMBER OF SHARES
OUTSTANDING:
Primary................................ 18,587,472 18,087,556 18,087,556 18,087,556
=========== =========== =========== ===========
Fully-diluted.......................... 19,286,027 19,484,667 19,463,556 19,463,556
=========== =========== =========== ===========
</TABLE>
F-35
<PAGE> 94
MEGO FINANCIAL CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
For the years ended August 31, 1996, 1995, and 1994
<TABLE>
<CAPTION>
THREE MONTHS ENDED
-------------------------------------------------------------
AUGUST 31, MAY 31, FEBRUARY 28, NOVEMBER 30,
1995 1995 1995 1994
----------- ----------- ------------ ------------
<S> <C> <C> <C> <C>
REVENUES:
Net timeshare interest and land
sales............................ $ 8,497 $ 13,876 $ 8,073 $ 11,048
Gain on sale of receivables and
mortgage related securities...... 6,782 4,221 1,445 1,371
Interest income.................... 2,162 2,350 1,748 1,919
Financial income and other......... 2,714 2,160 1,593 1,601
----------- ----------- ----------- -----------
Total revenues........... 20,155 22,607 12,859 15,939
----------- ----------- ----------- -----------
EXPENSES:
Direct costs of timeshare interest
and land sales................... 1,244 1,540 1,009 1,348
Operating expenses................. 12,721 14,939 14,031 12,716
Provision for credit losses........ 306 312 139 107
Interest........................... 2,529 1,755 1,466 1,211
----------- ----------- ----------- -----------
Total expenses........... 16,800 18,546 16,645 15,382
----------- ----------- ----------- -----------
Income (loss) before income
taxes............................ 3,355 4,061 (3,786) 557
Income taxes....................... 696 1,189 356 1,052
----------- ----------- ----------- -----------
Net income (loss) from continuing
operations....................... 2,659 2,872 (4,142) (495)
Gain on discontinued operations,
net of income taxes(2)........... -- 295 578 --
----------- ----------- ----------- -----------
Net income (loss).................. 2,659 3,167 (3,564) (495)
Cumulative preferred stock
dividends........................ 90 90 90 90
----------- ----------- ----------- -----------
Net income (loss) applicable to
common stock..................... $ 2,569 $ 3,077 $ (3,654) $ (585)
=========== =========== =========== ===========
EARNINGS (LOSS) PER SHARE (3):
Primary............................ $ 0.14 $ 0.17 $ (0.20) $ (0.03)
=========== =========== =========== ===========
Fully-diluted...................... $ 0.14 $ 0.17 $ N/A $ N/A
=========== =========== =========== ===========
WEIGHTED-AVERAGE NUMBER OF SHARES
OUTSTANDING:
Primary............................ 17,859,161 17,631,169 18,086,750 18,086,750
=========== =========== =========== ===========
Fully-diluted...................... 18,685,119 18,431,037 N/A N/A
=========== =========== =========== ===========
</TABLE>
- ---------------
(1) See Note 17 of Notes to Consolidated Financial Statements.
(2) See Note 21 of Notes to Consolidated Financial Statements.
(3) Fully diluted earnings per share are not presented for the quarters ended
November 30, 1994 and February 28, 1995 because the effects would have been
anti-dilutive.
F-36
<PAGE> 95
INDEPENDENT AUDITORS' REPORT
To the Board of Directors and Stockholders of
Mego Financial Corp. and Subsidiaries
Las Vegas, Nevada
We have audited the consolidated financial statements of Mego Financial
Corp. and its subsidiaries (the "Company") as of August 31, 1996 and 1995, and
for each of the three years in the period ended August 31, 1996, and have issued
our report thereon dated October 25, 1996, included elsewhere in this Form 10-K.
Our audits also included the consolidated financial statement schedule of the
Company, listed in Item 8 of this Form 10-K. This consolidated financial
statement schedule is the responsibility of the Company's management. Our
responsibility is to express an opinion based on our audits. In our opinion,
such consolidated financial statement schedule, when, considered in relation to
the basic consolidated financial statements taken as a whole, present fairly, in
all material respects the information set forth therein.
DELOITTE & TOUCHE LLP
Las Vegas, Nevada
October 25, 1996
S-1
<PAGE> 96
SCHEDULE VIII
MEGO FINANCIAL CORP. AND SUBSIDIARIES
VALUATION AND QUALIFYING ACCOUNTS
(thousands of dollars)
For the Year Ended August 31, 1996
<TABLE>
<CAPTION>
ADDITIONS
-----------------------
BALANCE AT CHARGED TO CHARGED TO BALANCE AT
BEGINNING COSTS AND OTHER END OF
DESCRIPTION OF PERIOD EXPENSES ACCOUNTS DEDUCTIONS PERIOD
- -------------------------------------------------- ---------- ---------- ---------- ---------- ----------
<S> <C> <C> <C> <C> <C>
Allowances for cancellations...................... $ 11,969 $ 11,288 $ -- $(11,650) $ 11,607
Unamortized valuation discount.................... 343 471 -- (362) 452
Revaluation adjustment............................ -- -- -- -- --
------- ------- ------- -------- -------
$ 12,312 $ 11,759 $ -- $(12,012) $ 12,059
======= ======= ======= ======== =======
</TABLE>
- ---------------
(a) Excess of book value over cost at September 1, 1989.
(b) Amortization of excess of book value over cost.
S-2
<PAGE> 97
SCHEDULE VIII
MEGO FINANCIAL CORP. AND SUBSIDIARIES
VALUATION AND QUALIFYING ACCOUNTS
(thousands of dollars)
For the Year Ended August 31, 1995
<TABLE>
<CAPTION>
ADDITIONS
-----------------------
BALANCE AT CHARGED TO CHARGED TO BALANCE AT
BEGINNING COSTS AND OTHER END OF
DESCRIPTION OF PERIOD EXPENSES ACCOUNTS DEDUCTIONS PERIOD
- -------------------------------------------------- ---------- ---------- ---------- ---------- ----------
<S> <C> <C> <C> <C> <C>
Allowances for cancellations and credit losses.... $ 13,281 $ 10,359 $ -- $(11,671) $ 11,969
Unamortized valuation discount.................... 281 103 -- (41) 343
Revaluation adjustment............................ 166(a) -- -- (166)(b) --
------- ------- ------- -------- -------
$ 13,728 $ 10,462 $ -- $(11,878) $ 12,312
======= ======= ======= ======== =======
</TABLE>
- ---------------
(a) Excess of book value over cost at September 1, 1989.
(b) Amortization of excess of book value over cost.
S-3
<PAGE> 98
SCHEDULE VIII
MEGO FINANCIAL CORP. AND SUBSIDIARIES
VALUATION AND QUALIFYING ACCOUNTS
(thousands of dollars)
For the Year Ended August 31, 1994
<TABLE>
<CAPTION>
ADDITIONS
-----------------------
BALANCE AT CHARGED TO CHARGED TO BALANCE AT
BEGINNING COSTS AND OTHER END OF
DESCRIPTION OF PERIOD EXPENSES ACCOUNTS DEDUCTIONS PERIOD
- -------------------------------------------------- ---------- ---------- ---------- ---------- ----------
<S> <C> <C> <C> <C> <C>
Allowances for cancellations...................... $ 14,764 $7,775 $ -- $ (9,258) $ 13,281
Unamortized valuation discount.................... 275 292 -- (286) 281
Revaluation adjustment............................ 588(a) -- -- (422)(b) 166
------- ------ ------- ------- -------
$ 15,627 $8,067 $ -- $ (9,966) $ 13,728
======= ====== ======= ======= =======
</TABLE>
- ---------------
(a) Excess of book value over cost at September 1, 1989.
(b) Amortization of excess of book value over cost.
S-4
<TABLE> <S> <C>
<ARTICLE> 5
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> AUG-31-1996
<PERIOD-START> SEP-01-1995
<PERIOD-END> AUG-31-1996
<CASH> 9,842
<SECURITIES> 0
<RECEIVABLES> 57,279
<ALLOWANCES> 12,059
<INVENTORY> 35,876
<CURRENT-ASSETS> 0
<PP&E> 33,812
<DEPRECIATION> 13,550
<TOTAL-ASSETS> 165,597
<CURRENT-LIABILITIES> 0
<BONDS> 84,449
0
0
<COMMON> 184
<OTHER-SE> 25,667
<TOTAL-LIABILITY-AND-EQUITY> 165,597
<SALES> 45,746
<TOTAL-REVENUES> 86,795
<CGS> 5,842
<TOTAL-COSTS> 38,450
<OTHER-EXPENSES> 40,327
<LOSS-PROVISION> 1,510
<INTEREST-EXPENSE> 8,597
<INCOME-PRETAX> 8,018
<INCOME-TAX> 3,167
<INCOME-CONTINUING> 4,851
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 4,851
<EPS-PRIMARY> 0.24<F1>
<EPS-DILUTED> 0.24<F1>
<FN>
<F1>Cumulative preferred stock dividend--$240.
</FN>
</TABLE>
