ITEM 1. BUSINESS
HISTORY AND OWNERSHIP
Epic Resorts, LLC, a Delaware limited liability company (the "Company"), was formed in June 1998 to merge with Epic Resorts, Inc. Epic Resorts, Inc. had been formed to combine the ownership of the London Bridge Resort and the Daytona Beach Regency and their vacation ownership acquisition and development businesses. London Bridge Resort was acquired in 1986 by London Bridge Resort, Inc., a Delaware corporation wholly owned by Thomas F. Flatley, the Company's President. In April 1996, the Daytona Beach Regency Resort was acquired by Daytona Beach Regency, Ltd., a limited partnership of which Mr. Flatley is the general partner.
In connection with the private placement of $130 million aggregate principal amount of the Company's Senior Secured Redeemable Notes due 2005 (the "Notes") in July 1998, Epic Resorts, Inc. was merged into Epic Resorts, LLC and certain of its subsidiaries were merged into limited liability companies. Mr. Flatley simultaneously contributed his membership interests in certain of those subsidiaries to the Company. In connection with the issuance of the Notes, the Company acquired four new resorts (Desert Paradise Resort, Scottsdale Links Resort, Palm Springs Marquis Villas and Island Links Resort) and purchased the limited partnership interests in Daytona Beach Regency, Ltd. not owned by Mr. Flatley.
EPIC'S VACATION OWNERSHIP BUSINESS
The Company is a nationwide developer and marketer of vacation ownership resorts located in major tourist destinations. Vacation ownership interests typically entitle the buyer to a fully furnished vacation residence in any one of the Company's six resorts based on the number of points purchased in Epic Vacation Club, a nonprofit corporation operated by the Company (the "Club"). The Club holds units of each of the Company's resorts which are transferred into the Club by each of the Company's operating subsidiaries. The Company converted its operations to this vacation club system in January 1999. Prior to this time, a customer would purchase a one-week interest at one particular resort, and would receive a deed evidencing their purchase. The Company now sells points ("Vacation Points") in the Club, which entitle the purchaser to reserve units at any of the Company's six resorts and in increments as short as one day. A customer now has access to all of the Company's resorts, as well as over 1,700 other resorts worldwide through the Company's participation in vacation ownership interest exchange networks. The vacation club system offers the Company's customers greater flexibility in their vacation planning, a wider variety of vacation options, and easier access to the Company's network of resorts.
The Company's six resorts are located in Las Vegas, Nevada; Scottsdale, Arizona; Palm Springs, California; Daytona Beach, Florida; Lake Havasu City, Arizona; and Hilton Head, South Carolina.
The Company marketed and sold its deeded vacation ownership interests and markets and sells its Vacation points through both on-site and off-site sales centers. In addition, the Company generates income through the rental of available suites at its resorts. The Company sells Vacation Ownership Interests to purchasers for leisure purposes and not for investment purposes.
EPIC VACATION CLUB
The Club is a Delaware nonprofit, non stock corporation formed by the Company in 1998. The Club's articles of incorporation provide that it was formed for the specific purpose of owning and managing the real property conveyed to it by the Company and its resort subsidiaries. Purchasers of Club Points ("Purchasers") receive the right to reserve time at any of the resort units conveyed to the Club as well as the right to vote to elect the Club's board members and to vote on major Club matters. The number of votes that each Purchaser has is based on the number of Club Points the Purchaser owns.
The Club maintains a reserve, funded from the annual assessments collected from Purchasers, which is used to maintain and upgrade the interiors and furnishings of the resort units, and the exteriors and common areas of the resorts in which the Club owns all of the units. The Club collects maintenance dues from Purchasers based on the number of Vacation Points owned. Currently, the annual dues are 4-1/2(cent) per vacation point. These dues are intended to cover the Club's operating costs, including condominium association dues at each resort. The Company will pay association dues for all unsold Vacation Points.
The vacation club system provides Purchasers with significant flexibility in planning their vacations. Under this system, Purchasers can select vacations according to their schedules, space needs and available Vacation Points. The number of Vacation Points that are required to stay one day at one of the Company's resorts varies depending upon the particular resort, the size of the unit, the season and the day of the week. For example, a Friday or Saturday night stay at a one-bedroom unit may require 1,000 Vacation Points per night off-season and 1,500 Club Points per night in peak season. A midweek stay at the same one-bedroom unit would require less Vacation Points. Vacation Points are reissued on an anniversary date basis and any unused Vacation Points may be carried over for one year. A Purchaser may also borrow Vacation Points from their allotment for the next year.
The Club has a board of directors that manages its business and affairs. Each of the directors and principal executive officers of the Club are also officers of the Company. The Board must obtain the approval of a majority of the voting power represented to take certain actions, including (i) any incurrence of a capital expenditure exceeding 5% of the Club's budgeted gross expenses during any fiscal year and (ii) the sale of any of the Club's property during any fiscal year, if the aggregate fair market value is in excess of 5% of the Club's budgeted expenses for that year.
SALES AND MARKETING
The Company focuses its sales and marketing activities on generating a predictable flow of both off-site and on-site prospective purchasers of Vacation Ownership Interests at minimal cost.
OFF-SITE SALES CENTERS: The Company currently operates off-site sales centers in Torrence, California; Schaumburg, Illinios and in Philadelphia, Pennsylvania. The Company opened its fourth center in Atlanta, Georgia in the first quarter and plans to add its fifth and sixth centers by the end of 2000. The Company currently intends to locate these planned sales centers in major metropolitan areas, which can be conveniently toured during evenings and weekends. These centers, which are leased by the Company, are generally more cost effective because they reduce the need for on-site tours of the Company's resorts and are more easily accessible to the Company's target customers.
ON-SITE SALES CENTERS: The Company utilizes a variety of marketing techniques to generate on-site tours, including mini-vacations resulting from telemarketing and targeted mailings, retail center kiosks, in-house marketing to renters, marketing to current owners of Vacation Ownership Interests and referrals. The Company's completed but unsold inventory of resort units also provides additional revenue as well as sales and marketing cost advantages through (i) rental income, (ii) access to a steady source of high quality, low cost, on-site sales tours from rental customers, and (iii) lower mini-vacation marketing costs.
The Company's sales representatives are a critical component of its sales and marketing effort, and the Company continually strives to attract, train and retain a dedicated sales force. The Company provides sales instruction and training, which coupled with the sales representative's valuable knowledge of each resort, assists in acquainting prospective customers with the benefits of each resort. The Company's sales staff is required to provide each customer with a written disclosure statement regarding the Vacation Points to be sold prior to the time the customer signs a purchase agreement. This disclosure statement sets forth relevant information regarding ownership of a Vacation Ownership Interest at the resort and must be signed by every purchaser. The Company believes that this information statement contains all material and relevant information a customer requires to make an informed decision regarding the purchase of a Vacation Ownership Interest at one of its resorts, and contributes to its low rates of rescission. At closing, customers are also provided with a toll free customer service phone number to facilitate any additional information requests.
To support its marketing and sales efforts, the Company has also developed a computer database to track its vacation ownership marketing and sales programs. Management believes that as the Company's vacation ownership operations grow, this database will become an increasingly significant asset and will enable it to take advantage of less costly marketing and referral opportunities.
FINANCIAL INFORMATION ABOUT GEOGRAPHIC AREAS
The Company currently has no operations or sales outside the United States. 100% of the Company's revenues were generated from domestic sales of Vacation Ownership Interests and resort operations during each of the fiscal years ended December 31, 1997, 1998 and 1999. All of the Company's long-lived assets are currently located in the United States. However, in the future, the Company may expand its operations to include the acquisition or development of resorts outside the United States. See Note J to the Notes to Consolidated Financial Statements included herein for additional segment and geographical information regarding the Company.
CUSTOMER FINANCING
Approximately 90% of the Company's customers finance their purchase of Vacation Points with the Company. These customers are required to make a down payment of at least 10% of the Vacation Points sales price. The balance is typically financed for a period of seven to ten years at a fixed interest rate.
As of December 31, 1999, the Company had a vacation ownership receivables portfolio totaling approximately $13.5 million in principal amount, with a weighted average contractual yield of approximately 14.2%, 15.5%, and 14.9% for the years ended December 31, 1999, 1998 and 1997, respectively. The adequacy of the Company's reserve for loan losses is determined by management and reviewed on a regular basis considering, among other factors, historical frequency of default, loss experience, present and expected economic conditions as well as the quality of receivables. The Company believes that its financing is attractive to purchasers who find it convenient to handle all facets of the purchase of Vacation Ownership Interests through a single source. In addition, the downpayments required by the Company are similar to those required by banks and mortgage companies which offer this type of credit, when such credit is available. The table below sets forth additional information relating to the Company's notes receivable (amounts in thousands).
LOAN UNDERWRITING
Consistent with industry practice, Vacation Ownership Interest financing is not subject to extensive loan underwriting criteria. While the Company requires a minimum downpayment of 10% of the purchase price, the Company encourages purchasers to make increased downpayments by offering a lower interest rate. In addition, purchasers who do not elect to participate in the Company's pre-authorized payment plan are charged interest at a rate which is one percent greater than the otherwise prevailing rate.
COLLECTION POLICIES
The Company bears the responsibility of overseeing collection activities under its receivables financing facility. The Company's practice has been to continue to accrue interest on its loans to purchasers of Vacation Ownership Interests until such loans are deemed to be uncollectible, at which point it commences foreclosure proceedings. Upon obtaining title, the Company returns the Vacation Ownership Interests to inventory for resale. The Company closely monitors its loan accounts and determines whether to foreclose on a case-by-case basis. If a purchaser of a Vacation Ownership Interest defaults on the notes and mortgage during the early part of the loan amortization period, the Company will not have recovered its marketing, selling (other than certain sales commissions) and general and administrative costs relating to such Vacation Ownership Interest. In addition, although in certain jurisdictions the Company may seek recourse against a defaulting customer for the sales price of a Vacation Ownership Interest, the Company has not historically pursued such a remedy.
SALES OF RECEIVABLES
In September 1998, the Company entered into a $75 million vacation ownership loan participation facility with a financial institution. Under this facility, the Company sells its Vacation Ownership Interest Receivables to a limited purpose, bankruptcy remote subsidiary of the Company, which are then pledged to the financial institution as security for the funding used by the subsidiary to acquire the receivables. This facility provides the Company with non-recourse interim funding for Vacation Ownership Interests receivable pending their permanent funding through receivables securitization transactions. The Company expects to be able to fund a significant portion of its future development from funds provided by this receivables facility.
In December 1999, the Company and EPIC Funding completed a sale of $78 million of receivables to EPIC Receivables 1999, a wholly owned qualifying special purpose entity for the purpose of Epic Receivables entering into a $95.0 million securitization. The closing was used to pay down the receivables facility. Refer to Note C of the notes to the consolidated Financial statements for additional disclosure.
RECEIVABLES SERVICING
Receivables servicing includes collecting payments from borrowers and remitting such funds to the owners, lenders or investors in such receivables, accounting for receivables principal and interest, making advances when required, contacting delinquent borrowers, foreclosing in the event that defaults are not remedied and performing other administrative duties. The Company outsources the servicing of its receivables to a third party vendor, and paid aggregate fees of $221,000 and $228,000 in fiscal 1998 and 1997, respectively. For fiscal 1999, the Company performed collection services through its own personnel.
CUSTOMER SERVICE
The Company emphasizes customer satisfaction and maintains full-time customer service representatives in its King of Prussia, Pennsylvania headquarters to respond to customer inquiries. At closing, all purchasers are provided with a toll-free customer service phone number to facilitate any additional information requests.
COMPETITION
The Company competes with other vacation ownership resort providers as well as hotels, motels, condominium developments and second homes. Competition is based primarily upon the attractiveness and location of the resort property and amenities. In addition to the direct competition of individual resorts, other competitors also include alternative accommodations such as hotels, motels, bed-and-breakfasts and small vacation ownership operators located within the immediate geographic vicinity of each of the Company's resorts.
The vacation ownership industry historically has been highly fragmented and dominated by a very large number of local and regional resort developers and operators, each with limited portfolios. More recently, many of the world's most widely-recognized lodging, hospitality and entertainment companies have begun to develop and sell timeshare and vacation ownership interests under their brand names. Many entities with which the Company competes have significantly greater access to financial, sales and marketing and other resources than those of the Company and may be able to grow at a more rapid rate or more profitably as a result. Management anticipates that competition will increase in the future as a result of consolidation in the vacation ownership industry.
VACATION OWNERSHIP EXCHANGE NETWORKS
According to the American Resort Developers Association, the primary reason cited by consumers for purchasing a Vacation Ownership Interest is the ability to exchange such interest for accommodations at other resorts through worldwide exchange networks. Membership in an exchange network allows the owner of a Vacation Ownership Interest at one of the Company's resorts to exchange their occupancy right for a similar right at another participating resort, based upon availability and the payment of a variable exchange fee. A Vacation Ownership Interest can be exchanged by listing the interest as available with the exchange network affiliated with the owner's home resort and requesting occupancy at another participating resort, indicating the preferred resort or geographic area, the size of the unit desired, and the period during which occupancy is desired. The exchange network assigns a rating to each listed Vacation Ownership Interest, which is based upon a number of factors, including the location and size of the unit, the quality of the resort and the time of year during which the exchanging owner's Vacation Ownership Interest is available. The network then attempts to satisfy the exchange request by providing an occupancy right in a participating resort with a similar rating.
All of EPIC's resorts are affiliated with Interval International ("II"), one of the leading worldwide vacation ownership exchange companies. Participation in II entitles owners to exchange their annual Vacation Ownership Interests for occupancy at over 1,700 II resorts worldwide. All six Epic Resort locations have received Five-Star designations from II, the highest designation under II's rating system. II awards this designation to less than 10% of its 1500 member resorts.
GOVERNMENT REGULATION The Company's marketing and sales activities and other resort operations are subject to extensive regulation by the federal government and the states in which the Company's resorts are located and in which its Vacation Ownership Interests are marketed and sold. Federal legislation to which the Company is or may be subject includes the Federal Trade Commission Act, the Fair Housing Act, the Truth-in-Lending Act, the Real Estate Settlement Procedures Act, the Equal Credit Opportunity Act, the Interstate Land Sales Full Disclosure Act, the Telemarketing and Consumer Fraud and Abuse Prevention Act, and the Civil Rights Acts of 1964, 1968 and 1991. Many states have adopted legislation as well as specific laws and regulations regarding the sale of vacation ownership interests. The laws of most states require a designated state authority to approve a public report of condominium, a detailed offering statement describing the Company and all material aspects of the resort and the sale of Vacation Ownership Interests at such resort. In addition, the laws of most states in which the Company sells Vacation Ownership Interests grant the purchaser of such an interest the right to rescind a contract of purchase at any time within a statutory rescission period, which generally ranges from three to ten days. Furthermore, most states have other laws which regulate the Company's activities, such as real estate licensure laws, travel sales licensure laws, anti-fraud laws, telemarketing laws, prize, gift and sweepstakes laws, labor laws and various regulations governing access and use of the Company's resorts by disabled persons. The Company believes that it is in material compliance with all applicable federal, state, local and foreign laws and regulations to which it is currently subject.
EMPLOYEES
As of December 31, 1999, the Company employed a total of 1,728 full time employees. None of the Company's employees are represented by a collective bargaining unit. The Company believes that its relations with its employees are good. ITEM 2.
ITEM 2. PROPERTIES
The Company owns and operates six resorts. Set forth below is a description of each resort property.
LONDON BRIDGE RESORT. The London Bridge Resort is situated on twelve acres in Lake Havasu City, Arizona. The resort, formerly a 180 room hotel, currently consists of 122 studio, one- and two-bedroom suites.
DAYTONA BEACH REGENCY. The Daytona Beach Regency is located in Daytona Beach, Florida and currently consists of 81 one- and two-bedroom suites. Formerly a 198 room hotel, the Company has renovated 81 of the resort's 90 vacation ownership suites.
SCOTTSDALE LINKS RESORT. The Scottsdale Links Resort is located on the TPC golf courses in Scottsdale, Arizona, and Scottsdale Links Resort offers 228 one-, two- and three-bedroom suites.
DESERT PARADISE RESORT. The Desert Paradise Resort is located one and one-half miles west of the Las Vegas Strip in Las Vegas, Nevada. The resort consists of 152 one- and two-bedroom suites.
PALM SPRINGS MARQUIS VILLAS. Located on seven acres in downtown Palm Springs, California, the Palm Springs Marquis Villas consists of 101 one- and two-bedroom suites.
ISLAND LINKS RESORT. Located on Hilton Head Island off the coast of South Carolina, the Island Links Resort currently consists of 58 one-and two-bedroom suites. The Company expects to complete development of a total of 102 additional one- and two-bedroom suites at the resort. Such construction commenced in the third quarter of 1998 and will be completed in phases of eight to nine suites each.
The Company also leases three off-site sales centers located in Philadelphia, Pennsylvania, Torrence, California and Schaumberg, Illinois.
ITEM 3.
ITEM 3. LEGAL PROCEEDINGS
The Company is not presently involved in any material legal proceedings. However, from time to time during the ordinary course of business, the Company is threatened with, or may become a party to legal actions and other proceedings incidental to its business. The Company believes that its potential exposure to such legal actions is adequately covered by its general liability insurance.
ITEM 4.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matter was submitted during the fourth quarter of the fiscal year covered by this report to a vote of the Company's security holders.
ITEM 5.
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
The Company is a limited liability company and has no equity securities that trade.
ITEM 6.
ITEM 6. SELECTED FINANCIAL DATA
SELECTED FINANCIAL DATA
The following table sets forth selected financial data of the Company. The selected consolidated financial data as of and for the five years ended December 31, 1999 have been derived from audited financial statements. The following selected financial data should be read in conjunction with "Management's Discussion and Analysis of Results of Operations and Financial Condition" and the consolidated financial statements of the Company and related notes thereto appearing elsewhere herein.
ITEM 7.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
OVERVIEW
The following represents a discussion of Epic Resorts, LLC, as successor to Epic Resorts, Inc. The information presents all of the operations of the Company's resorts as of their respective dates of acquisition, including:
- ---------- * On July 8, 1998 the Company acquired the remaining minority partners' interests in Daytona Beach Regency and now owns 100% of this resort.
The Company generates revenues from the sale and financing of Vacation Points at its resorts, as well as from resort operations which include commercial rentals, food and beverage sales, green fees, rentals of suites available at the Company's resorts and from fees associated with managing the vacation ownership resorts.
The Company recognizes revenue from Vacation Points sales when a minimum of 10% of the sales price has been received in cash, the refund or rescission period has expired, collectibility of the receivable representing the remainder of the sales price is reasonably assured and the Company has completed substantially all of its obligations with respect to any development relating to the Vacation Points sold.
The Company has been dedicating greater resources to the acquisition and development of vacation ownership projects. Costs associated with the acquisition and development of vacation ownership resorts, including carrying costs, are capitalized as inventory and allocated to cost of sales as the respective revenue is recognized.
Epic vacation club belongs to the Homeowner's Association that has been established for each resort. Currently, there are six (6) separate homeowners associations. The Association is a not-for-profit corporation and operates primarily to collect the assessments from its members and remit to the developer of the property the Association's pro-rata share of direct and allocated expenditures including real estate taxes, property insurance, grounds maintenance, utility costs and housekeeping services. Typically, the Association reimburses the developer or property manager for the Association's pro-rata share of such expenditures.
RESULTS OF OPERATIONS
The following analysis summarizes the significant changes in the results of operations and financial condition of the Company and should be read in conjunction with the Company's consolidated financial statements and related notes.
COMPARISON OF THE YEAR ENDED DECEMBER 31, 1999 TO YEAR ENDED DECEMBER 31, 1998
REVENUES. For the year ended December 31, 1999, the Company recognized total revenues of $118.8 million compared to $60.3 million for the year ended December 31, 1998, an increase of $58.5 million, or 97.0%. This increase was primarily the result of $1.6 of gains recognized in 1999 from the sales of notes and mortgages receivable and other financing income and a $47.9 million increase in sales of Vacation Points and Ownership Interests to $84.2 million during 1999 from $36.3 million during 1998, an increase of 132.0% and increased revenues of $19.0 million from resort operations.
Sales of Vacation Points and Ownership Interests increased primarily as a result of (i) increased sales growth due to expansion, the company added three resorts and two additional sales centers in 1999 and (ii) an increase in Sales Price.
Resort operations revenue increased 144.9%, to $19.1 million in 1999 from $7.8 million in 1998, primarily as a result of additional resort revenues of $3.40 million during 1999 from the newly acquired resorts and the sale of vacation packages of $7.9 million by Epic Marketing, a venture started in the fourth quarter of 1998.
Gains on sales of receivables and other financing income increased 15.7% to $11.8 million in 1999 as compared to $10.2 million in 1998. This increase can be attributed to additional sales into Epic's Receivables Facility as discussed in Note C to the Company's consolidated financial statements.
Interest income decreased $4.4 million to $1.1 million in 1999 from $5.5 million in 1998. The decrease of 80.0%, is attributed primarily from the sale of receivables to the receivables facility reducing the portfolio of loans held on the companies books.
Other income increased $2.3 million to $2.7 million in 1999 from $.4 million in 1998 primarily attributable to the $2.1 million of Ambassador Club activity. Ambassador Club sales provide a limited package of visits for a moderate price to customers who cannot commit to a full purchase obligation.
COST OF SALES. Cost of sales as a percentage of sales of Vacation Points and Ownership Interests decreased to 18.7% in 1999 from 22.3% in 1998, reflecting higher average selling prices for Vacation Points and ownership interests as well as a lower product cost for the Scottsdale Links, Palm Spring Marquis and Desert Paradise properties.
RESORT OPERATIONS EXPENSE. Resort operations expense increased approximately $16.6 million to $23.7 million in 1999 from $7.1 million in 1998. As a percentage of resort operations revenue, resort operations expense increased to 124.1% in 1999 from 91.0% in 1998 primarily as a result of increased operational expenses at the Scottsdale Links, Desert Paradise and Palm Springs Marquis properties. The company expects this trend to stabalize as these resorts develop a following among tourists and travel agents.
SELLING AND MARKETING EXPENSES. Selling and marketing expenses (including commissions) as a percentage of sales of Vacation Points and Ownership Interests increased to 45.8% in 1999 from 41.6% in 1998. In 1999, the Company incurred $327,000 in start-up selling and marketing expenses as it prepared for the (i) commencement of selling efforts at the three new western locations in the first quarter of 1999 and $515,000 due to (ii) opening of its offsite sales center in Schaumburg and Torrence in the middle of the fourth quarter of 1999.
GENERAL AND ADMINISTRATIVE EXPENSES. General and administrative expenses increased 137.9% to $15.7 million in 1999 from $6.6 million in 1998 reflecting the Company's continued growth. As a percentage of total revenues, general and administrative expenses increased to 13.2% in 1999 from 10.9% in 1998 which was attributable to the increased staffing incurred at each of the start-up locations in 1999. As part of the Company's growth plan, the Company increased general and administrative expenses at its headquarters by $1.0 million to have in place the infrastructure required to support the Company's business plan to continue to add offsite sales centers and new resorts. The Company continues to evaluate its administrative support and expects to continue to increase its investment in resources to support its anticipated growth.
INTEREST EXPENSE. Interest expense increased to $19.0 million in 1999 from $12.1 million in 1998, an increase of $6.9 million, which reflects a full year of debt service relating to the Notes issued in July 1998.
PROVISION FOR LOAN LOSSES. Provision for loan losses as a percentage of sales of Vacation Points and Ownership Interests decreased to 2.5% in 1999 from 3.0% in 1998.
COMPARISON OF THE YEAR ENDED DECEMBER 31, 1998 TO YEAR ENDED DECEMBER 31, 1997
REVENUES. For the year ended December 31, 1998, the Company recognized total revenues of $60.3 million compared to $40.3 million for the year ended December 31, 1997, an increase of $20.0 million, or 49.6%. This increase was primarily the result of $10.2 of gains recognized in 1998 from the sales of mortgages receivable and a $6.3 million increase in sales of Vacation Ownership Interests to $36.3 million during 1998 from $30.0 million during 1997, an increase of 21.0%.
Sales of Vacation Ownership Interests increased primarily as a result of (i) increased sales growth at the Daytona Beach Regency Resort to $17.4 million during 1998 from $14.6 million during 1997, an increase of $2.8 million or 19.2% and (ii) $3.3 million of sales generated from the new sales activities at the Island Links Resort and the Philadelphia offsite sales center.
Resort operations revenue increased 16.4%, to $7.8 million in 1998 from $6.7 million in 1997, primarily as a result of additional resort revenues of $1.6 million during 1998 from the newly acquired resorts and the sale of vacation packages of $0.2 million by Epic Marketing, a new venture started in the fourth quarter of 1998. This increase was offset by a $0.6 million decrease in resort operations revenue at London Bridge Resort and the Daytona Beach Regency Resort which reflects the decreasing availability of suites for rent in 1998 as the Company continues to convert suites at these resorts to Vacation Ownership Interests.
Gains on sales of receivables and other financing income of $10.2 million relate to the Company's initial fundings in October, November and December 1998 under its Receivables Facility as discussed in Note C to the Company's consolidated financial statements.
Interest income increased $2.0 million to $5.5 million in 1998 from $3.5 million in 1997, an increase of 57.1%, primarily from investing a portion of the proceeds from the sale of the Notes into short-term investments.
Other income increased $0.3 million to $0.4 million in 1998 from $0.1 million in 1997 primarily attributable to the $0.2 million of Ambassador Club activity. Ambassador Club sales provide a limited package of visits for a moderate price to customers who cannot commit to a full purchase obligation.
COST OF SALES. Cost of sales as a percentage of sales of Vacation Ownership Interests decreased to 22.3% in 1998 from 24.3% in 1997, reflecting higher average selling prices for Vacation Ownership Interests at London Bridge Resort and Daytona Beach Regency.
RESORT OPERATIONS EXPENSE. Resort operations expense increased approximately $2.5 million to $7.1 million in 1998 from $4.6 million in 1997. As a percentage of resort operations revenue, resort operations expense increased to 91.0% in 1998 from 68.7% in 1997 primarily as a result of increased operational expenses of $2.1 million from the newly acquired resorts.
SELLING AND MARKETING EXPENSES. Selling and marketing expenses (including commissions) as a percentage of sales of Vacation Ownership Interests increased to 41.6% in 1998 from 38.7% in 1997. In 1998, the Company incurred $476,000 in start-up selling and marketing expenses as it prepared for the (i) commencement of selling efforts at the three new western locations in the first quarter of 1999 and (ii) opening of its offsite sales center in Philadelphia in the middle of the fourth quarter of 1999. As part of the Company's development of its marketing strategy, the Company also incurred approximately $400,000 to implement a comprehensive marketing effort on the East Coast.
GENERAL AND ADMINISTRATIVE EXPENSES. General and administrative expenses increased 106.3% to $6.6 million in 1998 from $3.2 million in 1997 reflecting the Company's growth and the newly acquired resorts in 1998. As a percentage of total revenues, general and administrative expenses increased to 10.9% in 1998 from 7.9% in 1997 which was attributable to the increased staffing and start-up costs incurred prior to the commencement of sales operations at the newly acquired resorts. As part of the Company's growth plan, the Company increased general and administrative expenses at its headquarters by $1.3 million to have in place the infrastructure required to support the addition of its four new resorts and its additional offsite sales center. The Company
continues to evaluate its administrative support and expects to continue to increase its investment in resources to support its anticipated growth.
INTEREST EXPENSE. Interest expense increased to $12.1 million in 1998 from $3.7 million in 1997, an increase of $8.4 million, which reflects the increased indebtedness from the Notes issued in July 1998.
PROVISION FOR LOAN LOSSES. Provision for loan losses as a percentage of sales of Vacation Ownership Interest decreased to 3.0% in 1998 from 4.6% in 1997. This decrease was attributable to the lower receivables base resulting from the sales of mortgages receivable through the Receivables Facility.
CHANGES IN FINANCIAL CONDITION
YEARS ENDED DECEMBER 31, 1999, 1998 AND 1997
Cash and cash equivalents increased by $15.8 million and $0.2 million for the years ended December 31, 1998 and 1997, respectively, and decreased $13.7 million for the year ended December 31, 1999.
Net cash used in operating activities was $ 47.6 million, $74.2 million and $3.5 million in 1999, 1998 and 1997, respectively. The change in net cash used in operating activities from 1998 to 1999 is primarily attributed to the increased issuance of notes receivable to finance Vacation Points Purchases offset by the reduction of completed inventory as sales increased as well as the increase in net income from operations. The change in net cash used in operating activities from 1997 to 1998 is primarily attributable to the acquisition of the four additional resorts for a cash purchase price of $64.0 million during 1998. The change in net cash used in operating activities from 1996 to 1997 is primarily attributable to the increase in net income and the net change in inventory, which included a net decrease of $4.7 million in 1997 (due primarily to increased sales activity).
Net cash used in investing activities was $19.1 million, $17.8 million, and $2.3 million in 1999, 1998, and 1997 respectively. The increase from 1998 to 1999 is primarily attributable to the purchase of equipment at each of the resorts the tenant improvements incurred to open our new sales offices and sales of notes and mortgages receivable to the receivable facility. The increase from 1997 to 1998 is primarily attributable to the $15.2 million investment in residual interests associated with the sales of receivables through the Receivables Facility.
Net cash provided by financing activities was $53.0 million, $107.9 million, and $6.0 million in 1999, 1998, and 1997 respectively. The net increase in cash provided by financing activities from 1998 to 1999 is primarily attributable to the increased sales of notes receivable. The net increase in cash provided by financing activities from 1997 to 1998 is primarily attributable to the $130.0 million proceeds received on July 8, 1998 from the sale of the Notes, which was used to purchase the new resorts as discussed above, and the payoff of $23.8 million of outstanding debt and the payment of $6.7 million of deferred financing costs.
LIQUIDITY AND CAPITAL RESOURCES
The Company generates cash from operations through the sale and financing of Vacation Points, resort operations, transient rental of resort accommodations and management fees. With respect to the sale of Vacation Points, the Company generates cash from operations from customer downpayments and the sale of notes receivable through the warehouse facility in amounts typically equal to 88% of the related customer notes and mortgages receivable. The Company generates additional cash flow from its Vacation Interests receivable portfolio through receipt of the spread between the yield on such portfolio and the cost of the Receivables Facility upon completion of securitizations of such receivables.
The Company requires funds to finance the acquisition and development of resorts and related inventory, and to finance customer purchases of Vacation Points. Historically, these funds have been provided by indebtedness secured by a portion of the Company's inventory of unsold Vacation Points and Vacation Ownership Interests, customer notes and mortgages receivable and other assets.
In September 1998, the Company entered into a non-recourse $75 million vacation ownership loan participation facility with a financial institution (the "Receivables Facility"). Under this facility, the Company sells its Vacation Ownership Interest receivables to a limited purpose, bankruptcy remote subsidiary of the Company, which are then pledged to the financial institution as security for the funding used by the subsidiary to acquire the receivables. The Receivables Facility provides for advance rates of 88% of the lesser of (i) unpaid principal balance of the receivables sold to the subsidiary or (ii) the market value of such receivables as determined by the financial institution. Borrowings under the Receivables Facility bear interest at one month LIBOR plus 1.50%, reset daily. The Receivables Facility provides the Company with non-recourse interim funding for the Vacation Points and Ownership Interests receivables pending their permanent funding through receivables securitization transactions. The Company expects to be able to fund a significant portion of its future development from funds provided by the Receivables Facility.
The Company's capital resources are provided from the following sources: (i) cash flows from operations and (ii) proceeds from the Receivables Facility. Thereafter, The Company maintains escrow funds in an escrow account sufficient to make the next required interest payment of $8.5 million on the Notes.
The Company is committed to make an offer to repurchase $65.0 million of the Notes between June 15, 2000 and June 15, 2002. The Company does not intend to make this offer in the year 2000.
The Company intends to pursue a growth-oriented strategy; accordingly, the Company may, from time to time acquire, among other things, additional vacation ownership resorts and additional land upon which vacation ownership resorts may be developed, and companies operating quality resorts or having vacation ownership assets, management, sales or marketing expertise commensurate with the Company's operations in the vacation ownership industry.
The Company believes that the net proceeds from the sale of the mortgages and notes receivable, together with cash generated from operations and future borrowings, will be sufficient to meet the Company's working capital and capital expenditure needs through the end of the fiscal year. The Company may, in the future, require additional credit facilities or issuances of other corporate debt or equity securities in connection with acquisitions or otherwise. Any debt incurred or issued by the Company may be secured or unsecured, at fixed or variable rates of interest and may be subject to such terms as management deems prudent. The Company's credit facilities and the indenture for the Notes include customary conditions to funding, eligibility requirements for collateral, certain financial and other affirmative and negative covenants, including, among others, limits on the incurrence of indebtedness, covenants concerning net worth and fixed charge coverage requirements and debt to equity ratios and events of default.
YEAR 2000
The Year 2000 issue is the result of computer programs being written using two digits rather than four to define applicable years. Computer programs that have date-sensitive software may recognize a date coded "00" as the year may cause disruptions of operations, including temporary inability to process transactions. Prior to year-end 1999, the Company completed an assessment of all of its significant operating systems. The Company had, in the ordinary course of business, purchased new software packages for most of its computer systems. Most of these purchases occurred prior to the 1999 fiscal year. The Company had also implemented, through routine software releases, Year 2000-compliant upgrades to most of its financial and operational software. Any remaining software applications were insignificant to the Company's operations, and were upgraded to Year 2000-compliant status prior to the end of 1999. The Company had also addressed the Year 2000 activities of its suppliers and customers. By reviewing their Year 2000 Readiness Disclosures, or by direct contact, the Company determined that substantially all of its significant suppliers and customers were Year 2000 compliant. The Company has not, to date, experienced any negative effects from its suppliers or customers related to the Year 2000 issue. While there can be no guarantee that Year 2000 issues by a third party will not occur in future periods, and such effects could have a material adverse effect on the Company, management believes that its continuing communications with its suppliers and customers will minimize these risks. The Company has to date not experienced any negative effects from the Year 2000 date change, and does not expect any such effects in future periods. The Company has not incurred and does not anticipate incurring
material incremental costs for Year 2000 issues relating to its computer information systems, since all updates or replacements of such systems occurred in the ordinary course of business, most of which occurred prior to the 1999 year.
FORWARD LOOKING STATEMENTS
From time to time, information the Company provides, statements by the Company's employees or information included in its filings with the Securities and Exchange Commission (including those portions of the Management's Discussion and Analysis that refer to the future) may contain forward-looking statements that are not historical facts. Those statements are "forward-looking" within the meaning of the Private Securities Litigation Reform Act of 1995. Such forward-looking statements, and the Company's future performance, operating results, financial position and liquidity, are subject to a variety of factors that could materially affect results, including:
THE VACATION OWNERSHIP INDUSTRY IS HIGHLY SENSITIVE TO CHANGES IN NATIONAL AND REGIONAL ECONOMIC CONDITIONS
Changes in economic conditions such as reductions in levels of employment, discretionary disposable income, consumer confidence, available financing as well as any increase in interest rates will affect the Company's sales of Vacation Ownership Interests. A downturn in the economy in general or in the market for vacation ownership property could have a material adverse effect on the Company's business, operating results and financial condition.
CUSTOMERS MAY NOT BE ABLE TO REPAY LOANS MADE BY THE COMPANY FOR THE PURCHASE OF VACATION OWNERSHIP INTERESTS
General economic conditions have an impact on the ability of borrowers to repay loans. Loss of earnings, illness and other similar factors affecting borrowers may lead to an increase in delinquencies. If the vacation ownership market should experience an overall decline in values such that the outstanding balances of the Company's notes receivable are greater than the value of the respective Vacation Ownership Interests, the actual rates of delinquencies, foreclosures and losses could be materially higher than those now experienced. An increase in delinquency rates or defaults on the Company's receivables could have a material adverse effect on the Company's business, operating results and financial condition as well as the Company's ability to obtain financing under the Receivables Facility or any other pledged receivables facility. In addition, if a purchaser of a Vacation Ownership Interest defaults early in the repayment schedule, the costs associated with marketing and sales commissions may not be recouped, and similar costs and commissions will be incurred in connection with the resale of such Vacation Ownership Interest after the Company regains possession of that Vacation Ownership Interest. The Company may also incur substantial costs and delays in connection with the servicing of its receivables, including costs in foreclosing or realizing on its collateral and additional marketing and sales costs with respect to reacquired property.
THE COMPANY HAS SUBSTANTIAL LEVERAGE AND MAY NOT BE ABLE TO SERVICE ITS DEBT
The Company has significant debt service obligations. The Company anticipates that it will continue to require external sources of liquidity to support its operations in the future. The Company's ability to pay cash dividends and to repay subordinated debt is also limited by certain restrictions.
The Company's ability to service or to refinance its indebtedness or to obtain additional financing (including its ability to consummate future notes receivable securitizations) depends on its future performance, which is subject to a number of factors, including the Company's results of operations, leverage, financial condition and business prospects, the performance of its receivables, prevailing interest rates, general economic conditions and perceptions about the vacation ownership industry. The Receivables Facility includes, among other things, various representations and warranties, conditions to funding, eligibility requirements for collateral, affirmative, negative and financial covenants and events of default. Specifically, the Company must maintain a Tangible Net Worth (as defined in the Receivables Facility) of at least $13.0 million and must meet all financial covenants contained in the indenture under which the Notes were issued.
The Company's level of debt and debt service requirements will have several important effects on its future operations, including the following:
the Company will have significant cash requirements to service debt, reducing funds available for operations and future business opportunities as well as increasing the Company's vulnerability to adverse economic and industry conditions;
the Company's leveraged position will increase its vulnerability to competitive pressures;
the financial covenants and other restrictions contained in the indenture governing the Notes and other agreements relating to the Company's indebtedness will require the Company to meet certain financial tests and will restrict its ability to, among other things, borrow additional funds, dispose of assets or pay cash dividends on, or repurchase, preferred or common stock; and
funds available for working capital, capital expenditures, acquisitions and general corporate purposes may be limited.
THE TIMING, QUALITY AND COMPLETION OF CONSTRUCTION AND DEVELOPMENT ACTIVITIES AT THE COMPANY'S RESORTS ARE CONTROLLED BY THIRD PARTY CONTRACTORS AND THE AVAILABILITY OF GOVERNMENTAL PERMITS AND AUTHORIZATIONS
Development activities are also subject to risks relating to the inability to obtain, or delays in obtaining, all necessary zoning, land-use, building, occupancy, sales and other required governmental permits and authorizations, the ability of the Company to coordinate construction activities with the process of obtaining such permits and authorizations, and the ability of the Company to obtain the financing necessary to complete the necessary acquisition, construction, and/or conversion work at its projects and resorts. The failure to obtain or maintain such zoning permits would have a material adverse effect on the Company's business, results of operations and financial condition. In addition, certain state and local laws may impose liability on property developers with respect to construction defects discovered or repairs made by future owners of such property.
NATURAL DISASTERS COULD HAVE A MATERIAL ADVERSE EFFECT ON THE COMPANY
The Company's resorts are located in areas that are susceptible to wind storms, hurricanes, floods, mud slides, earthquakes, and other natural disasters. The Company's resorts could suffer significant damage as a result of storms or natural disasters. Any such damage could impair the Company's ability to sell Vacation Ownership Interests at its resorts, and to collect on outstanding notes receivable arising from such sales and significantly adversely affect the Company's business, operating results and financial condition.
APPLICABILITY OF FEDERAL SECURITIES LAWS TO THE SALE OF VACATION OWNERSHIP INTERESTS
It is possible that the Vacation Ownership Interests may be deemed to be a security as defined in Section 2(1) of the Securities Act of 1933. If the Vacation Ownership Interests were determined to be a security for such purpose, their sale would require registration under the Securities Act. The Company has not registered the sale of the Vacation Ownership Interests under the Securities Act and does not intend to do so in the future. If the sale of the Vacation Ownership Interests were found to have violated the registration provisions of the Securities Act, purchasers of the Vacation Ownership Interests would have the right to rescind their purchases of Vacation Ownership Interests. If a substantial number of purchasers sought rescission and were successful, the Company's business, results of operations and financial condition could be materially adversely affected. Because of the nature of the Company's Vacation Ownership Interest program and the sales practices utilized in such program, the Company does not believe that its Vacation Ownership Interests constitute a security within the meaning of Section 2(1) of the Securities Act.
ITEM 7A.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The Company is not exposed to interest rate risk in the near term, as substantially all of the Company's indebtedness is at fixed rates (principally the $130 million of senior secured notes which bear interest at a fixed rate of 13.0%). The Company does not maintain a trading account for any class of financial instrument, has never purchased any derivative instruments, and is not directly subject to any foreign currency exchange or commodity price risk.
ITEM 8.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
REPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS
Member Epic Resorts, LLC
We have audited the accompanying consolidated balance sheet of Epic Resorts, LLC (a Delaware limited liability company) as of December 31, 1999, and the related consolidated statements of income, changes in member's equity and cash flows for the year ended December 31, 1999. 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 audit.
We conducted our audit in accordance with auditing standards generally accepted in the United States. 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 audit provides a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of Epic Resorts, LLC as of December 31, 1999, and the results of its operations and its cash flows for the year ended December 31, 1999, in conformity with auditing standards generally accepted in the United States.
/s/ GRANT THORNTON, LLP
Philadelphia, Pennsylvania April 3, 2000
Report of Independent Public Accountants
To the Member of Epic Resorts, LLC:
We have audited the accompanying consolidated balance sheet of Epic Resorts, LLC (a Delaware limited liability company) as of December 31, 1998, and the related consolidated statements of operations, cash flows and changes in member's equity for the years ended December 31, 1998 and 1997. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audit.
We conducted are audits in accordance with auditing standards generally accepted in the United States. 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, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of Epic Resorts, LLC as of December 31, 1998, and the results of their operations and their cash flows for the years ended December 31, 1998 and 1997, in conformity with accounting principles generally accepted in the United States.
/s/ Arthur Andersen LLP
Philadelphia, Pennsylvania March 25, 1999
Epic Resorts, LLC
CONSOLIDATED BALANCE SHEETS
December 31,
The accompanying notes are an integral part of these statements.
Epic Resorts, LLC
CONSOLIDATED STATEMENTS OF INCOME
Years ended December 31,
The accompanying notes are an integral part of these statements.
Epic Resorts, LLC
CONSOLIDATED STATEMENTS OF CHANGES IN MEMBER'S EQUITY
Years ended December 31, 1999, 1998 and 1997
The accompanying notes are an integral part of these statements.
Epic Resorts, LLC CONSOLIDATED STATEMENTS OF CASH FLOWS Year ended December 31,
The accompanying notes are an integral part of these statements.
Epic Resorts, LLC
NOTES TO FINANCIAL STATEMENTS
December 31, 1999, 1998 and 1997
NOTE A - NATURE OF BUSINESS AND BASIS OF PRESENTATION
Epic Resorts, LLC (a sole-member Delaware Limited Liability Company) and its wholly owned subsidiaries (the Company) generate revenue from the sale and financing of vacation points in its resorts. Customers acquire the right to use a fully furnished vacation residence, based upon the number of points purchased in Epic Vacation Club, in perpetuity or over an extended period not less than 35 years (Vacation Points). The Company's principal operations consist of (i) acquiring, developing and operating vacation ownership resort locations, (ii) marketing and selling Vacation Points in its resorts, and (iii) providing customer financing to individual purchasers of Vacation Points at its resorts. The Company also generates income from the transient rental of resort accommodations.
In January 1999, the Company adopted a vacation club system. The vacation club holds units of each of the Company's resort locations. The units of each resort location are contributed to the club. The club then sells "Vacation Points". Prior to January 1999, the Company sold vacation ownership interests in its resorts. The customer acquired the right to use a fully furnished vacation residence, generally for a one-week period each year.
The Company was formed in June 1998 to merge and succeed to the business of Epic Resorts, Inc. (the Predecessor) which had a sole stockholder who is the sole member of the Company. The Predecessor business was responsible for operating the wholly-owned resort at Lake Havasu City, Arizona known as London Bridge Resort, Inc. (LBR), and a majority owned resort at Daytona Beach, Florida known as Dayton Beach Regency, Ltd. (DBR).
The accompanying financial statements include the combined accounts of the Company, London Bridge Resort, Inc. and Daytona Beach Regency, Ltd., which together are now doing business as Epic Resorts, LLC. All of the entities operated under the common control of the sole stockholder. Accordingly, all of the net assets of the entities under common control have been recorded at their historical cost and their results of operations have been included in the combined results since their dates of acquisition. Minority interest reflects the historical results of operations pertaining to the 44% partnership interest in DBR for all periods up until the Company's acquisition of this minority interest in June 1998.
On June 30, 1998, the Company used $55.4 million of proceeds from a bridge loan to purchase the following resorts: Scottsdale Links Resort (a 228-suite complex in Scottsdale, Arizona), Palm Springs Marquis Villas (a 101-suite complex in Palm Springs, California) and Westpark Resort (a 152-suite complex in Las Vegas, Nevada). The total purchase price was allocated to the cost basis of inventory at these resorts in accordance with the purchase method of accounting. The Company also purchased the remaining 44% limited partnership interest in DBR at a cost of $3.3 million which has been capitalized as a component of inventory at this resort, net of the $2.4 million of minority interest acquired.
(Continued)
Epic Resorts, LLC
NOTES TO FINANCIAL STATEMENTS - CONTINUED
December 31, 1999, 1998 and 1997
NOTE A - NATURE OF BUSINESS AND BASIS OF PRESENTATION - Continued
On July 8, 1998, the Company issued 130,000 Units, representing $130 million principal amount of 13% Senior Secured Redeemable Notes due 2005 (the Notes) and warrants to purchase membership interests or warrants to purchase common stock in a private placement offering (the Offering) pursuant to Rule 144A of the Securities Act of 1933. Proceeds of the Offering were used by the Company (i) to repay the $55.4 million bridge loan described above; (ii) to repay $23.8 million of certain indebtedness of the Company; (iii) to fund an escrow of the first two interest payments under the Notes of $16.9 million; (iv) for working capital and general corporate purposes and (v) to pay fees and expenses related to the Offering and resort acquisitions. Proceeds of the Offering were also used by the Company to acquire the Planter's Quarters Resort on the island of Hilton Head in South Carolina on July 8, 1998 for cash purchase of $3.8 million. The resort contains 36 two and three bedroom suites and was accounted for by the purchase method of accounting.
On August 13, 1998, the Company filed a registration statement with the Securities and Exchange Commission relating to an exchange offer for another series of notes of the Company, containing substantially the same terms as the Notes. These notes are now available to be publicly traded and are held by institutional investors.
NOTE B - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
1. CASH AND CASH EQUIVALENTS
Cash and cash equivalents consist of cash, money market and all highly liquid investments purchased with an original maturity of three months or less. Funds received from purchases which are held during the statutory rescission period, or until all conditions are met for the sales transaction to be recognized and title conveyed, are maintained in escrow accounts and are reflected as restricted cash.
2. NOTES AND MORTGAGES RECEIVABLE
Notes and mortgages receivable reflect the amounts due from purchases of Vacation Points and Vacation Ownership Interests who have accepted financing from the Company. The obligations are evidenced by promissory notes and mortgages. The majority of these notes and mortgages receivable collateralize certain debt obligations of the Company.
Notes receivable are sold by the Company on a non-recourse basis in connection with a loan participation facility with a financial institution (see note C) and a loan securitization.
3. ALLOWANCE FOR DOUBTFUL ACCOUNTS
The Company provides for estimated future losses related to uncollectible receivables currently included in its notes receivable portfolio and in connection with substitution of collateral provisions of sales of notes receivables. The provision is estimated based upon management's estimate of losses which may result because of cancellation of the related financing contract.
(Continued)
Epic Resorts, LLC
NOTES TO FINANCIAL STATEMENTS - CONTINUED
December 31, 1999, 1998 and 1997
NOTE B - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES - Continued
4. PROPERTY AND EQUIPMENT
Property and equipment are stated at cost and depreciated using the straight-line method over the estimated useful lives. Furniture, fixtures and equipment are depreciated over a period of 5 to 7 years. Buildings and improvements are depreciated over 40 years.
5. DEFERRED FINANCING COSTS
Financing and loan origination fees incurred in connection with obtaining certain acquisition and development funding have been capitalized and are being amortized over the term of the indebtedness.
6. INCOME TAXES
The Company is a Delaware limited liability company, accordingly no federal or state income taxes are payable by the Company, and none have been provided for in the accompanying financial statements. The sole member is to include his respective share of the Company's profits or losses in his tax return.
7. SALES RECOGNITION AND SELLING POLICIES
The Vacation Points purchaser has the right to rescind or cancel their purchase contract within a set period of time following contract execution (generally three to ten calendar days depending on the state in which the sale is consummated), and is entitled to a full refund of their deposit. All funds received by the Company are held in escrow, by an independent agent, until the expiration of the rescission period and points are conveyed to the purchaser. Sales, which are principally made through installment contracts, are not recognized until the Company has received at least 10 percent of the total purchase price, the statutory rescission period has elapsed, and certificates of occupancy in the underlying units have been issued. Prior to sales recognition, all payments received are accounted for as advance deposits. Closing costs collected from the purchaser are used to offset a portion of the closing costs incurred by the Company.
8. COST OF SALES AND INVENTORY
Cost of sales is computed by allocating the total project acquisition and conversion costs associated with the total Vacation Ownership Points available for sale over the number of points available for sale, based upon fifty-one weeks of availability per individual unit. Inventory, including all development costs, contents and improvements is stated at cost, which is not greater than net realizable value. Points transferred back to the Company attributable to forfeiture, legal foreclosure, or reconveyance of a deed-in-lieu of legal foreclosure, are returned to inventory at the original amount expensed as the cost of sale. Marketing, advertising, commissions, and other selling costs are expensed as incurred.
(Continued)
Epic Resorts, LLC
NOTES TO FINANCIAL STATEMENTS - CONTINUED
December 31, 1999, 1998 and 1997
NOTE B - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES - Continued
9. COMPREHENSIVE INCOME
The Financial Accounting Standards Board (FASB) has issued Statement of Financial Accounting Standards (SFAS) No. 130, "Reporting Comprehensive Income." The standard established additional disclosure for the elements of comprehensive income and a total comprehensive income calculation. Net income as reported by the Company reflects total comprehensive income for each of the three years in the three year period ended December 31, 1999.
10. USE OF ESTIMATES
The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amount of revenues and expenses during the reporting period. Actual results could differ from those estimates.
11. NEW ACCOUNTING PRONOUNCEMENTS
In June 1998, the FASB issued SFAS No. 133, "Accounting for Derivative Instruments and Hedging Activities". SFAS No. 133 will require the Company to record all derivatives on the balance sheet at fair value. Changes in derivative fair values will either be recognized in earnings as offsets to the changes in fair value of related hedged assets, liabilities and firm commitments or for forecasted transactions, deferred and recorded as a component of accumulated other comprehensive income (loss) in member's equity until the hedged transactions could occur and are recognized in earnings. The ineffective portion of a hedging derivative's change in fair value will be immediately recognized in earnings. In June 1999, the FASB issued SFAS No. 137, "Accounting for Derivative Instruments and Hedging Activities - Deferral of the Effective Date of SFAS No. 133." SFAS No. 133 is now effective for fiscal years beginning after June 15, 2000. The Company expects to adopt SFAS No. 133 on January 1, 2001 and does not believe the effect of adopting SFAS No. 133 will have any material effect on its consolidated financial position or results of operations.
NOTE C - NOTES AND MORTGAGES RECEIVABLE
The Company provides financing to its customers, which is collateralized by such purchasers' Vacation Points or Vacation Ownership Interests. The Company offers certain customers, who make deposits of 33%, one-year financing on an noninterest-bearing basis. The notes generally mature over terms which approximate 84 months, with fixed interest rates ranging from 13.9 percent to 16.9 percent, per annum. The notes may be prepaid at any time, without penalty. The weighted average rate of interest on outstanding notes receivable is 14.2%, 15.5% and 14.9% for the years ended December 31, 1999, 1998 and 1997, respectively.
(Continued)
Epic Resorts, LLC
NOTES TO FINANCIAL STATEMENTS - CONTINUED
December 31, 1999, 1998 and 1997
NOTE C - NOTES AND MORTGAGES RECEIVABLE - Continued
The following schedule reflects the schedule principal maturities of notes and mortgages receivable:
The activity in the notes and mortgages receivable allowance for doubtful accounts is as follow:
During 1999 and 1998, the Company sold $68,061,000 and $45,479,000 of notes and mortgages receivable as part of its $75 million Vacation Ownership Loan Participation Facility (Receivables Facility). Under this Receivables Facility, the Company sells its Vacation Points Receivables on a non-recourse basis to Epic Master Funding Corporation (Epic Funding), a wholly-owned subsidiary which is a qualifying special purpose entity as defined in SFAS No. 125, "Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities." The Receivables Facility provides for advance rates of 88% of the lesser of (i) unpaid principal balance of the receivables sold or (ii) the market value of such receivables as determined by the financial institution. The Receivables Facility contains a customary provision requiring the substitution of collateral in an equal amount if receivables become 60 days past due.
(Continued)
Epic Resorts, LLC
NOTES TO FINANCIAL STATEMENTS - CONTINUED
December 31, 1999, 1998 and 1997
NOTE C - NOTES AND MORTGAGES RECEIVABLE - Continued
The Company accounts for the transfers of receivables to Epic Funding as sales in accordance with SFAS No. 125. Gains on the sale of a portion of notes receivable are based on the relative fair market value of the note receivable portions sold and retained. At December 31, 1999 and 1998, the retained interests were valued by the Company assuming discount rates of 11.50% and 10% respectively, including estimated defaults and prepayments applied to the residual cash flows. The Company accounts for this investment as a trading security in accordance with SFAS No. 115, "Accounting for Certain Investments and Debt Securities". The Company records changes in the fair value of the investment as other financing income, which is a component of gains on sales of receivables and other financing income in the consolidated statements of income.
In December 1999, the Company and Epic Funding completed a sale of $78 million of receivables to Epic Receivables 1999, a wholly-owned qualifying special purpose entity, for the purpose of Epic Receivables 1999 entering into a $95 million securitization transaction. The closing resulted in net proceeds of approximately $87 million, of which $68 million was used to pay down the Receivables Facility. $16 million was recorded in a prefunding account to be drawn on as additional receivables become available through March 15, 2000, (which the Company drew down during the first quarter of 2000) and $3.1 million was placed into escrow as reserves for payments of principal and interest to the note holders in the securitization. The Company retains an interest in the excess cash flows of Epic Receivables 1999, which is recorded at fair value and is classified as a residual interest. The escrow reserves are reflected in cash in escrow and have been discounted to reflect their current fair market value.
Gains on sales of receivables and other financing income consists of the following for the years ended December 31:
NOTE D - INVENTORY
Inventory and accumulated cost of sales consist of the following as of December 31:
Epic Resorts, LLC
NOTES TO FINANCIAL STATEMENTS - CONTINUED
December 31, 1999, 1998 and 1997
NOTE E - PROPERTY AND EQUIPMENT
Property and equipment consist of the following as of December 31:
NOTE F - SENIOR SECURED NOTES AND NOTES PAYABLE
On July 8, 1998, the Company issued 130,000 units, representing $130,000,000 principal amount of Senior Secured Redeemable Notes (the Notes). The Notes bear interest at the rate of 13% per annum, payable semiannually on June 15 and December 15 of each year and are scheduled to mature on June 15, 2005. The notes were recorded at their fair value less the initial value of warrants of $2,757,000 and will be accreted to their redeemable value through maturity. The Company maintains $8,450,000 at all times in escrow to cover the next required interest payment.
All of the Company's operating subsidiaries (the Subsidiary Guarantors) have fully and unconditionally guaranteed the Notes. Epic Resorts, LLC's activities are limited to owning and operating the Company's six resort properties. In addition, their activities include the owning and collecting of the Company's investment in the residual interests. Accordingly, the combined financial information of the Subsidiary Guarantors is equivalent to the consolidated financial statements of the Company, except for the Company's investment in the residual interest of $29,465,000 and $15,223,000 at December 31, 1999 and 1998, respectively, as described in note C. The holders of the Notes would have a direct claim to the residual interest in the event of a default, as defined, under the Notes. The separate financial statements and other disclosures concerning the Subsidiary Guarantors are not presented because management has determined that they are not material to investors.
Between June 15, 2000 and June 15, 2002, the Company is required to make offers to the noteholders to purchase the notes at 101% of the aggregate principal amount up to the maximum amount of $65,000,000.
Concurrent with the issuance of the Notes, the Company issued 130,000 warrants with a par value of $.01 per warrant. These warrants have been valued using the Black-Scholes pricing model and are being amortized as a component of additional interest expense over the seven year term of the Notes. The amortization increases the redemption value of the notes through maturity.
(Continued)
Epic Resorts, LLC
NOTES TO FINANCIAL STATEMENTS - CONTINUED
December 31, 1999, 1998 and 1997
NOTE F - SENIOR SECURED NOTES AND NOTES PAYABLE - Continued
During 1998, in connection with the repayment of debt related to proceeds of the Offering, the Company incurred $2,055,000 of prepayment penalties. The Company wrote off $667,000 of unamortized deferred financing costs related to the extinguished debt. During the fourth quarter of 1998, the Company used the proceeds from the initial funding of the Receivables to pay off $20.0 million of outstanding notes payable. The Company incurred $2,029,000 of prepayment penalties and wrote off $613,000 of unamortized deferred financing costs. These expenses have been reflected as extraordinary losses in the accompanying statement of income for the year ended December 31, 1998.
Notes payable at December 31, 1999 and 1998 consist of the following:
NOTE G - RELATED PARTY TRANSACTIONS
As of December 31, 1999 and 1998, the Company has accrued $967,000 and $829,000 as receivables from various homeowners' associations at its resorts. The Company generally accrues receivables from homeowners' associations for management fees and certain other expenses paid on behalf of the homeowners' associations. The receivables are included in other assets in the accompanying consolidated balance sheets.
In 1998, the Company paid $1,601,000 of construction and inventory-related items to certain companies which are affiliated with a manager and member of the Company's Advisory Board. The Company believes that these transactions have been made on substantially the same terms as those prevailing in the current market place.
In October 1990, the Company obtained a nonrecourse line of credit not to exceed $3,413,000 from an affiliate of the sole member, all of which remained outstanding as of December 31, 1997. The loan was collateralized by an assignment of a second mortgage on the Company's property. This loan is subordinated to the claims of the Company's construction and equipment loans and was not payable until these notes were paid in full. Interest accrued at a rate of 8.5% per annum up to a maximum amount of $500,000. Upon reaching $500,000 in 1995 the note became noninterest bearing and the accrued liability was capitalized into the loan's principal. During 1998, 1997 and 1996, no interest was accrued under the terms of this note. This note, together with a fee paid to a related party of $1,087,000, was paid in full during 1998 with the proceeds of the Offering.
Through June 30, 1998, in the normal course of operations, an affiliate of the sole member provided the Company with administrative services including payroll and insurance processing.
Epic Resorts, LLC
NOTES TO FINANCIAL STATEMENTS - CONTINUED
December 31, 1999, 1998 and 1997
NOTE H - COMMITMENTS AND CONTINGENCIES
1. LEASES
The Company leases commercial real estate to various retail operators, for the operation of a shopping mall, under various lease agreements that expire through January 2009. Future minimum rental income expected to be recognized from noncancellable operating leases on a straight-line basis as of December 31, 1999, is as follows:
The Company has various operating lease agreements, primarily for its home office, sales offices and land at its Palm Springs, California resort. These obligations generally have remaining noncancellable terms of five years or less, except the land lease which has a sixty-five year term. Future minimum lease payments are as follows for the years ending December 31:
Rent expense amounted to $1,087,000, $298,000 and $118,000 for the three years ended December 31, 1999, 1998 and 1997, respectively.
2. LITIGATION
The Company is a defendant in various lawsuits in the ordinary course of business. Management is defending against these actions and does not believe the suits will have a material impact on the Company's financial position or results of operations.
Epic Resorts, LLC
NOTES TO FINANCIAL STATEMENTS - CONTINUED
December 31, 1999, 1998 and 1997
NOTE I - FAIR VALUE OF FINANCIAL INSTRUMENTS
SFAS No. 107, "Disclosures About Fair Value of Financial Instruments," requires that the Company disclose estimated fair values for its financial instruments. The following methods and assumptions were used by the Company in estimating its fair value disclosures for financial instruments.
CASH AND CASH EQUIVALENTS: The carrying amount reported in the balance sheets for cash and cash equivalents approximates their fair value because of the short-term maturity of these instruments.
CASH IN ESCROW: The carrying amounts reported in the balance sheets have been discounted to reflect estimated fair value.
INVESTMENT IN RESIDUAL INTERESTS: The carrying amounts reported in the balance sheets approximate fair value.
NOTES AND MORTGAGES RECEIVABLE: The carrying amounts reported in the balance sheets for notes and mortgages receivable approximates their fair value because the weighted average interest rate on the portfolio of notes and mortgages receivable approximates current interest rates to be received on similar current notes and mortgages receivable.
SENIOR SECURED NOTES PAYABLE AND NOTES PAYABLE: The carrying amounts reported in the balance sheets approximates their fair value because the interest rates on these instruments approximate current interest rates charged on similar current borrowings.
NOTE J - SEGMENT AND GEOGRAPHIC INFORMATION
The Company operates in one industry segment, which includes the development, acquisition, marketing, selling, financing and management of vacation ownership resorts. The Company does not operate outside of the United States. The Company's customers are not concentrated in any specific geographic region and no single customer accounts for a significant amount of the Company's sales.
NOTE K - SUMMARY OF QUARTERLY RESULTS (UNAUDITED)
The following presents a summary of the unaudited quarterly financial information for the years ended December 31, 1999 and 1998:
(Continued)
Epic Resorts, LLC
NOTES TO FINANCIAL STATEMENTS - CONTINUED
December 31, 1999, 1998 and 1997
NOTE K - SUMMARY OF QUARTERLY RESULTS (UNAUDITED) - Continued
------------------------------------ (1)Expenses during the 3rd quarter of 1998 include start-up and staffing costs incurred prior to the commencement of sales operations at the newly acquired resorts.
(2)On June 30, 1998, the Company completed the buyout of minority interest upon the acquisition of all of the minority partner's interest in Daytona Beach Regency, Ltd.
(3)Represents the extraordinary losses on the early repayments of existing company indebtedness, including prepayment penalties and write-off of unamortized deferred, financing costs (see note F to the consolidated financial statements).
ITEM 9.
ITEM 9.CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
The Company filed a current report on Form 8-K, regarding a change in the Company's independent accountants, dated March 3, 2000.
PART III
ITEM 10.
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
MANAGING MEMBER
The Company's Managing Member is Epic Membership Corp., a Delaware corporation wholly owned by Mr. Flatley. Pursuant to the Company's Operating Agreement, the Managing Member has the sole power to conduct, manage, control and make all decisions affecting the conduct of the business, assets and affairs of the Company. The Company also maintains a Board of Managers which acts in an advisory capacity to the Managing Member and performs such other functions as delegated to it by the Managing Member.
EXECUTIVE OFFICERS
The following table sets forth certain information concerning the executive officers of the Company. Officers hold office until their successors are elected and qualified.
Thomas F. Flatley has been President, Chief Executive Officer and a Director of predecessors of the Company since 1991. Mr. Flatley has also served as the President and a Director of American Financial Mortgage Corporation, a national mortgage banking company, since 1988. From 1974 to 1982, Mr. Flatley practiced as a Certified Public Accountant with Price Waterhouse, LLP. Mr. Flatley was recently awarded the 1998 ARDA Community Service Award.
Scott J. Egelkamp has been Vice President and Chief Financial Officer of predecessors of the Company since 1992. Mr. Egelkamp has also served, since 1988, as Vice President and Chief Financial Officer of American Financial Mortgage Corporation. Mr. Egelkamp has over 15 years of experience as a financial manager in service and manufacturing environments.
ITEM 11.
ITEM 11. EXECUTIVE COMPENSATION
SUMMARY COMPENSATION TABLE. The following table sets forth, for the fiscal years 1997 and 1998, certain information about the compensation paid to the chief executive officer and the other executive officers of the Company.
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(a) Mr. Flatley did not receive a salary in 1997.
EMPLOYMENT AGREEMENTS. Each of Thomas F. Flatley and Scott J. Egelkamp have entered into employment agreements with the Company. Each agreement provides for an employment term of three years, commencing May 20, 1998 (the "Employment Period") and an annual base salary of $280,000 and $125,000, for Mr. Flatley and Mr. Egelkamp, respectively. The annual base salary is subject to increase at the discretion of the Chief Executive Officer of the Company. Each of Mr. Flatley and Mr. Egelkamp's employment agreements provide that if he is terminated for any reason other than violation of the agreement, he is entitled to 120 days notice prior to termination, to payment of all accrued and unpaid salary and benefits through the date of termination, and a lump sum payment equal to one year of his salary. In addition, if the employment agreement of either officer is terminated without cause upon the occurrence of a merger, consolidation or other business combination in which the Company is not the surviving entity, such officer will be entitled to a lump sum payment equal to two years of his salary.
Pursuant to the employment agreements, each of the Executive Officers has agreed:
not to compete with the Company in the vacation ownership business during the Employment Period and for a period of six months after the termination of such period,
to keep all proprietary information of the Company confidential for a period of two years following the termination of his employment with the Company, and
that he will not solicit any employee to leave the employ of the Company during the Employment Period or for two years following the termination of his employment with the Company.
LIFE INSURANCE POLICY. The Company purchased an annual renewable term life insurance policy on Mr. Flatley from CNA Life Insurance Company. This policy has a face value of $15 million. The Company is the sole beneficiary of this policy.
ITEM 12.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
99% of the 1,118,000 outstanding membership interests in the Company are held by Mr. Flatley, its President and Chief Executive Officer. The remaining 1% of outstanding membership interests are owned by the Managing Member of the Company, Epic Membership Corp., which is wholly owned by Mr. Flatley. In connection with the offering of the Notes, the Company issued warrants exercisable in the aggregate for approximately 14% of the total outstanding membership interests on a fully diluted basis after giving effect to the offering of the Notes.
ITEM 13.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
In October 1990, London Bridge Resort obtained a line of credit not to exceed $3,412,545. This loan was collateralized by an assignment of a second mortgage on London Bridge Resort's facilities and properties. The loan was subordinate to the claims of London Bridge Resort's construction and equipment loans and would become payable when those construction and equipment loans were paid in full. American Realty Group, Inc., a Pennsylvania corporation wholly owned by Mr. Flatley ("American Realty"), was the holder of a promissory note evidencing such loan (the "American Realty Debt"). Interest on the promissory note accrued at a rate of 8.5% per annum up to a maximum amount of $500,000. In 1995, interest accrued to $500,000 and the promissory note became non-interest bearing. As of December 31, 1997, the balance of the promissory note was $3,912,545, and was repaid in July 1998 out of the proceeds of the offering of the Notes. Pursuant to an Agreement to Subordinate dated October 30, 1995, between American Realty and Queen's Bay Joint Venture (the predecessor to London Bridge Resort, LLC.), American Realty was entitled to receive a fee of $1,087,455 upon the repayment of certain financing of Queen's Bay Joint Venture as consideration for American Realty's agreement to subordinate the American Realty Debt to such financing. Such fee was paid in July 1998 in connection with the offering of the Notes.
PART IV
ITEM 14.
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K.
(a) FINANCIAL STATEMENTS
Exhibit 27vFinancial Data Schedule.
(b) REPORTS. No reports on Form 8-K have been filed during the last quarter of the fiscal year ended December 31, 1999.
(c) EXHIBITS
(d) FINANCIAL STATEMENT SCHEDULES
Schedules are omitted because they are not applicable or are not required or because the information is reported in the consolidated financial statements or notes thereto.
Supplemental information to be furnished with reports filed pursuant to Section 15 of the Act by Registrants which have not registered securities pursuant to Section 12 of the Act. No annual report or proxy statement covering
the Company's last fiscal year has been or will be circulated to security holders.
SIGNATURE
Pursuant to the requirements of Section 13 of the Securities Exchange Act of 1934, the registrant has duly caused this annual report on Form 10-K to be signed on its behalf by the undersigned thereunto duly authorized.
EPIC RESORTS, LLC Date: April 14, 2000 By:
Scott J. Egelkamp VICE PRESIDENT AND CHIEF FINANCIAL OFFICER (DULY AUTHORIZED OFFICER AND PRINCIPAL FINANCIAL OFFICER)
Pursuant to the requirements of the Securities Exchange Act of 1934, this annual report on Form 10-K has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated.