ITEM 3. LEGAL PROCEEDINGS
The Company is subject to litigation arising in the normal course of its business. Litigation has been initiated from time to time by persons seeking individual recoveries for themselves, as well as, in some instances, persons seeking recoveries on behalf of an alleged class. The Company has been able to settle such claims in the past upon terms that it believes were immaterial to its operations and financial condition. Such litigation includes claims regarding matters concerning employment, tort, contract, truth-in-lending, marketing and sale of Vacation Intervals, and other consumer protection related matters.
CERTAIN ALLEGED CLASS ACTION CLAIMS. In September 1999, an action was commenced against the Company by various named Plaintiffs who brought the action on behalf of themselves and on behalf of a purported class of plaintiffs made up of persons who purchased Vacation Intervals from the Company between 1995 and 1999. The case was filed in federal district court in Texas in reliance upon alleged violations of the federal truth in lending statutes. The asserted claims involved an alleged inconsistency between the way a certain handling and recording fee was described in the contract signed by each alleged class member and the form of the settlement statement utilized by the Company to close the sales. While the Company believes that the case was without merit and that it would have been successful in defending the action in court, the Company determined that it would be less expensive to settle the matter than to defend it. The Company and the named Plaintiffs settled the claim through mediation. The settlement was later approved by the court. Except for the costs of setting aside sales of approximately fifteen Vacation Intervals and a $75,000 lump sum payment to named Plaintiffs, the Company paid no money; however, the Company did agree to certification of a class so that it could receive a release in a form which bound the entire class concerning the allegations raised in the complaint. The Company believes that the value of the recovered Vacation Intervals essentially offset the payments made to the twenty-seven named Plaintiffs. Additionally, the Company granted upgrade credits ranging from $20 to $350 per Vacation Interval to class members to upgrade their Vacation Interval to a higher price interval. The upgrade credits may not be used for any other purpose and are non-transferable, non-assignable and expire if unused in 2002. The Company also paid the legal fees of the counsel for the named Plaintiffs in an amount of approximately $514,000.
A second purported class action suit was filed in state district court in Texas against the Company in March 2000 by various Named Plaintiffs who brought the action on behalf of themselves and on behalf of a purported class of Plaintiffs made up of persons who owned a Vacation Interval, with Bonus Time Privileges. The Plaintiffs asserted various claims against the Company based primarily on the Company's sale of Vacation Intervals with Bonus Time Program benefits. The Plaintiffs asserted there were various misrepresentations regarding the limitations on the use of the Bonus Time, as well as other similar allegations. The Company believes it had substantial defenses to the claims asserted by the Plaintiffs and had made more than adequate written disclosures as well as signed acknowledgments from each purported class member regarding the limitations of the Bonus Time Program, which would have prevented any recovery under the various theories relied upon. In addition, the Company believes that the court would not have certified the case as a class action because there were too many fact issues applicable to each putative class member. The case was successfully submitted to mediation and a Mediation Settlement Agreement and Memorandum of Understanding was signed by the parties. This out of court settlement was subsequently approved by the court. All members of the class, including the Named Plaintiffs, released the Company and the Silverleaf Club from any and all claims they held in regards to the suit. In return, the Company and Silverleaf Club released the Named Plaintiffs, and Silverleaf Club provided all Class Members with one Preferred Guest Reservation Certificate. These Certificates allow the holder to receive a five night and six day reservation (Sunday through Thursday and during white or blue color times only) at one of the Company's resorts during a four year period, so long as the holder is current on their dues and note payable obligations. Each Certificate is guaranteed by the Company but only to the extent of $100 per Certificate if the reservation cannot be fulfilled. In addition to the Certificates the Company and the Silverleaf Club, agreed to make various changes to its sales, operating and marketing procedures, including changes to its Bonus Time Program which the Company implemented in 2001. As part of the settlement, the Company also paid the Class Representatives $8,000 for each time share week owned for a total of $120,000 and set aside fifteen Vacation Interval sales to the Class Representatives. Finally, in order to facilitate a prompt conclusion to this matter on grounds deemed to be favorable, the Company paid $1,000,000 in attorneys' fees, plus court costs. The Company also paid Plaintiff's counsel $30,000 for all expenses.
An additional purported class action was filed in state district court in Texas against the Company on October 19, 2001 by Plaintiffs who each purchased Vacation Intervals from the Company. The Plaintiffs allege that the Company violated the Texas Timeshare Act, the Texas Deceptive Trade Practices Act and the Texas Timeshare Act by failing to deliver to them complete copies of the contracts for the purchase of the Vacation Intervals as they did not receive a complete legal description of the Hill Country Resort as attached to the Declaration of Restrictions, Covenants and Conditions of the Resort. The Plaintiffs also claim that the Company violated various provisions of the Texas Deceptive Trade Practices Act with respect to the maintenance fees charged by the Company to its Vacation Interval owners. The Petition asserts Texas class
action allegations and alleges actual damages in the amount of $34,536,505 plus consequential damages in an unspecified amount and all attorneys' fees, expenses and costs. The Company intends to vigorously defend against the Plaintiffs' claims and believes it has valid defenses to the claims. Discovery with regard to the Plaintiffs' claims is still at the preliminary stage. The Company was only recently served with this action and has not yet fully assessed the claims.
A further purported class action was filed in state district court against the Company on February 26, 2002, by a couple who purchased a Vacation Interval from the Company. The Company was served with this action via U. S. Mail and first received a copy of the Plaintiff's original petition on or about March 5, 2002. The Plaintiffs allege that the Company violated the Texas Government Code by charging a document preparation fee in regard to instruments affecting title to real estate. Alternatively, the Plaintiffs allege that the document preparation fee constituted a partial prepayment that should have been credited against their note and additionally seek a declaratory judgment. The petition asserts Texas class action allegations and seeks recovery of the $275.00 document preparation fee and treble damages for a total of $1,100.00, and injunctive relief preventing the Company from engaging in the unauthorized practice of law in connection with the sale of its Vacation Intervals in Texas. Since the Company was served very recently, it is in the process of retaining defense counsel and has not yet had sufficient time to evaluate the merits of the case.
CERTAIN CONSTRUCTION CLAIMS BY CONDOMINIUM OWNERS. The homeowner associations of three condominium projects that a former subsidiary of the Company constructed in Missouri filed separate actions against the Company and one of its subsidiaries alleging construction defects and breach of management agreements pursuant to which the Company is responsible for the management of the projects. Two of the suits have been consolidated. One of the Company's insurers has agreed to provided a defense to the Company, subject to a reservation of rights. The Company paid approximately $1.3 million in 1999 and 2000 correcting a portion of the problems alleged by the Plaintiffs. The Company believes that a substantial portion of these costs may be reimbursed by its insurance carrier though the Company continues to contest additional claims alleged by the Plaintiffs. The Company cannot predict the final outcome of these claims and cannot estimate the additional costs it could incur.
Additional claims may be made against the Company in the future. Following a complete assessment of such claims, the Company will either defend the claims or attempt to settle such claims out of court if management believes that the cost of settlement would be less than the cost to defend such matters.
Various legal actions and claims may be instituted or asserted in the future against the Company and its subsidiaries, including those arising out of the Company's sales and marketing activities and contractual arrangements. Some of the matters may involve compensatory, punitive or other treble damage claims in very large amounts, which, if granted, could be materially adverse to the Company's financial condition.
Litigation is subject to many uncertainties, and the outcome of individual litigated matters is not predictable with assurance. Reserves will be established from time to time by the Company when deemed appropriate under generally acceptable accounting principles. However, the outcome of a claim for which the Company has not deemed a reserve to be necessary may be decided unfavorably to the Company and could require the Company to pay damages or make other expenditures in amounts or a range of amounts that could be materially adverse to the Company.
ITEM 4.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted to a vote of security holders during the fourth quarter of 2000.
PART II
ITEM 5.
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
The following table sets forth the high and low closing prices of the Company's common stock for the quarterly periods indicated, which correspond to the quarterly fiscal periods for financial reporting purposes. Prices for the common stock are closing prices on the NYSE through June 2001 and last sale prices reported by the Electronic Quotation Service of the Pink Sheets LLC.
The Company's common stock was traded on the NYSE until June, 2001 when it was suspended from trading and subsequently delisted in August 2001. Since August 2001, there has been no established market for the common stock; however, the common stock has been quoted since then on the Electronic Quotations Service of the Pink Sheets LLC under the symbol "SVLF." The Pink sheets are not an exchange but only an interdealer quotation system. Quotations appearing in the Pink Sheets may not necessarily be indicative of actual trading activity. The Pink Sheets may be accessed over the internet at www.pinksheets.com.
Because of the various uncertainties related to the Company's future prospects, it is unlikely that an active public trading market will develop for the Common Stock in the foreseeable future and the Common Stock may be illiquid or experience significant price and volume volatility.
DIVIDEND POLICY
The Company is, and will continue to be restricted from paying dividends and, therefore, does not intend to pay cash dividends on its common stock in the foreseeable future. The Company currently intends to retain future earnings to finance its operations and fund the growth of its business. Any payment of future dividends will be at the discretion of the Board of Directors of the Company and will depend upon, among other things, the Company's earnings, financial condition, capital requirements, level of indebtedness, contractual and other restrictions in respect of the payment of dividends, and other factors that the Company's Board of Directors deems relevant.
ITEM 6.
ITEM 6. SELECTED FINANCIAL DATA
The following selected historical consolidated financial data has been taken or derived from the consolidated financial statements of the Company and should be read in conjunction with the consolidated financial statements and the notes thereto beginning on page, of which the Report of the Independent Auditors contains a disclaimer of opinion with respect to the consolidated financial statements for the year ended December 31, 2000 as a result of pervasive uncertainties related to the Company's ability to continue as a going concern.
As discussed in Note 19 to the Company's consolidated financial statements beginning on Page, the Company's financial statements have been restated to give effect to adjustments identified subsequent to their original issuance.
(1) Earnings (loss) per share are based on the weighted average number of shares outstanding. Diluted income from continuing operations per share and net income per share for the year ending December 31, 1998 were $1.37.
(2) Adjusted EBITDA represents income (loss) from operations before interest expense, income taxes and depreciation and amortization and impairment loss of long lived assets. Adjusted EBITDA is presented because it is a widely accepted indicator of a company's financial performance. However, Adjusted EBITDA should not be construed as an alternative to net income (loss) as a measure of the Company's operating results or to cash flows from operating activities (determined in accordance with generally accepted accounting principles) as a measure of liquidity. Since revenues from Vacation Interval sales include promissory notes received by the Company, Adjusted EBITDA does not reflect cash flow available to the Company. Additionally, due to varying methods of reporting Adjusted EBITDA within the timeshare industry, the computation of EBITDA for the Company may not be comparable to other companies in the timeshare industry which compute EBITDA in a different manner. The Company's management interprets trends in EBITDA to be an indicator of the Company's financial performance, in addition to net income and cash flows from operating activities (determined in accordance with generally accepted accounting principles).
ITEM 7.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following discussion should be read in conjunction with the "Selected Financial Data" and the Company's Financial Statements and the notes thereto and other financial data included elsewhere herein. The following Management's Discussion and Analysis of Financial Condition and Results of Operations contains forward-looking statements that involve risks and uncertainties. The Company's actual results could differ materially from those anticipated in these forward-looking statements.
Subsequent to the issuance of its annual and interim financial statements for the year ended December 31, 1999 and the quarterly periods in the nine months ended September 30, 2000, the Company's management determined that accounting treatment afforded to certain types of transactions was inappropriate. Accordingly, the previously reported financial information for the first, second, and third quarters of 2000, the year ended December 31, 1999 and all quarters within 1999, and the year ended December 31, 1998 have been restated. Such restatement is further discussed in Note 19 to the Company's financial statements included herein. The discussion and analysis below takes into account the effect of the restatement.
OVERVIEW
In February 2001, the Company announced liquidity concerns arising from the inability to close a credit facility with its largest secured creditor. Since then, Company management and its financial advisors have been attempting to develop and implement a plan to return the Company to a liquid financial condition. During this period, the Company negotiated and closed short-term secured financing arrangements with its three principal secured lenders, which allowed it to operate at reduced sales levels as compared to 1999 and 2000. The Company remained in default under its agreements with these three secured lenders, but they each agreed to forebear taking any action as a result of the Company's defaults and to continue funding so long as the Company complies with the terms of the short-term financing arrangements with these lenders. Unless extended, these short-term arrangements expire March 31, 2002. In addition, the Company is in monetary default regarding delinquent interest due on the senior subordinated notes of $3.5 million and $3.9 million payable on April 1, 2001 and October 1, 2001, respectively, and principal due upon acceleration of maturity in May 2001. The Company is also in default due to under-collateralization under a non-revolving credit facility with the fourth secured creditor. If the Company is unable to complete the restructuring plan, it will not have sufficient cash to pay the principal and interest payments due under the secured credit facilities and senior subordinated notes. In that event, it is likely that the Company will be forced to seek protection from its creditors through a court-supervised reorganization.
CRITICAL ACCOUNTING POLICIES
The Company generates revenues primarily from the sale and financing of Vacation Intervals, including upgraded intervals. Additional revenues are generated from management fees from the Management Clubs, lease income from Sampler sales, and utility operations.
The Company recognizes Vacation Interval sales revenues on the accrual method. A sale is recognized after a binding sales contract has been executed, the buyer has made a down payment of at least 10%, and the statutory rescission period has expired. If all accrual method criteria are met except that construction is not substantially complete, revenues are recognized on the percentage-of-completion basis. Under this method, the portion of revenue applicable to costs incurred, as compared to total estimated construction and direct selling costs, is recognized in the period of sale. The remaining amount is deferred and recognized as Vacation Interval sales in future periods as the remaining costs are incurred. Certain Vacation Interval sales transactions are deferred until the minimum down payment has been received. The Company accounts for these transactions utilizing the deposit method. Under this method, the sale is not recognized, a receivable is not recorded, and inventory is not relieved. Any cash received is carried as a deposit until the sale can be recognized. When these types of sales are cancelled without a refund, deposits forfeited are recognized as income and the interest portion is recognized as interest income.
The Company accounts for uncollectible notes by recording a provision to its allowance for uncollectible notes at the time revenue is recognized. The Company classifies the components of the provision for uncollectible notes into the following three categories based on the nature of the item -- credit losses, customer returns (customers who fail to make their first installment payment), and customer releases (voluntary cancellations of properly recorded sales transactions, which in the opinion of management are consistent with the maintenance of overall customer goodwill). The provision for uncollectible notes pertaining to credit losses, customer returns, and customer releases is classified in the Consolidated Statements of Operations in provision for uncollectible notes, Vacation Interval sales, and operating, general and administrative expenses, respectively. The Company sets the provision for uncollectible notes at an amount sufficient to maintain the allowance at a
level which management considers adequate to provide for anticipated losses from customers' failure to fulfill their obligations under the notes. When inventory is returned to the Company, any unpaid notes receivable balances are charged against the previously established bad debt reserves net of the amount at which the Vacation Interval is restored to inventory, which is the lower of the historical cost basis or market value of the Vacation Interval.
Costs associated with the acquisition and development of resorts (including land, construction costs, furniture, interest, and taxes) are capitalized and included in inventory. Vacation Interval inventory is segregated into three ratings based on customer demand, with greater costs apportioned to higher value ratings. As Vacation Intervals are sold, these costs are deducted from inventory on a specific identification basis.
Vacation Intervals may be reacquired as a result of (i) foreclosure (or deed in lieu of foreclosure) and (ii) trade-in associated with the purchase of an upgraded or downgraded Vacation Interval. Vacation Intervals reacquired are recorded in inventory at the lower of their original cost or market value. Vacation Intervals that have been reacquired are relieved from inventory on a specific identification basis when resold. Inventory acquired prior to 1996 through the Company's program to reacquire Vacation Intervals owned but not actively used by Silverleaf Owners has a significantly lower average cost basis than recently constructed inventory, contributing significantly to historical operating margins. New inventory added through the Company's construction and acquisition programs has a higher average cost than the Company's pre-1996 inventory.
The Company recognizes interest income as earned. As interest payments become delinquent, the Company ceases recognition of the interest income until collection is probable.
The Company recognizes a maximum management fee of 15% of Silverleaf Club's gross revenues and 10% to 15% of Crown Club's dues collected, subject to a limitation of each Club's net income. However, if the Company does not receive the maximum management fees, such deficiency is deferred for payment in succeeding years, subject again to the net income limitation.
LIQUIDITY AND CAPITAL RESOURCES
Since February 2001, when the Company disclosed significant liquidity issues arising primarily from the failure to close a credit facility with its largest secured creditor, management and its financial advisors have been attempting to develop and implement a plan to return the Company to a liquid financial condition. During this period, the Company negotiated and closed short-term secured financing arrangements with its three principal secured lenders, which allowed it to operate at reduced sales levels as compared to 1999 and 2000. The Company remained in default under its agreements with these three secured lenders, but they each agreed to forebear taking any action as a result of the Company's defaults and to continue funding so long as the Company complies with the terms of the short-term financing arrangements with these lenders. Unless extended, these short-term arrangements expire March 31, 2002. In addition, the Company is in monetary default regarding interest due on the senior subordinated notes of $3.5 million and $3.9 million payable on April 1, 2001 and October 1, 2001, respectively, and principal due upon acceleration of maturity in May 2001. The Company is also in default due to under-collateralization under a non-revolving credit facility with the fourth secured creditor.
Under the proposed terms of the Exchange Offer, the agreeing holders of the senior subordinated debt notes will exchange their notes (the "Old Notes") for 65% of the post-Exchange Offer Silverleaf common stock and new notes (the "New Notes") for 50% of the original note balance bearing interest ranging from 5%, if 80% of the Old Notes are exchanged, to 8%, if 98% or more of the Old Notes are exchanged. Additionally, under the terms of the Exchange Offer, the Indenture related to the Old Notes will be amended, substantially reducing the rights of the original holders and making the Old Notes subordinate to the New Notes. Under the terms of the proposed reconstitution of the Board, following the Exchange Date, the five member Board of Directors will be comprised of (i) two existing directors, (ii) two directors designated for election by the Noteholders' Committee, and (iii) a fifth director elected by a majority vote of the other four directors. As a condition to the Exchange Offer, the secured credit facilities with the Company's four principal secured creditors must be restructured (including the waiver of any and all defaults) in a manner acceptable to the exchanging holders.
In this regard, management has negotiated two-year revolving, three-year term out, arrangements for $214 million with its three principal secured lenders, subject to completion of the Exchange Offer and funding under the off-balance sheet $100 million credit facility through the Company's Special Purpose Entity ("SPE"). Under these revised credit arrangements, two of the three creditors will convert $43.6 million of existing debt to a subordinated tranche B. Tranche A will be secured by a first lien on currently pledged notes receivable. Tranche B will be secured by a second lien on the notes, a lien on resort assets, an assignment of the Company's management contracts with the Clubs, a portfolio of unpledged receivables currently ineligible for pledge under the existing facility, and a security interest in the stock of the Company's SPE. Among other aspects of these revised arrangements, the Company will be required to meet certain financial covenants, including
maintaining a minimum tangible net worth of $100 million or greater, as defined, an acceptable level of sales and marketing expenses, a notes receivable delinquency rate below 25.0%, a minimum interest coverage ratio, and a minimum net income. However, such results cannot be assured.
Management negotiated a revised arrangement with the lender under the $100 million off-balance sheet credit facility through the Company's SPE. This arrangement requires completion of both the Exchange Offer and the arrangements with senior lenders described above. This revised facility will have a term of five years, however, the lender will have the right to put the loan back to the SPE after two years. It is vitally important to the Company's liquidity plan that this credit facility, or another new facility, continues beyond the two-year period. In addition, the Company's business plan assumes that expanded off-balance-sheet financing will be available to the Company in 2003 and 2004. This expanded facility will be necessary to reduce outstanding balances on non-revolving credit facilities and to finance future sales. Factors that could affect the Company's ability to obtain additional off-balance-sheet financing are as follows:
o Capital markets must be available to fund off-balance-sheet financings.
o The current facility requires a minimum number of payments and credit criteria before a customer note is eligible for funding. Management believes that the expanded facilities necessary in 2003 and 2004 will require enhanced eligibility requirements for customer notes receivable. Management has implemented revised sales practices that it believes will result in higher quality notes receivable by 2003 and 2004. If the quality of the notes receivable portfolio does not improve significantly by 2003, it is unlikely that the Company will be able to secure additional off-balance-sheet facilities. In this case, the Company will attempt to secure additional secured credit facilities.
Under the terms of the proposed debt refinancing and restructuring, future results must meet certain financial covenants that require significant improvements over 2000 and 2001 results. During the second and third quarters of 2001, the Company closed three outside sales offices, closed three telemarketing centers, and reduced headcount in sales, marketing, and general and administrative functions. As a result of these reductions, management believes that the necessary operating changes needed to achieve the desired sales, sales and marketing expense, and operating, general and administrative expense are being implemented.
Since the third quarter of 2001, the Company has been operating under new sales practices whereby no sales are permitted unless the touring customer has indicated a minimum income level above that previously required and has a valid major credit card. Further, the marketing division is employing a best practices program, which should facilitate marketing to customers who management believes are more likely to be a good credit risk. However, if the economy deteriorates further or if enhanced sales practices do not result in sufficiently improved collections, the Company may not be able to realize such improvements.
Management believes that the restructuring and refinancing transactions described above will occur, and that the operating improvements required under the debt covenants will be accomplished. If the Company accomplishes these goals, it will have adequate financing to operate for the two-year revolving term of the proposed financing with the senior lenders. If the Company is unable to complete the restructuring plan, it will not have sufficient cash to pay the principal and interest payments due under the secured credit facilities and senior subordinated notes. In that event, it is likely that the Company will be forced to seek protection from its creditors through a court-supervised reorganization.
Realization of inventory is dependent upon execution of management's long-term sales plan for each resort, which extend for up to fifteen years. Such sales plans depend upon management's ability to obtain financing to facilitate the build-out of each resort and marketing of the Vacation Intervals over the planned time period.
SOURCES OF CASH. The Company generates cash primarily from the cash received on the sale of Vacation Intervals, the financing of customer notes receivable from Silverleaf Owners, management fees, sampler sales, and resort and utility operations. The Company typically receives a 10% down payment on sales of Vacation Intervals and finances the remainder by receipt of a seven-year to ten-year customer promissory note. The Company generates cash from the financing of customer notes receivable by (i) borrowing at an advance rate of up to 85% of eligible customer notes receivable and (ii) from the spread between interest received on customer notes receivable and interest paid on related borrowings. Because the Company uses significant amounts of cash in the development and marketing of Vacation Intervals, but collects cash on customer notes receivable over a seven-year to ten-year period, borrowing against receivables has historically been a necessary part of normal operations. During the years ended December 31, 1998, 1999, and 2000, the Company's operating activities reflected cash used in operating activities of $99.5 million, $121.0 million, and $62.2 million, respectively. In 2000,
the decrease in cash used in operating activities compared to 1999 is the result of $62.9 million in proceeds from sales of notes receivable. The increase in cash used in operating activities in 1999 compared to 1998 primarily related to increases in customer notes receivable.
Net cash provided by financing activities for the years ended December 31, 1998, 1999, and 2000 was $118.4 million, $124.9 million, and $67.2 million, respectively. During 2000, the decrease in cash provided by financing activities compared to 1999 was primarily due to increased payments on borrowings against pledged notes receivable resulting from funds received from sales of notes receivable to the SPE. The increase in cash provided by financing activities in 1999 compared to 1998 primarily relates to increased borrowings against pledged notes receivable. At December 31, 2000, the Company's revolving credit facilities provided for loans of up to $291.0 million, of which approximately $257.0 million of principal and interest related to advances under the credit facilities was outstanding. For the year ended December 31, 2000, the weighted average cost of funds for all borrowings, including the senior subordinated debt, was 9.6%. Customer defaults have a significant impact on cash available to the Company from financing customer notes receivable in that notes more than 60 days past due are not eligible as collateral. As a result, the Company must repay borrowings against such delinquent notes.
Effective October 30, 2000, the Company entered into a $100 million revolving credit agreement to finance Vacation Interval notes receivable through an off-balance-sheet SPE, formed on October 16, 2000. The agreement presently has a term of 5 years. However, on the second anniversary date of the proposed amended facility, the SPE's lender under the credit agreement shall have the right to put, transfer, and assign to the SPE all of its rights, title, and interest in and to all of the assets securing the facility at a price equal to the then outstanding principal balance under the facility. During 2000, the Company sold $74 million of notes receivable to the SPE, which the Company services for a fee. The SPE funded these purchases through advances under a credit agreement arranged for this purpose. In conjunction with these sales, the Company received cash consideration of $62.9 million, which was used to pay down borrowings under its revolving loan facilities.
At December 31, 2000, the SPE held notes receivable totaling $70.2 million, with related borrowings of $63.6 million. Except for the repurchase of notes that fail to meet initial eligibility requirements, the Company is not obligated to repurchase defaulted or any other contracts sold to the SPE. It is anticipated, however, that the Company will place bids in accordance with the terms of the conduit agreement to repurchase some defaulted contracts in public auctions to facilitate the re-marketing of the underlying collateral. The investment in the SPE was valued at $5.3 million at December 31, 2000.
For regular federal income tax purposes, the Company reports substantially all of the Vacation Interval sales it finances under the installment method. Under this method, income on sales of Vacation Intervals is not recognized until cash is received, either in the form of a down payment or as installment payments on customer notes receivable. The deferral of income tax liability conserves cash resources on a current basis. Interest is imposed, however, on the amount of tax attributable to the installment payments for the period beginning on the date of sale and ending on the date the related tax is paid. If the Company is otherwise not subject to tax in a particular year, no interest is imposed since the interest is based on the amount of tax paid in that year. The consolidated financial statements do not contain an accrual for any interest expense that would be paid on the deferred taxes related to the installment method as the interest expense is not estimable. In addition, the Company is subject to current alternative minimum tax ("AMT") as a result of the deferred income that results from the installment sales treatment. Payment of AMT reduces the future regular tax liability attributable to Vacation Interval sales, and creates a deferred tax asset. In 1998, the Internal Revenue Service approved a change in the method of accounting for installment sales effective as of January 1, 1997. As a result, the Company's alternative minimum taxable income for 1997 through 1999 was increased each year by approximately $9.0 million for the pre-1997 adjustment, which results in the Company paying substantial additional federal and state taxes in those years. The Company's AMT loss for 2000 was decreased by such amount. Subsequent to December 31, 2000, the Company applied for and received refunds of $8.3 million as the result of the carryback of its 2000 AMT loss to 1999 and 1998.
The net operating losses ("NOL") expire between 2007 through 2020. Realization of the deferred tax assets arising from net operating losses is dependent on generating sufficient taxable income prior to the expiration of the loss carryforwards. Management currently does not believe that it will be able to utilize its net operating losses from normal operations. However, sufficient temporary differences existed at December 31, 2000 to allow for utilization of its NOL. At present, future NOL utilization is expected to be limited to the temporary differences creating deferred tax liabilities. If necessary, management could implement a strategy to accelerate income recognition for federal income tax purposes to utilize the existing NOL. The amount of the deferred tax asset considered realizable could be decreased if estimates of future taxable income during the carryforward period are reduced.
Given its current economic condition, the Company's access to capital and other financial markets is anticipated to be limited. However, to finance the Company's growth, development, and any future expansion plans, the Company may at some time be required to consider the issuance of other debt, equity, or collateralized mortgage-backed securities, the proceeds of which would be used to finance future acquisitions, refinance debt, finance mortgage receivables, or for other purposes. Any debt incurred or issued by the Company may be secured or unsecured, have fixed or variable rate interest, and may be subject to such terms as management deems prudent.
USES OF CASH. Investing activities typically reflect a net use of cash due to capital additions and property acquisitions. Net cash used in investing activities for the years ended December 31, 1998, 1999, and 2000 was $12.6 million, $10.5 million, and $3.1 million, respectively. In 2000, the cash used in investing activities decreased compared to 1999 due to reduced purchases of property and equipment. In 1999, the decrease in cash used in investing activities compared to 1998 resulted from proceeds from property sales, which offset investments in a new central telemarketing facility and related automated dialers and computer equipment, and investments in undeveloped land, including $1.5 million of undeveloped land near The Villages Resort in Tyler, Texas, $500,000 of undeveloped land near Holiday Hills Resort in Branson, Missouri, and $805,000 of undeveloped land near Fox River Resort in Sheridan, Illinois. In 1998, the acquisition of the Crown resorts, the Atlanta, Kansas City, and Philadelphia sites, and a second parcel of land in Galveston in 1998, contributed to the cash used in operating and investing activities in that year. The Company acquired a second tract of the Galveston property in February 1998 for $1.2 million, the Crown resorts in May 1998 for $4.8 million, the Kansas City site in September 1998 for $1.5 million, the Philadelphia site in December 1998 for $1.9 million, and various tracts of the Atlanta property throughout the fourth quarter of 1998 for $4.2 million. The decrease in net cash used in investing activities relates to a reduction in equipment purchases in 2001. The Company evaluates sites for additional new resorts or acquisitions on an ongoing basis. As of December 31, 2000, the Company had construction commitments of approximately $13.3 million, the majority of which had been paid by December 31, 2001. Certain debt agreements include restrictions on the Company's ability to pay dividends based on minimum levels of net income and cash flow.
RESULTS OF OPERATIONS
The following table sets forth certain operating information for the Company.
RESULTS OF OPERATIONS FOR THE YEARS ENDED DECEMBER 31, 2000 AND DECEMBER 31,
Revenues
Revenues in 2000 were $285.8 million, representing a $55.4 million, or 24.0%, increase over revenues of $230.4 million for the year ended December 31, 1999. The increase was primarily due to a $42.0 million increase in sales of Vacation Intervals and a $9.5 million increase in interest income. The strong increase in Vacation Interval revenues primarily resulted from increased sales at Holiday Hills Resort in Branson, Missouri, Silverleaf's Seaside Resort in Galveston, Texas, which
opened a sales office in the first quarter of 2000, and Apple Mountain Resort near Atlanta, Georgia, which opened a sales office in 1999. Also contributing to increased Vacation Interval revenues were improved closing percentages and higher sales prices. In 2000 and 1999, sales were reduced by $7.0 million and $3.7 million, respectively, for cancellations related to customer returns (i.e., customers who failed to make their first installment payment).
In 2000, the number of Vacation Intervals sold, exclusive of upgraded Vacation Intervals, increased 1.4% to 16,216 from 15,996 in 1999; the average price per interval increased 9.7% to $9,768 from $8,901. Total interval sales for 2000 included 6,230 biennial intervals (counted as 3,115 Vacation Intervals) compared to 5,936 biennial intervals (counted as 2,968 Vacation Intervals) in 1999. The Company also experienced increased sales of upgraded intervals through the continued implementation of marketing and sales programs focused on selling upgraded intervals to the Company's existing Vacation Interval owners. In 2000, the number of upgraded Vacation Intervals sold was 16,112 at an average price of $4,741 compared to 11,400 upgraded Vacation Intervals sold in 1999 at an average price of $4,420. In addition, Vacation Interval sales at existing resorts increased as a result of enhanced telemarketing capacity, arising from investments in computer and automated dialing technology.
Sampler sales increased to $3.6 million in 2000 compared to $1.7 million in 1999. The increase is consistent with the overall growth in Company sales resulting from increased marketing efforts and an expanded sales force.
Interest income increased 33.7% to $37.8 million for the year ended December 31, 2000 from $28.3 million for 1999. This increase primarily resulted from an increase in notes receivable, net of allowance for uncollectible notes, in 2000 compared to 1999.
Management fee income decreased 83.6% to $462,000 in 2000 from $2.8 million in 1999. The decrease in management fee income was primarily the result of increased operating expenses at the management clubs.
Other income consists of water and utilities income, condominium rental income, marina income, golf course and pro shop income, and other miscellaneous items. Other income was $4.9 million for both the years ended December 31, 2000 and December 31, 1999. In 2000, a $317,000 gain associated with the sale of land, growth in water and utilities income, and increased pro shop income at two resorts was offset by a reduction in sales of Bonus Time Program upgrades to owners of seven resorts managed by the Company since May 1998.
Gain on sale of notes receivable was $4.3 million for the year ended December 31, 2000, compared to $0 in 1999. This gain resulted from the sale of $74 million of notes receivable to a special purpose entity ("SPE") in the fourth quarter of 2000.
Cost of Sales
Cost of sales as a percentage of Vacation Interval sales increased to 25.2% in 2000 from 15.9% in 1999. Due to liquidity concerns experienced in the fourth quarter of 2000, the Company reduced its future sales plan for most resorts and discontinued its efforts to sell Crown intervals. As a result, the Company recorded an inventory write-down of $15.5 million based on a lower of cost or market assessment and wrote-off $3.1 million of unsold Crown inventory intervals. In addition, as the Company continues to deplete its inventory of low-cost Vacation Intervals acquired primarily in 1995 and 1996, the Company's sales mix has shifted to more recently constructed units, which were built at a higher average cost per Vacation Interval. Hence, the cost of sales as a percentage of Vacation Interval sales has increased compared to 1999 regardless of the impairments recorded. These percentage increases, however, were partially offset by increased sales prices since the third quarter of 1999.
Sales and Marketing
Sales and marketing costs as a percentage of total sales was 52.6% for the year ended December 31, 2000 compared to 52.4% for 1999. Due to 2000 growth rates and implementation of new lead generation programs, the Company experienced relatively higher marketing costs in 2000 compared to 1999. The Company increased its headcount at the call centers significantly since the third quarter of 1999, which created inefficiencies due to temporary lack of available training resources in the first half of the year. The Company also moved towards reliance on national retail chains for its lead generation efforts, in addition to the traditional local programs. The transition to national programs was slower in generating leads than originally planned.
Provision for Uncollectible Notes
Provision for uncollectible notes as a percentage of Vacation Interval sales increased to 46.3% for the year ended December 31, 2000 from 10.1% for 1999. The provision for uncollectible notes in 2000 related to sales originating in 2000 was approximately 26%, with the remainder relating to an additional provision needed for notes related to sales from prior years. The increase in the provision is the result of the deterioration in the economy that came to public awareness in late 2000 and the Company's decision to substantially reduce two programs during 2000 that had previously been used to remedy defaulted notes receivable. The assumptions program, which had been used by the Company since December 1997 to allow delinquent loans to be assumed by other customers, was virtually eliminated due to its high cost of operation. The downgrade program, which was implemented in April 2000 to supplement the assumptions program, allows delinquent customers to downgrade to a more affordable product. Late in 2000, the downgrade program was reduced as it became apparent that this program did not significantly reduce delinquencies. As a result of these issues, the provision for uncollectible notes recognized in 2000 was increased by approximately $85 million.
Operating, General and Administrative
Operating, general and administrative expenses as a percentage of total revenues increased to 12.9% in 2000 from 11.8% in 1999. The increase is primarily attributable to higher salaries, increased headcount, increased legal expense, and increased title and recording fees due to increased borrowings against pledged notes receivable. In addition, the Company incurred $3.5 million in 2000 related to three lawsuits.
Depreciation and Amortization
Depreciation and amortization expense as a percentage of total revenues increased to 2.6% in 2000 from 2.5% in 1999. Overall, depreciation and amortization expense increased $1.8 million from 1999, primarily due to investments in new automated dialers, investments in telephone systems, and investments in a central marketing facility, which opened in September 1999.
Interest Expense
Interest expense as a percentage of interest income increased to 86.6% for the year ended December 31, 2000 from 59.6% in 1999. This increase is primarily the result of interest expense related to increased borrowings against pledged notes receivable.
Impairment Loss of Long-Lived Assets
Due to liquidity concerns experienced in the fourth quarter of 2000, the Company was required to abandon plans to develop two resorts already in predevelopment status, place one resort in predevelopment status on hold, and abandon plans to sell at the Crown resorts. As a result, the Company recorded an impairment of $5.4 million to write-down land to its estimated fair value and land held for sale to its estimated sales price less estimated disposal costs. Due to its decision to discontinue sales efforts of Crown intervals, the Company also wrote-off $922,000 of intangible assets, originally recorded with the acquisition of Crown resorts in May 1998, which management believes are not recoverable under its new business plan.
Write-off of Affiliate Receivable
At December 31, 2000, due to the liquidity concerns and the planned reduction in future sales, the Company anticipated that future membership dues would not be sufficient to recover its advances to Silverleaf Club. Hence, the Company's Board of Directors approved the write-off of $7.5 million of uncollectible receivables from Silverleaf Club.
Income (Loss) Before Provision (Benefit) for Income Taxes and Extraordinary Item
Income (loss) before provision (benefit) for income taxes and extraordinary item decreased to a loss of $98.5 million for the year ended December 31, 2000, from income of $28.8 million for the year ended December 31, 1999, as a result of the above mentioned operating results.
Provision (Benefit) for Income Taxes
Provision (benefit) for income taxes as a percentage of income (loss) before provision (benefit) for income taxes and extraordinary item was 37.1% in 2000 versus 38.5% in 1999. The decrease in effective income tax rate was primarily the result of permanent differences in 2000 lowering the benefit recognized.
Extraordinary Item
The Company recognized an extraordinary gain of $2.1 million, net of income tax of $1.3 million, related to the early extinguishment of $8.3 million of 10 1/2% senior subordinated notes during the year ended December 31, 2000. There were no extraordinary items during the year ended December 31, 1999.
Net Income (Loss)
Net income (loss) was a net loss of $59.9 million for the year ended December 31, 2000, as compared to net income of $17.7 million for the year ended December 31, 1999, as a result of the above mentioned operating results.
RESULTS OF OPERATIONS FOR THE YEARS ENDED DECEMBER 31, 1999 AND DECEMBER 31,
Revenues
Revenues in 1999 were $230.4 million, representing a $72.0 million, or 45.5%, increase over revenues of $158.4 million for the year ended December 31, 1998. The increase was primarily due to a $58.4 million increase in sales of Vacation Intervals and an $11.4 million increase in interest income. The strong increase in Vacation Interval revenues primarily resulted from increased sales at core resorts and increased sales at new resorts, primarily relating to Oak N' Spruce near Boston, Massachusetts, which opened a sales office in the second quarter of 1998, Foxwood Hills in Westminster, South Carolina, which opened a sales office in the third quarter of 1998, and Apple Mountain near Atlanta, Georgia, which opened a sales office in the first quarter of 1999. In 1999 and 1998, sales were reduced by $3.7 million and $1.9 million, respectively, for cancellations related to customer returns (i.e., customers who failed to make their first installment payment).
In 1999, the number of Vacation Intervals sold, exclusive of upgraded Vacation Intervals, increased 22.6% to 15,996 from 13,046 in 1998; the average price per interval increased 10.7% to $8,901 from $8,042. Total interval sales for 1999 included 5,936 biennial intervals (counted as 2,968 Vacation Intervals) compared to 3,860 biennial intervals (counted as 1,930 Vacation Intervals) in 1998. The Company also experienced increased sales of upgraded intervals through the continued implementation of marketing and sales programs focused on selling upgraded intervals to the Company's existing Vacation Interval owners. In 1999, the number of upgraded Vacation Intervals sold was 11,400 at an average price of $4,420 compared to 6,817 upgraded Vacation Intervals sold in 1998 at an average price of $4,396. In addition, Vacation Interval sales at existing resorts increased as a result of enhanced telemarketing capacity, arising from investments in computer and automated dialing technology.
Sampler sales increased to $1.7 million in 1999 compared to $1.4 million in 1998. Increased sales of overnight samplers were partially offset by an increase in biennial interval sales, which are an alternative to the sampler program. The increase is consistent with the overall growth in Company sales resulting from increased marketing efforts and an expanded sales force.
Interest income increased 67.4% to $28.3 million for the year ended December 31, 1999 from $16.9 million for 1998. This increase primarily resulted from an increase in notes receivable, net of allowance for uncollectible notes, since December 31, 1998, due to increased sales. The increase in interest income related to notes receivable was partially offset by interest income on short-term investments, which decreased from $959,000 in 1998 to $234,000 in 1999 as proceeds from the debt and equity offerings completed in April 1998 were invested prior to their utilization.
Management fee income increased 10.7% to $2.8 million in 1999 from $2.5 million in 1998. The increase in management fee income was primarily the result of greater net income from the Management Clubs due to higher dues income resulting from an increased membership base, partially offset by an increase in the Management Clubs' operating expenses.
Other income consists of water and utilities income, condominium rental income, marina income, golf course and pro shop income, and other miscellaneous items. Other income increased 53.4% to $4.9 million for the year ended December 31, 1999 from $3.2 million for the year ended December 31, 1998. The increase primarily relates to the Apple Mountain golf course and pro shop, which opened in the fourth quarter of 1998, and the Holiday Hills restaurant, which opened in the second quarter of 1999, and increased sales of Bonus Time Program upgrades to owners at seven resorts managed by the Company since May 1998.
Cost of Sales
Cost of sales as a percentage of Vacation Interval sales increased to 15.9% in 1999 from 14.8% in 1998. As the Company continues to deplete its inventory of low-cost Vacation Intervals acquired primarily in 1995 and 1996, the Company's sales mix has shifted to more recently constructed units, which were built at a higher average cost per Vacation Interval. Hence, the cost of sales as a percentage of Vacation Interval sales has increased compared to 1998. This increase, however, was partially offset by increased sales prices during 1999.
Sales and Marketing
Sales and marketing costs as a percentage of total sales was 52.4% for the year ended December 31, 1999 compared to 49.0% for 1998. This increase, in part, was due to the implementation of new marketing programs, including a vacation product whereby related revenues received are deferred until the guest actually stays at the resort. Additionally, the Company is incurring substantial marketing and start-up costs associated with two new sales offices and one expanded sales office in recently opened markets where sales have not yet reached mature levels. Implementation costs associated with new predictive dialing equipment at the Company's call centers as well as the opening of a fourth central marketing facility in September 1999 also contributed to the increase.
Provision for Uncollectible Notes
Provision for uncollectible notes as a percentage of Vacation Interval sales decreased to 10.1% in 1999 from 12.1% in 1998. This is the result of continued improvements in the Company's collection efforts, including increased staffing, improved collections software, the implementation of a program through which delinquent loans are assumed by existing owners with a consistent payment history, and an increase in receivables related to upgrade sales, which typically represent better performing accounts, resulting in fewer delinquencies.
Operating, General and Administrative
Operating, general and administrative expenses as a percentage of total revenues increased to 11.8% in 1999 from 10.8% in 1998. The increase is primarily attributable to higher salaries, increased headcount, increased travel, legal, and professional fees, primarily related to expansion into new markets, an increase in title and recording fees due to increased borrowings against pledged notes receivable, an increase in costs to the Apple Mountain golf course and pro shop, which opened in the fourth quarter of 1998, and an increase in costs to operate the Holiday Hills restaurant, which opened in the second quarter of 1999.
Depreciation and Amortization
Depreciation and amortization expense as a percentage of total revenues increased to 2.5% in 1999 from 2.2% in 1998. Overall, depreciation and amortization expense increased $2.2 million from 1998, primarily due to investments in new automated dialers, investments in telephone systems, and investments in two central marketing facilities, which opened in September 1998 and September 1999, respectively.
Interest Expense
Interest expense as a percentage of interest income increased to 59.6% for the year ended December 31, 1999 from 41.2% in 1998. This increase is primarily the result of interest expense related to increased borrowings against pledged notes receivable.
Income Before Provision for Income Taxes
Income before provision for income taxes increased 2.2% to $28.8 million for the year ended December 31, 1999, from $28.2 million for the year ended December 31, 1998, as a result of the above mentioned operating results.
Provision for Income Taxes
Provision for income taxes as a percentage of income before provision for income taxes remained relatively flat at 38.5% in 1999 versus 38.3% in 1998.
Net Income
Net income increased $330,000, or 1.9%, to $17.7 million for the year ended December 31, 1999, from $17.4 million for the year ended December 31, 1998, as a result of the aforementioned operating results.
INFLATION
Inflation and changing prices have not had a material impact on the Company's revenues, operating income, and net income during any of the Company's three most recent fiscal years. However, to the extent inflationary trends affect short-term interest rates, a portion of the Company's debt service costs may be affected as well as the rates the Company charges on its customer notes receivable.
RECENT ACCOUNTING PRONOUNCEMENTS
SFAS No. 133 - In June 1998, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 133, "Accounting for Derivative Instruments and Hedging Activities" ("SFAS No. 133"). SFAS No. 133, as amended, is effective for fiscal years beginning after June 15, 2000 and was adopted January 1, 2001. SFAS No. 133 requires that all derivative instruments be recorded on the balance sheet at their fair value. Changes in the fair value of the derivatives are recorded each period in current earnings or other comprehensive income depending on whether a derivative is designated as part of a hedge transaction, and if it is, the type of hedge transaction. The adoption of SFAS No. 133 had no significant impact on the Company's results of operations, financial position, or cash flows in 2001.
SAB No. 101 - In December 1999, the Securities and Exchange Commission issued Staff Accounting Bulletin No. 101, "Revenue Recognition" ("SAB No. 101"), which was adopted by the Company in the fourth quarter of 2000. In connection with the adoption of SAB No. 101, management determined that its methodology for recording sampler sales was inappropriate. As a result, the Company has changed its method of accounting for sampler sales, which change has been treated as a correction of an error. (See Note 19 to the Consolidated Financial Statements.) There were no other significant changes in the Company's accounting practices resulting from the adoption of SAB No. 101.
SFAS No. 140 - In September 2000, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 140, "Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities" ("SFAS No. 140"), which replaces SFAS No. 125, "Accounting for Transfers and Servicing of Financial Assets and Extinguishment of Liabilities." SFAS No. 140 revises SFAS No. 125's standards for accounting for securitizations and other transfers of financial assets and collateral and requires certain disclosures, but it carries over most of the SFAS No. 125's provisions without reconsideration. SFAS No. 140 was effective for transfers and servicing of financial assets and extinguishments of liabilities occurring after March 31, 2001 and for recognition and reclassification of collateral and for disclosures relating to securitization transactions and collateral for fiscal years ending after December 15, 2000. The Company has adopted the new disclosures required under SFAS No. 140 as of December 31, 2000. SFAS No. 140 is to be applied prospectively with certain exceptions. The adoption of SFAS No. 140 in 2001 did not have a material impact on the Company's results of operations, financial position, or cash flows.
SFAS No. 144 - In August 2001, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets" ("SFAS No. 144"), which supersedes SFAS No. 121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed Of." SFAS No. 144 establishes a single accounting method for long-lived assets to be disposed of by sale, whether previously held and used or newly acquired, and extends the presentation of discontinued operations to include more disposal transactions. SFAS No. 144 also requires that an impairment loss be recognized for assets held-for-use when the carrying amount of an asset (group) is not recoverable. The carrying amount of an asset (group) is not recoverable if it exceeds the sum of the undiscounted cash flows expected to result from the use and eventual disposition of the asset (group), excluding interest
charges. Estimates of future cash flows used to test the recoverability of a long-lived asset (group) must incorporate the entity's own assumptions about its use of the asset (group) and must factor in all available evidence. SFAS No. 144 is effective on January 1, 2002. Management has yet to determine the impact that the adoption of SFAS No. 144 will have on the Company's results of operations, financial position, or cash flows.
ITEM 7A.
ITEM 7A. QUALITATIVE AND QUANTITATIVE DISCLOSURES ABOUT MARKET RISK
As of and for the year ended December 31, 2000, the Company had no significant derivative financial instruments or foreign operations. Interest on the Company's notes receivable and senior subordinated notes is fixed. See notes 5, 6, 10 and 14 to the Company's consolidated financial statements beginning on page.
ITEM 8.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
See the information described in the Index to Consolidated Financial Statements beginning on Page of this report on Form 10-K.
ITEM 9.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS OR ACCOUNTING AND FINANCIAL DISCLOSURES
None.
PART III
ITEM 10.
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
RECONSTITUTION OF BOARD FOLLOWING EXCHANGE OFFER
One of the principal terms of the Exchange Offer negotiated with the Noteholders' Committee involves a reconstitution of the Company's existing Board of Directors. Under the terms of the proposed reconstitution of the Board, following the Exchange Date, the five member Board of Directors will be comprised of (i) two existing directors, (ii) two directors designated for election by the Noteholders' Committee, and (iii) a fifth director elected by a majority vote of the other four directors. Each of the two designees of the Noteholders' Committee will serve on both the Audit Committee and the Compensation Committee, with one of the Noteholders' Committee's designees holding the chairmanship of each of these two committees.
DIRECTORS AND EXECUTIVE OFFICERS OF THE COMPANY AT DECEMBER 31 2000
The following table sets forth certain information concerning each person who is a director or executive officer of the Company.
ROBERT E. MEAD, founded the Company, has served as its Chairman of the Board since its inception, and has served as its Chief Executive Officer since May 1990. Mr. Mead began his career in hotel and motel management and also operated his own construction company. Mr. Mead has over 23 years of experience in the timeshare industry, with special expertise in the areas of consumer finance, hospitality management, and real estate development.
SHARON K. BRAYFIELD, has served as the President of the Company since 1992 and manages all of the Company's day to day activities. Ms. Brayfield began her career with an affiliated company in 1982 as the Public Relations Director of Ozark Mountain Resort. In 1989, she was promoted to Executive Vice President of Resort Operations for an affiliated company and in 1991 was named Chief Operations Officer of the Company.
DAVID T. O'CONNOR, has over 23 years of experience in real estate and timeshare sales and has worked periodically with Mr. Mead over the past 17 years. Mr. O'Connor has served as the Company's Executive Vice President -- Sales for the past five years and as Vice President -- Sales since 1991. In such capacities he directed all field sales, including the design and preparation of all training materials, incentive programs, and follow-up sales procedures.
THOMAS C. FRANKS was hired in August 1997 as President of a newly-formed, wholly-owned subsidiary of the Company, Silverleaf Resort Acquisitions, Inc. In February 1998, Mr. Franks was named as Vice President -- Investor Relations and Governmental Affairs for the Company, and in October 1998 he was named Executive Vice President--Corporate Affairs. Mr. Franks has more than 17 years of experience in the timeshare industry and is responsible for acquisitions and industry and governmental relations. Mr. Franks served as the President of ARDA from February 1991 through July 1997.
HARRY J. WHITE, JR., joined the Company in June 1998 as Chief Financial Officer and has responsibility for all accounting, financial reporting, and taxation issues. Prior to joining the Company, Mr. White was Chief Financial Officer of Thousand Trails, Inc. from 1992 to 1998 and previously was a senior manager with Deloitte & Touche LLP.
LARRY H. FRITZ, has been employed by the Company (or an affiliated company) in various marketing management positions. Since 1991, Mr. Fritz has served as the Company's chief marketing officer, with responsibility for daily marketing operations, and currently serves as the Company's Vice President -- Marketing.
IOANNIS N. GIOLDASIS has been with the Company since May 1993 and currently serves as Vice President -- Promotions. Mr. Gioldasis is responsible for the design and implementation of marketing strategies and promotional concepts for lead generation in Texas and other markets. Prior to joining the Company, Mr. Gioldasis was a national field director for Resort Property Consultants, Inc.
ALLEN L. HUDSON joined the Company on June 1, 1998 as Vice President - Architecture and Engineering Services. Prior to joining the Company, Mr. Hudson was President and Chief Operating Officer of an architectural firm which provided consultant design and project management services to the Company from 1995 until June 1998. See "Certain Relationships and Related Transactions."
MICHAEL L. JONES, was appointed Vice President -- Information Services in May 1999. For more than five years prior to that time, Mr. Jones served in various positions with the Company, including Network Manager, Payroll Manager, and Director of Information Services.
EDWARD L. LAHART, has served as Vice President -- Corporate Operations since June 1998. Prior to June 1998, Mr. Lahart served in various capacities in the Company's Credit and Collections department.
ROBERT G. LEVY, was appointed Vice President -- Resort Operations in March 1997 and administers the Company's Management Agreement with the Silverleaf Club. Since 1990, Mr. Levy has held a variety of managerial positions with Silverleaf Club including Project Manager, General Manager, Texas Regional Manager, and Director of Operations. Prior thereto, Mr. Levy spent 18 years in hotel, motel, and resort management, and was associated with the Sheraton, Ramada Inn, and Holiday Inn hotel chains.
DAVID D. MCPHERSON was elected Vice President--Finance in May 1999. Prior to that time, Mr. McPherson served as Director of Audit of the Company from July 1998 to May 1999 and as Director of Finance from May 1997 to July 1998. Before joining the Company, Mr. McPherson served as Chief Financial Officer of Neutral Posture Ergonomics, Inc. from May 1996 to April 1997 and as a Senior Auditor of Deloitte & Touche, LLP from September 1992 until May 1996.
JAMES J. OESTREICH joined the Company in February 1998 as Vice President -- Marketing Development. From January 1991 to August 1995, Mr. Oestreich served as Vice President of Sales and Marketing for Casablanca Express, Inc. From August 1995 until joining the Company in 1998, Mr. Oestreich served as President of Bull's Eye Marketing, Inc., a provider of marketing services to the resort and direct sales industries. See "Certain Relationships and Related Transactions."
SANDRA G. CEARLEY, has served as Secretary of the Company since its inception. Ms. Cearley maintains corporate minute books, oversees regulatory filings, and coordinates legal matters with the Company's attorneys.
JAMES B. FRANCIS, JR., was elected as a Director of the Company in July 1997. During 1996, Mr. Francis' company, Francis Enterprises, Inc., served as a consultant to the Company in connection with governmental and public affairs. From 1980 to 1996, Mr. Francis was a partner in the firm of Bright & Co., which managed various business investments, including the Dallas Cowboys Football Club.
MICHAEL A. JENKINS, was elected as a Director of the Company in July 1997. In 1971, Mr. Jenkins founded and became the President of Leisure and Recreation Concepts, Inc., which as planned and designed over 850 theme parks, resorts, retail areas, and major attractions worldwide. Mr. Jenkins has more than 35 years in the leisure industry. Mr. Jenkins also serves as President of the Dallas Summer Musicals, Inc. and the Broadway Contemporary Series.
STUART MARSHALL BLOCH was elected as a Director of the Company in July 1997. Since 1972, Mr. Bloch has been a partner in the law firm of Ingersoll & Bloch, in Washington, D.C. Ingersoll & Bloch has served as general counsel to ARDA since 1972. Mr. Bloch is also currently serving as counsel to the law firm of Holland & Knight, LLC. Mr. Bloch is the founding director and a past president of the International Foundation for Timesharing. Mr. Bloch has authored numerous articles dealing with real estate law and the timeshare industry.
ITEM 11.
ITEM 11. EXECUTIVE COMPENSATION
SUMMARY COMPENSATION TABLE
The following table sets forth the annual base salary and other annual compensation earned in 1998, 1999 and 2000 by the Company's Chief Executive Officer and each of the other four most highly compensated executive officers whose cash compensation (salary and bonus) exceeded $100,000 (the "Named Executive Officers").
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(a) The amounts shown are before elective contributions by the Named Executive Officers in the form of salary reductions under the Company's Section 125 Flexible Benefit Plan. Such plan is available to all employees, including the Named Executive Officers.
(b) Except as otherwise noted, these amounts represent additional compensation based on sales of Vacation Intervals and other sales related criteria. See "Executive Compensation -- Employment and Noncompetition Agreements" for a discussion of other annual compensation.
(c) A portion of this amount was paid as sales commissions to Recreational Consultants, Inc., a corporation of which Mr. O'Connor is the principal. See "Certain Relationships and Related Transactions."
(d) Effective as of January 1, 2002, Mr. Franks was no longer employed by the Company.
(e) Effective as of March 15, 2001, Mr. Oestreich was no longer employed by the Company.
EMPLOYMENT AND NONCOMPETITION AGREEMENTS
Effective January 1, 2000, Mr. Mead entered into a three-year employment agreement with the Company which provides for an annual base salary of $500,000, a company vehicle, and other fringe benefits such as health insurance, vacation, and sick leave as determined by the Board of Directors of the Company from time to time.
Effective January 1, 2000, Ms. Brayfield entered into a three-year employment agreement with the Company which provides for an annual base salary of $435,000, a company vehicle, and other fringe benefits such as health insurance, vacation, and sick leave as determined by the Board of Directors of the Company from time to time.
Effective January 1, 2000, Mr. O'Connor entered into a three-year employment agreement with the Company which, as amended, provides for base compensation payable equal to five tenths percent (0.5%) of the Company's net sales from outside
sales and six tenths percent (0.6%) of the Company's net sales from in-house sales, plus incentive bonuses based upon performance, a company vehicle, and other fringe benefits such as health insurance, vacation, and sick leave as determined by the Board of Directors of the Company from time to time.
Effective June 29, 1998, Mr. White entered into an employment agreement with the Company which provides for an annual base salary of $250,000, a company vehicle, and other fringe benefits such as health insurance, vacation, and sick leave as determined by the Board of Directors of the Company from time to time. The agreement provides for severance pay equal to six months of Mr. White's then current salary if his services are terminated at any time for a reason other than good cause.
The agreements with Ms. Brayfield and Messrs. Mead and O'Connor also provide that for a period of two years following the termination of his or her services with the Company, he or she will not engage in or carry on, directly or indirectly, either for himself or herself or as a member of a partnership or other entity or as a stockholder, investor, officer or director of a corporation or as an employee, agent, associate or contractor of any person, partnership, corporation or other entity, any business in competition with the business of the Company or its affiliates in any county of any state of the United States in which the Company or its affiliates conduct such business or market the products of such business immediately prior to the effective date of termination.
EMPLOYEE BENEFIT PLANS
1997 STOCK OPTION PLAN. The Company adopted the 1997 Stock Option Plan (the "Plan") in May 1997 to attract and retain directors, officers, and key employees of the Company. The Plan was amended by the Company's shareholders at the 1998 Annual Meeting of Shareholders to increase the number of options which may be granted under the Plan to 1,600,000 and to modify the number of outside directors who, as members of the Compensation Committee, may administer the Plan. The following is a summary of the provisions of the Plan. This summary does not purport to be a complete statement of the provisions of the Plan and is qualified in its entirety by the full text of the Plan.
The purpose of the Plan is to afford certain of the Company's directors, officers and key employees and the directors, officers and key employees of any subsidiary corporation or parent corporation of the Company who are responsible for the continued growth of the Company, an opportunity to acquire a proprietary interest in the Company, and thus to create in such directors, officers and key employees an increased interest in and a greater concern for the welfare of the Company. The Company, by means of the Plan, seeks to retain the services of persons now holding key positions and to secure the services of persons capable of filling such positions. The Plan provides for the award to directors, officers, and key employees of nonqualified stock options and provides for the grant to salaried key employees of options intended to qualify as "incentive stock options" under Section 422 of the Internal Revenue Code of 1986, as amended (the "Code"). The Company has filed a Registration Statement to register such shares.
Nonqualified stock options provide for the right to purchase common stock at a specified price which may be less than fair market value on the date of grant (but not less than par value). "Fair market value" per share shall be deemed to be the average of the high and low quotations at which the Company's shares of common stock are sold on a national securities exchange, or if not sold on a national securities exchange, the closing bid and asked quotations in the over-the-counter market for the Company's shares on such date. If no public market exists for the Company's shares on any date on which the fair market value per share is to be determined, the Compensation Committee shall, in its sole discretion and best, good faith judgment, determine the fair market value of a share. Nonqualified stock options may be granted for any term and upon such conditions determined by the Compensation Committee.
Incentive stock options are designed to comply with the provisions of the Code and are subject to restrictions contained therein, including exercise prices equal to at least 100% of fair market value of common stock on the grant date and a ten year restriction on their term; however, incentive stock options granted to any person owning more than 10% of the voting power of the stock of the Company shall have exercise prices equal to at least 110% of the fair market value of the common stock on the grant date and shall not be exercisable after five years from the date the option is granted. Except as otherwise provided under the Code, to the extent that the aggregate fair market value of Shares with respect to which Incentive Options are exercisable for the first time by an employee during any calendar year exceeds $100,000, such Incentive Options shall be treated as Non-Qualified Options.
The Plan may either be administered by the Compensation Committee or the Board of Directors which selects the individuals to whom options are to be granted and determines the number of shares granted to each optionee. For the period ending December 31, 2000, the Compensation Committee and the Board of Directors made all decisions concerning administration of the Plan.
An optionee may exercise all or any portion of an option that is exercisable by providing written notice of such exercise to the Corporate Secretary of the Company at the principal business office of the Company, specifying the number of shares to be purchased and specifying a business day not more than fifteen days from the date such notice is given, for the payment of the purchase price in cash or by certified check. Options are not transferable by the optionee other than by will or the laws of descent and distribution, and an option may be exercised only by the optionee.
The following are the federal tax rules generally applicable to options granted under the Plan. The grant of a stock option will not be a taxable event for the participant nor a tax deduction for the Company. The participant will have no taxable income upon exercising an incentive stock option within the meaning of section 422 of the Internal Revenue Code of 1986, as amended (except that the alternative minimum tax may apply). Upon exercising a stock option that is not an incentive option, the participant must recognize ordinary income in an amount equal to the difference between the exercise price and the fair market value of the stock on the exercise date and the Company receives a tax deduction equal to the amount of ordinary income recognized by the participant. The tax treatment upon disposition of shares of the Company's Common Stock acquired under the Plan through the exercise of a stock option will depend on how long such shares have been held, and on whether or not such shares were acquired by exercising an incentive stock option.
An option shall terminate upon termination of the directorship, office or employment of an optionee with the Company or its subsidiary, except that if an optionee dies while serving as a director or officer or while in the employ of the Company or one of its subsidiaries, the optionee's estate may exercise the unexercised portion of the option. If the directorship, office or employment of an optionee is terminated by reason of the optionee's retirement, disability, or dismissal other than "for cause" while such optionee is entitled to exercise all or any portion of an option, the optionee shall have the right to exercise the option, to the extent not theretofore exercised, at any time up to and including (i) three months after the date of such termination of directorship, office or employment in the case of termination by reason of retirement or dismissal other than for cause and (ii) one year after the date of termination of directorship, office, or employment in the case of termination by reason of disability. If an optionee voluntarily terminates his directorship, office or employment, or is discharged for cause, any option granted shall, unless otherwise specified by the Compensation Committee pursuant to the terms and condition of the grant of the option, forthwith terminate with respect to any unexercised portion thereof. All terminated options shall be returned to the Plan and shall be available for future grants to other optionees.
The Plan will terminate on May 15, 2007 (the "Termination Date"), the tenth anniversary of the day the Plan was adopted by the Board of Directors of the Company and approved by its shareholders. Any options granted prior to the Termination Date and which remain unexercised may extend beyond that date in accordance with the terms of the grant thereof.
Under the Plan, the Board of Directors of the Company reserves the right to exercise the powers and functions of the Compensation Committee. Also, the Board of Directors reserves the right to amend the Plan at any time; however, the Board of Directors may not, without the approval of the shareholders of the Company (i) increase the total number of shares reserved for options under the Plan (other than for certain changes in the capital structure of the Company), (ii) reduce the required exercise price of any incentive stock options, or (iii) modify the provisions of the Plan regarding eligibility.
OPTION GRANTS DURING YEAR ENDED DECEMBER 31, 2000. The following table contains information concerning the grant of stock options under the Plan made during the year ended December 31, 2000 to the Named Executive Officers. The table also lists potential realizable values of such options on the basis of assumed annual compounded stock appreciation rates of 5% and 10% over the life of the options which are set for a maximum of ten years. No options were exercised during 2000 by any of the Named Executive Officers.
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(a) These options will vest in four equal increments on the first, second, third and fourth anniversaries of the date of the grant.
(b) The potential realizable value (in thousands of dollars) is reported net of the option price, but before income taxes associated with exercise. These amounts represent assumed annual compounded rates of appreciation at 5% and 10% only from the date of grant to the expiration date of the option. The rates of appreciation shown in this table are required by the Securities and Exchange Commission and are not intended to forecast or be indicative of possible future performance of the Common Stock.
(c) As of January 1, 2002, Mr. Franks is no longer employed by the Company.
(d) As of March 15, 2001, Mr. Oestreich is no longer employed by the Company.
OPTIONS/SARS EXERCISES AND DECEMBER 31, 2000 YEAR-END VALUE TABLE.
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(a) The Unexercised Options of the Named Executive Officers were not in-the-money at fiscal year end; therefore, the options had no value as of December 31, 2000.
(b) As of January 1, 2002, Mr. Franks was no longer employed by the Company.
(c) As of March 15, 2001, Mr. Oestreich was no longer employed by the Company.
SECTION 162(m) LIMITATION. In general, under Section 162(m) of the Code, income tax deductions of publicly-held corporations may be limited to the extent total compensation (including base salary, annual bonus, stock option exercises and non-qualified benefits paid) for certain executive officers exceeds $1 million (less the amount of any "excess parachute payments" as defined in Section 280G of the Code) in any one year. However, under Section 162(m), the deduction limit does not apply to certain "performance-based compensation" established by an independent compensation committee which is adequately disclosed to, and approved by, the shareholders.
DISCRETIONARY PERFORMANCE AWARDS. Performance awards, including bonuses, may be granted by the Compensation Committee on an individual or group basis. Generally, these awards will be based upon specific agreements or performance criteria and will be paid in cash.
401(k) PLAN. Effective January 1, 1999, the Company established the Silverleaf Resorts, Inc. 401(k) Plan (the "401(k) Plan"), a qualified defined contribution retirement plan covering employees 21 years of age or older who have completed one year of service. The Plan allows eligible employees to defer receipt of up to 15% of their compensation and contribute such amounts to various investment funds. The employee contributions vest immediately. Other than normal costs of administration, the Company has no obligation to make any payments under the 401(k) Plan.
ITEM 12.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
Set forth in the following table is the beneficial ownership of the Company's Common Stock as of December 31, 2000 by (i) those persons known to the Company to be the beneficial owners of more than five percent of the outstanding shares, (ii) each director and the five executive officers of the Company named under the table titled "Executive Compensation" and (iii) all directors and executive officers as a group.
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* Less than 1%
(a) Except as otherwise indicated, each beneficial owner has the sole power to vote and to dispose of all shares of Common Stock owned by such beneficial owner.
(b) Pursuant to the rules of the Securities and Exchange Commission, in calculating percentage ownership, each person is deemed to beneficially own his own shares subject to options exercisable within sixty days, but options owned by others (even if exercisable within sixty days) are deemed not to be outstanding shares. In calculating the percentage ownership of the directors and officers as a group, the shares subject to options exercisable by directors and officers within sixty days are included within the number of shares beneficially owned.
(c) The address of such person is 1221 River Bend Drive, Suite 120, Dallas, Texas 75247.
(d) Includes options to purchase 68,750 shares which options were exercisable within sixty days from December 31, 2000.
(e) Comprised of options to purchase shares which options were exercisable within sixty days from December 31, 2000.
(f) Includes options to purchase 46,667 shares which options were exercisable within sixty days from December 31, 2000.
(g) The address of such person is 1300 N Street N.W., Washington, D.C. 20005.
(h) The address of such person is 2911 Turtle Creek Boulevard, Suite 925, Dallas, Texas 75219.
(i) The address of such person is 2151 Fort Worth Avenue, Dallas, Texas 75211-1812.
(j) Dimensional Fund Advisors, Inc. ("Dimensional") furnishes investment advice to four investment companies and serves as investment manager to certain other commingled group trusts and separate accounts (the "Funds"). The shares described are owned by the Funds. In its role as investment adviser or manager to the Funds, Dimensional possesses voting and/or investment power over the shares described, but disclaims beneficial ownership of such securities. The address for Dimensional is 1299 Ocean Avenue, 11th Floor, Santa Monica, California 90401. This information is based upon information provided by Dimensional on Schedule 13G dated February 2, 2001.
ITEM 13.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Each timeshare owners association has entered into a management agreement, which authorizes the Management Clubs to manage the resorts. The Management Clubs, in turn, have entered into management agreements with the Company, whereby the Company manages the operations of the resorts. Pursuant to the management agreements, the Company receives a management fee equal to the lesser of 15% of gross revenues for Silverleaf Club and 10% to 15% of dues collected for owners associations within Crown Club or the net income of each Management Club; however, if the Company does not receive the aforementioned maximum fee, such deficiency is deferred for payment in the succeeding year(s), subject again to the net income limitation. The Silverleaf Club Management Agreement is effective through March 2010, and will continue year-to-year thereafter unless cancelled by either party. Crown Club consists of several individual Club agreements that have terms of two to five years with a minimum of two renewal options remaining. During the years ended December 31, 1998, 1999, and 2000, the Company recorded management fees of $2.5 million, $2.8 million, and $462,000, respectively, in management fee income.
The direct expenses of operating the resorts are paid by the Management Clubs. To the extent the Management Clubs provide payroll, administrative, and other services that directly benefit the Company, a separate allocation charge is generated and paid by the Company to the Management Clubs. During the years ended December 31, 1998, 1999, and 2000, the Company incurred $5.8 million, $10.3 million, and $155,000, respectively, of expenses under these agreements. As of January 1, 2000, certain employees were transferred from the Management Clubs to the Company. Hence, the allocation of overhead from the Management Clubs to the Company was substantially reduced in 2000. As a result of the payroll changes implemented January 1, 2000, the Company allocated overhead to the Management Clubs of $1.7 million during the year ended December 31, 2000.
The following schedule represents amounts due from (to) affiliates at December 31, 1999 and 2000 (in thousands):
In December 2000, the Company wrote-off its receivable from Silverleaf Club and incurred a charge of $7.5 million. At December 31, 2000, due to liquidity concerns and the planned reduction in future sales, the Company anticipated that future membership dues would not be sufficient to pay down the receivable. Hence, the Company's Board of Directors approved the write-off of this amount.
At December 31, 2000, the amount due to SPE primarily relates to upgrades of sold notes receivable, which was subsequently paid. Upgrades represent sold notes that are replaced by new notes when holders of said notes upgrade to a more valuable Vacation Interval.
An affiliate of a director of the Company is entitled to a 10% net profits interest from sales of certain land in Mississippi. During 2000, the affiliate of the director was paid $49,637 under this agreement. As of December 31, 2000, the Company owns approximately 14 acres of land that is subject to this net profits interest.
In 1997, the Company entered into a ten-year lease agreement with the principal shareholder for personal use of flood plain land adjacent to one of the Company's resorts in exchange for an annual payment equal to the property taxes attributable to the land. The lease has four renewal options of ten years at the option of the lessee.
In August 1997, subject to an employment agreement with an officer, the Company purchased a house for $531,000 and leased the house, with an option to purchase, to the officer for 13 months at a rental rate equal to the Company's expense for interest, insurance, and taxes, which was approximately $3,000 per month. In September 1998, the officer exercised his option to purchase the house at the end of the lease for $531,000. In March 2001, the Company forgave the remaining $48,000 balance on a note due from the officer.
In 1998, the Company incurred and made payments of $736,000 to Recreational Consultants, Inc., an entity of which an officer of the Company is the principal. Recreational Consultants, Inc. generated tours of the Company's resorts.
In June 1998, the Company entered an employment agreement, whereby the Company paid $108,000 for an employee's condominium in Branson, Missouri, upon his relocation to Dallas, Texas, and will pay $500,000 over a three-year period as compensation for and in consideration of the exclusivity of his services. Prior to becoming an employee in June 1998, the Company paid this employee's former architectural firm $246,000 during 1998 for architectural services rendered to the Company.
PART IV
ITEM 14.
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
(a) The following documents are filed as part of this report:
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* Filed herewith
(b) No reports on Form 8-K were filed by the Company during the three-month period ended December 31, 2000.
(c) The exhibits required by Item 601 of Regulation S-K have been listed above.
(d) Financial Statement Schedules
None. Schedules are omitted because of the absence of the conditions under which they are required or because the information required by such omitted schedules is set forth in the consolidated financial statements or the notes thereto.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized in the City of Dallas, State of Texas, on November 19, 2002.
SILVERLEAF RESORTS, INC.
By: /s/ ROBERT E. MEAD ------------------------------------------- Name: Robert E. Mead Title: Chairman of the Board and Chief Executive Officer
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, this report has been signed below on behalf of the Registrant in the capacities and on the dates indicated.
CERTIFICATION
I, Robert E. Mead, Chief Executive Officer, certify that:
1. I have reviewed this annual report on Form 10-K of Silverleaf Resorts, Inc.;
2. Based on my knowledge, this annual report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this annual report; and
3. Based on my knowledge, the financial statements, and other financial information included in this annual report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this annual report.
Date: November 19, 2002 /s/ ROBERT E. MEAD ----------------- -------------------------------------- Robert E. Mead Chief Executive Officer
CERTIFICATION
I, Harry J. White, Jr., Chief Financial Officer, certify that:
1. I have reviewed this annual report on Form 10-K of Silverleaf Resorts, Inc.;
2. Based on my knowledge, this annual report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this annual report; and
3. Based on my knowledge, the financial statements, and other financial information included in this annual report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this annual report.
Date: November 19, 2002 /s/ HARRY J. WHITE, JR. ----------------- ---------------------------------------- Harry J. White, Jr. Chief Financial Officer
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
INDEPENDENT AUDITORS' REPORT
To the Shareholders of Silverleaf Resorts, Inc.
We have audited the accompanying consolidated balance sheets of Silverleaf Resorts, Inc. and subsidiaries (the "Company") as of December 31, 1999 and 2000, and the related consolidated statements of operations, shareholders' equity, and cash flows for each of the three years in the period ended December 31, 2000. These consolidated financial statements are the responsibility of the Company's management. Our responsibility is to express (or disclaim) an opinion on these consolidated financial statements based on our audits.
We conducted our audits in accordance with auditing standards generally accepted in the United States of America. 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 report.
In our opinion, the consolidated financial statements as of December 31, 1999 and for the years ended December 31, 1999 and 1998 present fairly, in all material respects, the financial position of Silverleaf Resorts, Inc. and subsidiaries as of December 31, 1999, and the results of their operations and their cash flows for the years ended December 31, 1999 and 1998 in conformity with accounting principles generally accepted in the United States of America.
The accompanying 2000 consolidated financial statements have been prepared assuming that the Company will continue as a going concern. As described in Notes 2 and 3 to the consolidated financial statements, at December 31, 2000 the Company was in default under the terms of its senior subordinated notes and was not in compliance with certain covenants of its other long-term loan agreements. The Company is attempting to negotiate a debt restructuring with the holders of its senior subordinated notes that would involve the exchange of new notes and shares of its common stock for the existing notes, and to modify the terms and covenants of its other long-term debt agreements. The Company's difficulties in meeting its loan agreement covenants and financing needs, its losses from operations, and its negative cash flows from operating activities raise substantial doubt about its ability to continue as a going concern. Management's plans concerning these matters are also described in Notes 2 and 3. The financial statements do not include any adjustments that might result from the outcome of this uncertainty.
Because of the possible material effects of the uncertainty referred to in the preceding paragraph, we are unable to express, and we do not express, an opinion on the consolidated financial statements for 2000.
As discussed in Note 19, the accompanying consolidated financial statements as of December 31, 1999 and for the years ended December 31, 1999 and 1998 have been restated.
/s/ DELOITTE & TOUCHE LLP
Dallas, Texas March 12, 2002
SILVERLEAF RESORTS, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS (IN THOUSANDS, EXCEPT SHARE AND PER SHARE AMOUNTS)
See notes to consolidated financial statements.
SILVERLEAF RESORTS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS (IN THOUSANDS, EXCEPT SHARE AND PER SHARE AMOUNTS)
See notes to consolidated financial statements.
SILVERLEAF RESORTS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY (IN THOUSANDS, EXCEPT SHARE AND PER SHARE AMOUNTS)
See notes to consolidated financial statements.
SILVERLEAF RESORTS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS (IN THOUSANDS)
See notes to consolidated financial statements.
SILVERLEAF RESORTS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS FOR THE YEARS ENDED DECEMBER 31, 1998 (AS RESTATED), 1999 (AS RESTATED), AND 2000
1. NATURE OF BUSINESS
Silverleaf Resorts, Inc., a Texas Corporation (the "Company" or "Silverleaf") is in the business of marketing and selling vacation intervals ("Vacation Intervals"). Silverleaf's principal activities, in this regard, consist of (i) developing and acquiring timeshare resorts; (ii) marketing and selling one-week annual and biennial Vacation Intervals to new owners; (iii) marketing and selling upgraded Vacation Intervals to existing Silverleaf owners ("Silverleaf Owners"); (iv) providing financing for the purchase of Vacation Intervals; and (v) operating timeshare resorts. The Company has in-house sales, marketing, financing, and property management capabilities and coordinates all aspects of the operation of the 19 existing owned or managed resorts (the "Existing Resorts") and the development of any new timeshare resort, including site selection, design, and construction. Sales of Vacation Intervals are marketed to individuals primarily through direct mail and telephone solicitation.
Each Existing Resort has a timeshare owners' association (a "Club"). Each Club operates through a centralized organization to manage the Existing Resorts on a collective basis. The principal such organization is Silverleaf Club. Certain resorts, which are managed, but not owned, by the Company, are operated through Crown Club. Crown Club is not actually a separate entity, but consists of several individual Club management agreements (which have terms of two to five years with a minimum of two renewal options remaining). Silverleaf Club and Crown Club, in turn, have contracted with the Company to perform the supervisory, management, and maintenance functions at the Existing Resorts. All costs of operating the Existing Resorts, including management fees to the Company, are to be covered by monthly dues paid by Silverleaf Owners to their respective Clubs as well as income generated by the operation of certain amenities at the Existing Resorts. Subject to availability of funds from the Clubs, the Company is entitled to a management fee to compensate it for the services provided.
In addition to Vacation Interval sales revenues, interest income derived from financing activities, and management fees received from the Management Clubs, the Company generates additional revenue from leasing unsold intervals (i.e., sampler sales), utility operations related to the resorts, and other sources. All of the operations are directly related to the resort real estate development industry.
The consolidated financial statements of the Company as of and for the years ended December 31, 1998, 1999, and 2000, reflect the operations of the Company and its wholly owned subsidiaries, Condominium Builders, Inc. ("CBI"), Villages Land, Inc. ("VLI"), Silverleaf Travel, Inc., Database Research, Inc., Silverleaf Resort Acquisitions, Inc., Bull's Eye Marketing, Inc., Silverleaf Berkshires, Inc., and eStarCommunications, Inc. Two subsidiaries, CBI and VLI, were liquidated in 1998 and 2000, respectively.
2. BASIS OF PRESENTATION
The accompanying consolidated financial statements have been prepared on a going concern basis, which contemplates the realization of assets and satisfaction of liabilities in the ordinary course of business. As shown in the accompanying financial statements, during the year ended December 31, 2000, the Company incurred net losses of $59.9 million. It has also experienced negative cash flows from operating activities of $99.5 million, $121.0 million and $62.2 million during the years ended December 31, 1998, 1999, and 2000. In addition, as discussed in Note 3, the Company is in monetary default on its senior subordinated notes, is in default under loan agreements with its three principal lenders who have agreed to exercise forbearance subject to the Company's compliance with the terms of short-term financing arrangements that, unless extended, expire March 31, 2002, and is in default with a fourth non-revolving secured lender due to under-collateralization. These factors, among others, indicate that the Company may be unable to continue as a going concern.
The accompanying consolidated financial statements do not include any adjustments relating to the recoverability of recorded asset amounts or the amounts of liabilities that might be necessary should the Company be unable to continue as a going concern. The Company's continuation as a going concern is dependent upon its ability to generate sufficient cash flow to meet its obligations on a timely basis, to comply with the terms and covenants of its financing agreements, to obtain additional financing or refinancing as may be required, and ultimately to attain profitable operations.
As discussed in Note 3, the Company has finalized, subject to completion of an exchange offer (the "Exchange Offer"), refinancing and restructuring transactions related to its debt to provide liquidity to the Company. However, the terms of the proposed debt refinancing and restructuring require the Company to comply with certain financial covenants that will necessitate achievement of significant improvements in future operating results over the operating results for 2000. Compliance with those covenants will require that improvements be made in several areas of the Company's operations. The principal changes in operations that management believes will be necessary to satisfy the proposed financial covenants are to reduce sales and marketing expense as a percentage of sales, to improve profitability, and to improve customer credit quality, which the Company believes will result in reduced credit losses.
During the second and third quarters of 2001, the Company closed three outside sales offices, closed three telemarketing centers, and reduced headcount in sales, marketing, and general and administrative functions. These changes resulted in $2.7 million of asset write-offs, including $1.4 million of prepaid booth rentals and marketing supplies and $1.3 million of fixed assets related to the closed sales offices and closed telemarketing centers. As a result of these actions, management believes that the necessary operating changes needed to reduce sales and marketing expense to an appropriate level are being implemented.
Due to the high level of defaults experienced in customer receivables during 2000, the Company's provision for uncollectible notes was relatively high as a percentage of Vacation Interval sales during 2000. Management believes the high level of defaults experienced in 2000 was due to the deterioration of the economy in the United States, which began to have a significant impact on the Company's existing customers and on consumer confidence in general in late 2000, and a substantial reduction by the Company in two programs that were previously used to remedy defaulted notes receivable. Management believes the high level of defaults in 2001 was also attributable to the fact that customers concerned about the Company's liquidity issues began defaulting on their notes after the Company's liquidity announcement in February 2001, in addition to continuing economic concerns.
Since the third quarter of 2001, the Company has been operating under new sales practices whereby no sales are permitted unless the touring customer has a minimum income level beyond that previously required and has a valid major credit card. Further, the marketing division is employing a best practices program, which management believes should facilitate marketing to customers who are more likely to be a good credit risk. However, should there be further deterioration in the economy, and if enhanced sales practices do not result in sufficiently improved collections, the Company may not be able to realize improvements in the overall credit quality of its notes receivable portfolio that these actions are designed to achieve.
Management believes that if the Exchange Offer and the revised credit facilities are completed and the actions described above are effective, the Company will be able to improve its operating results sufficiently to achieve compliance with the proposed financial covenants during the terms of the new credit facilities, provided there is no further deterioration in the U.S. economy. However, the Company's plan to utilize certain of its assets, predominantly inventory, extends for periods up to fifteen years. Accordingly, the Company will need to either extend the revolving periods of the new facilities with its secured lenders upon expiration, or obtain new sources of financing in order to realize the value of its assets in the long-term. As a result, the ultimate outcome of this uncertainty is not presently determinable.
3. PROPOSED DEBT RESTRUCTURING
Since February 2001, when the Company disclosed significant liquidity issues arising primarily from the failure to close a credit facility with its largest secured creditor, management and its financial advisors have been attempting to develop and implement a plan to return the Company to a liquid financial condition. During this period, the Company negotiated and closed short-term secured financing arrangements with its three principal secured lenders, which allowed it to operate at reduced sales levels as compared to 1999 and 2000. The Company remained in default under its agreements with these three secured lenders, but they each agreed to forebear taking any action as a result of the Company's defaults and to continue funding so long as the Company complies with the terms of the short-term financing arrangements with these lenders. Unless extended, these short-term arrangements expire on March 31, 2002, and are discussed below.
Effective February 23, 2001, the Company reached a definitive agreement with a lender for a $10 million revolving loan agreement, due August 2002, principal and interest payable from the proceeds obtained on customer notes receivable pledged as collateral for the note, at an interest rate of LIBOR plus 4.00%. This revolving loan agreement reduced the $70 million revolving loan agreement with this same lender by $10 million.
Effective February 28, 2001, the Company reached a definitive agreement with a lender to extend the balance outstanding on its $60 million loan agreement, due December 2000, to February 2002. Effective September 1, 2001, the
interest rate on the balance outstanding was increased from LIBOR plus 2.55% to LIBOR plus 3.55%. Effective February 28, 2002, the Company reached a definitive agreement with this lender to extend the maturity date of this credit facility to August 2002, and upon the completion of the proposed debt restructuring to August 2003. Additional draws are no longer available under this facility.
Effective March 8, 2001, the Company reached a definitive agreement with a lender to increase the interest rate on its $45 million revolving loan agreement, due August 2005, from an interest rate of Prime to Prime plus 2.00%. Effective May 2, 2001, the Company reached a definitive agreement with this same lender to increase its revolving loan agreement to $55 million.
Effective April 17, 2001, the Company reached a definitive agreement with a lender for an additional $10.2 million revolving loan, due April 2006, principal and interest payable from the proceeds obtained on customer notes receivable pledged as collateral for the note, at an interest rate of Prime plus 2.00%.
The Company is also in monetary default with respect to interest owed on its senior subordinated notes. Under the proposed terms of the Exchange Offer, the agreeing holders will exchange their existing notes (the "Old Notes") for 65% of the post-Exchange Offer Silverleaf common stock and new notes (the "New Notes") for 50% of the original note balance bearing interest ranging from 5%, if 80% of the Old Notes are exchanged, to 8%, if 98% or more of the Old Notes are exchanged. Additionally, under the terms of the Exchange Offer, the Indenture related to the Old Notes will be amended, substantially reducing the rights of the original holders and making the Old Notes subordinate to the New Notes. Under the terms of the proposed reconstitution of the Board, following the Exchange Date, the five member Board of Directors will be comprised of (i) two existing directors, (ii) two directors designated for election by the Noteholders' Committee, and (iii) a fifth director elected by a majority vote of the other four directors. As a condition to the Exchange Offer, the secured credit facilities with the Company's three principal secured creditors must be restructured (including the waiver of any and all defaults) in a manner acceptable to the exchanging holders.
In this regard, management has negotiated two-year revolving, three-year term arrangements for $214 million with its three principal secured lenders, subject to completion of the Exchange Offer and funding under the off-balance sheet $100 million credit facility through the Company's SPE. Under these revised credit arrangements, two of the three creditors will convert $43.6 million of existing debt to a subordinated tranche B. Tranche A will maintain a first lien on currently pledged notes receivable. Tranche B will have a second lien on the notes, a lien on resort assets, an assignment of the Company's management contracts with the Clubs, a portfolio of unpledged receivables currently ineligible for pledge under the existing facility, and a security interest in the stock of the Company's SPE. Among other aspects of these revised arrangements, the Company will be required to meet certain financial covenants, including maintaining a minimum tangible net worth of $100 million or greater, as defined, sales and marketing expenses as a percentage of sales below 55.0% for the last three quarters of 2002 and below 52.5% thereafter, a notes receivable delinquency rate below 25%, a minimum interest coverage ratio, and minimum net income. However, such results cannot be assured.
Management negotiated a revised arrangement with the lender under the $100 million off-balance sheet credit facility through Silverleaf Finance I, Inc. ("SFI"), the Company's unconsolidated SPE. This arrangement is subject to completion of both the Exchange Offer and the arrangements with senior lenders described above.
Assuming the revised credit arrangements and restructuring described above occurs and that the Company is able to meet the financial covenants set forth, the Company expects to have adequate financing to operate for the two-year revolving term of the proposed financing with the senior lenders, at which time replacement revolving arrangements will need to be obtained. There can be no assurance that the Company will be able to obtain such financings at that time.
4. SIGNIFICANT ACCOUNTING POLICIES SUMMARY
Principles of Consolidation -- The consolidated financial statements include the accounts of the Company and its wholly owned subsidiaries (excluding SF1). All significant intercompany accounts and transactions have been eliminated in the consolidated financial statements.
Revenue and Expense Recognition -- A substantial portion of Vacation Interval sales are made in exchange for mortgage notes receivable, which are secured by a deed of trust on the Vacation Interval sold. The Company recognizes the sale of a Vacation Interval under the accrual method after a binding sales contract has been executed, the buyer's initial and continuing investment are adequate to demonstrate a commitment to the Vacation Interval, and the statutory rescission period has expired. If all accrual method criteria are met except that construction is not substantially complete, revenues are recognized on the percentage-of-completion basis. Under this method, the portion of revenue applicable to costs incurred, as compared to
total estimated construction and direct selling costs, is recognized in the period of sale. The remaining amount is deferred and recognized as the remaining costs are incurred. The deferral of sales and costs related to the percentage-of-completion method is not significant.
Certain Vacation Interval sales transactions are deferred until the minimum down payment has been received. The Company accounts for these transactions utilizing the deposit method. Under this method, the sale is not recognized, a receivable is not recorded, and inventory is not relieved. Any cash received is carried as a deposit until the sale can be recognized. When these types of sales are cancelled without a refund, deposits forfeited are recognized as income and the interest portion is recognized as interest income.
In addition to sales of Vacation Intervals to new prospective owners, the Company sells upgraded Vacation Intervals to existing Silverleaf Owners. Revenues are recognized on these upgrade Vacation Interval sales when the criteria described above are satisfied. The revenue recognized is the net of the incremental increase in the upgrade sales price and cost of sales is the incremental increase in the cost of the Vacation Interval purchased.
A provision for estimated customer returns (customer returns represent cancellations of sales transactions in which the customer fails to make the first installment payment) is reported net against Vacation Interval sales.
The Company recognizes interest income as earned. To the extent interest payments become delinquent the Company ceases recognition of the interest income until collection is probable.
Revenues related to one-time sampler contracts, which entitles the prospective owner to sample a resort for various periods, are recognized when earned. Revenue recognition is deferred until the customer uses the stay, purchases a Vacation Interval, or allows the contract to expire.
The Company receives fees for management services provided to the Management Clubs. These revenues are recognized on an accrual basis in the period the services are provided if collection is deemed probable.
Utilities, services, and other income are recognized on an accrual basis in the period service is provided.
Sales and marketing costs are charged to expense in the period incurred. Commissions, however, are recognized in the same period as the related sales.
Cash and Cash Equivalents -- Cash and cash equivalents consist of all highly liquid investments with an original maturity at the date of purchase of three months or less. Cash and cash equivalents include cash, certificates of deposit, and money market funds.
Restricted Cash -- Restricted cash consists of certificates of deposit that serve as collateral for construction bonds and cash restricted for repayment of debt.
Investment in Special Purpose Entity -- Sales of notes receivable from the Company to a SPE that meet certain underwriting criteria occur on a periodic basis with the gain or loss on the sale determined based on the proceeds received and the recorded value of notes receivable sold. The fair value of the investment in the SPE is estimated based on the present value of future expected cash flows of the SPE's residual interest in the notes receivable sold. For the year ended December 31, 2000, the Company utilized the following key assumptions to estimate the fair value of such cash flows: customer prepayment rate - 6.4%; expected accounts paid in full as a result of upgrades - 8.1%; expected credit losses - 7.8%; discount rate - 19%; base interest rate - 3.9%, agent fee - 2%, and loan servicing fees - 1%. The Company's assumptions are based on experience with its notes receivable portfolio, available market data, estimated prepayments, the cost of servicing, and net transaction costs.
Provision for Uncollectible Notes -- The Company records a provision for uncollectible notes at the time revenue is recognized. Such provision is recorded in an amount sufficient to maintain the allowance for uncollectible notes at a level management considers adequate to provide for anticipated losses resulting from customers' failure to fulfill their obligations under the terms of their notes. The allowance for uncollectible notes takes into consideration both notes held by the Company and those sold with recourse. Such allowance for uncollectible notes is adjusted based upon periodic analysis of the notes receivable portfolio, historical credit loss experience, and current economic factors. In estimating the allowance, the Company projects future cancellations related to each sales year by using historical cancellations experience.
The allowance for uncollectible notes is reduced by actual cancellations and losses experienced, including losses related to previously sold notes receivable which became delinquent and were reacquired pursuant to the recourse obligations discussed herein. Actual cancellations and losses experienced represents all notes identified by management as being probable of cancellation. Recourse to the Company on sales of customer notes receivable is governed by the agreements between the purchasers and the Company.
The Company classifies the components of the provision for uncollectible notes into the following three categories based on the nature of the item: credit losses, customer returns (cancellations of sales whereby the customer fails to make the first installment payment), and customer releases (voluntary cancellations of properly recorded sales transactions which in the opinion of management is consistent with the maintenance of overall customer goodwill). The provision for uncollectible notes pertaining to credit losses, customer returns, and customer releases are classified in provision for uncollectible notes, Vacation Interval sales, and operating, general and administrative expenses, respectively.
Inventories -- Inventories are stated at the lower of cost or market value. Cost includes amounts for land, construction materials, direct labor and overhead, taxes, and capitalized interest incurred in the construction or through the acquisition of resort dwellings held for timeshare sale. These costs are capitalized as inventory and are allocated to Vacation Intervals based upon their relative sales values. Upon sale of a Vacation Interval, these costs are charged to cost of sales on a specific identification basis. Vacation Intervals reacquired are placed back into inventory at the lower of their original historical cost basis or market value. Company management periodically reviews the carrying value of its inventory on an individual project basis to determine that the carrying value does not exceed market value.
Land, Equipment, Buildings, and Utilities -- Land, equipment (including equipment under capital lease), buildings, and utilities are stated at cost, which includes amounts for construction materials, direct labor and overhead, and capitalized interest. When assets are disposed of, the cost and related accumulated depreciation are removed, and any resulting gain or loss is reflected in income for the period. Maintenance and repairs are charged to expense as incurred; significant betterments and renewals, which extend the useful life of a particular asset, are capitalized. Depreciation is calculated for all fixed assets, other than land, using the straight-line method over the estimated useful life of the assets, ranging from 3 to 20 years. Company management periodically reviews its long-lived assets for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable.
Prepaid and Other Assets -- Prepaid and other assets consists primarily of prepaid insurance, prepaid postage, intangibles, commitment fees, debt issuance costs, novelty inventories, deposits, and miscellaneous receivables. Commitment fees and debt issuance costs are amortized over the life of the related debt. Intangibles are amortized over their useful lives, which do not exceed ten years.
Income Taxes -- Deferred income taxes are recorded for temporary differences between the bases of assets and liabilities as recognized by tax laws and their carrying value as reported in the consolidated financial statements. A provision is made or benefit recognized for deferred income taxes relating to temporary differences in the recognition of expense and income for financial reporting purposes. To the extent a deferred tax asset does not meet the criteria of "more likely than not" for realization, a valuation allowance is recorded.
Earnings (Loss) Per Share -- Basic earnings (loss) per share is computed by dividing net income (loss) by the weighted average shares outstanding. Earnings per share assuming dilution is computed by dividing net income by the weighted average number of shares and potentially dilutive shares outstanding. The number of potentially dilutive shares is computed using the treasury stock method, which assumes that the increase in the number of shares resulting from the exercise of the stock options is reduced by the number of shares that could have been repurchased by the Company with the proceeds from the exercise of the stock options.
The following table reconciles basic and diluted weighted average shares used in the calculation of per share data for the years ended December 31, 1998, 1999, and 2000:
For the year ended December 31, 2000, the impact of stock options on the net loss per share calculation was anti-dilutive.
Use of Estimates -- The preparation of the consolidated financial statements requires the use of management's estimates and assumptions in determining the carrying values of certain assets and liabilities and disclosure of contingent assets and liabilities at the date of the consolidated financial statements and the reported amounts for certain revenues and expenses during the reporting period. Actual results could differ from those estimated. Significant management estimates include the allowance for uncollectible notes and the future sales plan used to allocate certain inventories to cost of sales.
Reclassifications -- Certain reclassifications have been made to the 1998 and 1999 consolidated financial statements to conform to the 2000 presentation. These reclassifications had no effect on net income (loss). The most significant reclassification to the consolidated statements of operations relates to equity on sampler sales applied to the purchase of a Vacation Interval. The equity portion of the sampler upgrade sale is now classified as Vacation Interval sales rather than sampler sales.
Recent Accounting Pronouncements --
SFAS No. 133 -- In June 1998, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 133, "Accounting for Derivative Instruments and Hedging Activities" ("SFAS No. 133"). SFAS No. 133, as amended, was effective for fiscal years beginning after June 15, 2000 and was adopted for the period beginning January 1, 2001. SFAS No. 133 requires that all derivative instruments be recorded on the balance sheet at their fair value. Changes in the fair value of the derivatives are recorded each period in current earnings or other comprehensive income depending on whether a derivative is designated as part of a hedge transaction, and if it is, the type of hedge transaction. The adoption of SFAS No. 133 had no significant impact on the Company's results of operations, financial position, or cash flows in 2001.
SAB No. 101 - In December 1999, the Securities and Exchange Commission issued Staff Accounting Bulletin No. 101, "Revenue Recognition" ("SAB No. 101"), which was adopted by the Company in the fourth quarter of 2000. In connection with the adoption of SAB No. 101, management determined that its methodology for recording sampler sales was inappropriate. As a result, the Company has changed its method of accounting for sampler sales, and treated such change as a correction of an error. See Note 19. There were no other significant changes in the Company's accounting practices resulting from the adoption of SAB No. 101.
SFAS No. 140 - In September 2000, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 140, "Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities" ("SFAS No. 140"), which replaces SFAS No. 125, "Accounting for Transfers and Servicing of Financial Assets and Extinguishment of Liabilities." SFAS No. 140 revises SFAS No. 125's standards for accounting for securitizations and other transfers of financial assets and collateral and requires certain disclosures, but it carries over most of the SFAS No. 125's provisions without reconsideration. SFAS No. 140 was effective for transfers and servicing of financial assets and extinguishments of liabilities occurring after March 31, 2001 and for recognition and reclassification of collateral and for disclosures relating to securitization transactions and collateral for fiscal years ending after December 15, 2000. The Company has adopted the new disclosures required under SFAS No. 140 as of December 31, 2000. SFAS No. 140 is to be applied prospectively with certain exceptions. The adoption of SFAS No. 140 in 2001 did not have a material impact on the Company's results of operations, financial position, or cash flows.
SFAS No. 144 - In August 2001, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets" ("SFAS No. 144"), which supersedes Statement of Financial Accounting Standards No. 121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed Of." SFAS No. 144 establishes a single accounting method for long-lived assets to be disposed
of by sale, whether previously held and used or newly acquired, and extends the presentation of discontinued operations to include more disposal transactions. SFAS No. 144 also requires that an impairment loss be recognized for assets held-for-use when the carrying amount of an asset (group) is not recoverable. The carrying amount of an asset (group) is not recoverable if it exceeds the sum of the undiscounted cash flows expected to result from the use and eventual disposition of the asset (group), excluding interest charges. Estimates of future cash flows used to test the recoverability of a long-lived asset (group) must incorporate the entity's own assumptions about its use of the asset (group) and must factor in all available evidence. SFAS No. 144 is effective on January 1, 2000 for the Company. Management has not yet determined the impact that the adoption of SFAS No. 144 will have on the Company's results of operations, financial position, or cash flows.
5. CONCENTRATIONS OF RISK
Credit Risk -- The Company is exposed to on-balance sheet credit risk related to its notes receivable. The Company is exposed to off-balance sheet credit risk related to notes sold under recourse provisions.
The Company offers financing to the buyers of Vacation Intervals at the Company's resorts. These buyers generally make a down payment of at least 10% of the purchase price and deliver a promissory note to the Company for the balance. The promissory notes generally bear interest at a fixed rate, are payable over a seven-year to ten-year period, and are secured by a first mortgage on the Vacation Interval. The Company bears the risk of defaults on these promissory notes, and this risk is heightened inasmuch as the Company generally does not verify the credit history of its customers and will provide financing if the customer is presently employed and meets certain household income criteria.
If a buyer of a Vacation Interval defaults, the Company generally must foreclose on the Vacation Interval and attempt to resell it; the associated marketing, selling, and administrative costs from the original sale are not recovered; and such costs must be incurred again to resell the Vacation Interval. Although the Company in many cases may have recourse against a Vacation Interval buyer for the unpaid price, certain states have laws that limit the Company's ability to recover personal judgments against customers who have defaulted on their loans. Accordingly, the Company has generally not pursued this remedy.
Interest Rate Risk -- The Company has historically derived net interest income from its financing activities because the interest rates it charges its customers who finance the purchase of their Vacation Intervals exceed the interest rates the Company pays to its lenders. Because the Company's indebtedness bears interest at variable rates and the Company's customer receivables bear interest at fixed rates, increases in interest rates will erode the spread in interest rates that the Company has historically obtained and could cause the rate on the Company's borrowings to exceed the rate at which the Company provides financing to its customers. The Company has not engaged in interest rate hedging transactions. Therefore, any increase in interest rates, particularly if sustained, could have a material adverse effect on the Company's results of operations, cash flows, and financial position.
Availability of Funding Sources -- The Company funds substantially all of the notes receivable, timeshare inventories, and land inventories which it originates or purchases with borrowings through its financing facilities, sales of notes receivable, internally generated funds, and proceeds from public debt and equity offerings. Borrowings are in turn repaid with the proceeds received by the Company from repayments of such notes receivable. 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, cash flows, and financial condition. See Notes 2 and 3.
Geographic Concentration -- The Company's notes receivable are primarily originated in Texas, Missouri, Illinois, Massachusetts, and Georgia. 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 Vacation Interval inventories are concentrated in Texas, Missouri, Illinois, Massachusetts, and Georgia. The risk inherent in such concentrations is in the continued popularity of the resort destinations, which affects the marketability of the Company's products and the collection of notes receivable.
6. NOTES RECEIVABLE
The Company provides financing to the purchasers of Vacation Intervals, which are collateralized by their interest in such Vacation Intervals. The notes receivable generally have initial terms of seven to ten years. The average yield on outstanding notes receivable at December 31, 2000 was approximately 13.4%. In connection with the sampler program, the Company routinely enters into notes receivable with terms of 10 months. Notes receivable from sampler sales were $3.1 million and $3.7 million at December 31, 1999 and December 31, 2000, respectively.
In connection with promotional sales to certain customers, the Company entered into non-interest bearing notes receivable of $3.8 million and $1.5 million, for the years ended December 31, 1999 and December 31, 2000, respectively. The Company had a remaining note discount of $1.2 million and $940,000, for these notes receivable in aggregate as of December 31, 1999 and December 31, 2000, respectively, utilizing a 10% discount rate, which represents the lowest rate offered its existing customers.
Notes receivable are scheduled to mature as follows at December 31, 2000 (in thousands):
There were no notes sold with recourse during the years ended December 31, 1998, 1999, and 2000. Outstanding principal maturities of notes receivable sold with recourse as of December 31, 1999 and 2000, were $2.2 million and $817,000, respectively.
Effective October 30, 2000, the Company entered into a $100 million revolving credit agreement to finance Vacation Interval notes receivable through an off-balance-sheet SPE, formed on October 16, 2000. The agreement presently has a term of 5 years. Following the debt restructuring discussed in Note 3 the principal balance of the loan will mature on the fifth anniversary date of the amended loan; however, the lender shall have the right to put the loan back to the SPE at the end of two years following the date of the amendment. During 2000, the Company sold $74 million of notes receivable to the SPE and recognized pre-tax gains of $4.3 million. The SPE funded these purchases through advances under a credit agreement arranged for this purpose. In conjunction with these sales, the Company received cash consideration of $62.9 million, which was used to pay down borrowings under its revolving loan facilities.
At December 31, 2000, the SPE held notes receivable totaling $70.2 million, with related borrowings of $63.6 million. Except for the repurchase of notes that fail to meet initial eligibility requirements, the Company is not obligated to repurchase defaulted or any other contracts sold to the SPE. It is anticipated, however, that the Company will place bids in accordance with the terms of the conduit agreement to repurchase some defaulted contracts in public auctions to facilitate the re-marketing of the underlying collateral.
Management considers both pledged and sold-with-recourse notes receivable in the Company's allowance for uncollectible notes. The Company considers accounts over 60 days past due to be delinquent. As of December 31, 2000, $33.1 million of notes receivable, net of accounts charged off, were considered delinquent. An additional $38.6 million of notes would have been considered to be delinquent had the Company not granted payment concessions to the customers. The activity in the allowance for uncollectible notes is as follows for the years ended December 31, 1998, 1999, and 2000 (in thousands):
In 2000, the Company substantially increased its provision for uncollectible notes to provide for the poorer performance in the Company's notes receivable portfolio, which resulted from a general downturn in the economy and the elimination of certain programs that had been in place to remedy defaulted loans. The additional provision for uncollectible notes in 2000 was approximately $85 million.
7. INVENTORIES
Due to liquidity issues experienced, the Company reduced its future sales plans for most resorts and discontinued its efforts to sell Crown intervals. As a result, the Company recorded an inventory write-down of $15.5 million based upon a lower of cost or market assessment, and wrote-off $3.1 million of unsold Crown inventory intervals. These write-offs are included in Cost of Vacation Interval Sales in 2000.
Inventories consist of the following at December 31, 1999 and 2000 (in thousands):
Realization of inventories is dependent upon execution of management's long-term sales plan for each resort, which extend for up to fifteen years. Such sales plans depend upon management's ability to obtain financing to facilitate the build-out of each resort and marketing of the Vacation Intervals over the planned time period.
8. LAND, EQUIPMENT, BUILDINGS, AND UTILITIES
Land, equipment, buildings, and utilities consist of the following at December 31, 1999 and 2000 (in thousands):
Depreciation and amortization expense for the years ended December 31, 1998, 1999, and 2000 was $3.4 million, $5.7 million, and $7.5 million, respectively, which included amortization expense related to intangible assets included in prepaid and other assets of $179,000, $311,000, and $308,000 in 1998, 1999, and 2000, respectively.
Due to liquidity concerns experienced, the Company discontinued plans to develop certain properties. Consequently, the Company recorded an impairment of $5.4 million to write-down land to estimated fair value and land held for sale to estimated sales price less disposal costs. The Company also wrote-off $922,000 of intangible assets associated with the discontinuance of sales efforts related to Crown intervals. These impairments are included on the consolidated statement of operations for the year ended December 31, 2000 as impairment loss of long-lived assets.
9. INCOME TAXES
Income tax expense (benefit) consists of the following components for the years ended December 31, 1998, 1999, and 2000 (in thousands):
A reconciliation of income tax expense on reported pretax income at statutory rates to actual income tax expense for the years ended December 31, 1998, 1999, and 2000 is as follows (in thousands):
Deferred income tax assets and liabilities as of December 31, 1999 and 2000 are as follows (in thousands):
As of December 31, 2000, income taxes receivable of $12.5 million represents income tax refunds subsequently received.
The Company reports substantially all Vacation Interval sales, which it finances on the installment method for federal income tax purposes. Under the installment method, the Company does not recognize income on sales of Vacation Intervals until the down payment or installment payment on customer receivables are received by the Company. Interest is imposed, however, on the amount of tax attributable to the installment payments for the period beginning on the date of sale and ending on the date the related tax is paid. If the Company is otherwise not subject to tax in a particular year, no interest is imposed since the interest is based on the amount of tax paid in that year. The consolidated financial statements do not contain an accrual for any interest expense that would be paid on the deferred taxes related to the installment method. The amount of interest expense is not estimable as of December 31, 2000.
The Company has been subject to Alternative Minimum Tax ("AMT") as a result of the deferred income, which results from the installment sales treatment of Vacation Interval sales for regular tax purposes. The current AMT payable balance was adjusted in 1997 to reflect the change in method of accounting for installment sales under AMT granted by the Internal Revenue Service, effective as of January 1, 1997. As a result, the Company's alternative minimum taxable income for 1997 through 1999 was increased each year by approximately $9 million, which resulted in the Company paying substantial additional federal and state taxes in those years. The Company's AMT loss for 2000 was decreased by such amount. Subsequent to December 31, 2000, the Company applied for and received refunds of $8.3 million as the result of the carryback of its 2000 AMT loss to 1999 and 1998. The AMT liability creates a deferred tax asset which may, subject to certain limitations, be used to offset any future tax liability from regular federal income tax. This deferred tax asset has an unlimited carryover period.
The net operating losses ("NOL") expire between 2007 through 2020. Realization of the deferred tax assets arising from net operating losses is dependent on generating sufficient taxable income prior to the expiration of the loss carryforwards. Management currently does not believe that it will be able to utilize its net operating losses as a result of normal operations. However, sufficient temporary differences existed at December 31, 2000 to allow for utilization of its NOL. At present, future NOL utilization is expected to be limited to the temporary differences creating deferred tax liabilities. If necessary, management could implement a strategy to accelerate income recognition for federal income tax purposes to utilize the existing NOL. The amount of the deferred tax asset considered realizable could be decreased if estimates of future taxable income during the carryforward period are reduced.
If the Exchange Offer discussed in Note 3 is completed, it will result in an ownership change within the meaning of Section 382(g) of the Internal Revenue Code ("the Code"). As a result, a portion of the Company's NOL will become subject to an annual limitation for taxable years beginning after the date of the exchange ("change date"), and a portion of the taxable year which includes the change date. The annual limitation will be equal to the value of the stock of the Company
immediately before the ownership change, multiplied by the long-term tax-exempt rate (i.e., the highest of the adjusted Federal long-term rates in effect for any month in the 3-calendar-month period ending with the calendar month in which the change date occurs). This annual limitation may be increased for any recognized built-in gain to the extent allowed in Section 382(h) of the Code. The ownership change may also limit the use of the Company's minimum tax credit, described above, as provided in Section 383 of the Code.
The following are the expiration dates and the approximate net operating loss carryforwards at December 31, 2000 (in thousands):
10. DEBT
Notes payable, capital lease obligations, and senior subordinated notes as of December 31, 1999 and December 31, 2000 are as follows (in thousands):
At December 31, 2000, LIBOR rates were from 6.40% to 6.56%, and the Prime rate was 9.50%.
During 2000, the Company recognized an extraordinary gain of $2.1 million, net of income tax of $1.3 million, related to the early extinguishment of $8.3 million of 10 1/2% senior subordinated notes.
Effective August 18, 2000, the Company reached a definitive agreement with a lender to increase its $30 million revolving loan agreement, due September 2006, to a $40 million five-year revolving loan agreement, due August 2005. Effective October 16, 2000, the Company reached a definitive agreement with this same lender to increase its $40 million revolving loan agreement to a $45 million revolving loan agreement.
Certain of the above debt agreements include restrictions on the Company's ability to pay dividends based on minimum levels of net income and cash flow. The debt agreements contain covenants including requirements that the Company (i) preserve and maintain the collateral securing the loans; (ii) pay all taxes and other obligations relating to the collateral; and (iii) refrain from selling or transferring the collateral or permitting any encumbrances on the collateral. The debt agreements also contain restrictive covenants which include (i) restrictions on liens against and dispositions of collateral, (ii) restrictions on distributions to affiliates and prepayments of loans from affiliates, (iii) restrictions on changes in control and management of the Company, (iv) restrictions on sales of substantially all of the assets of the Company, and (v) restrictions on mergers, consolidations, or other reorganizations of the Company. Under certain credit facilities, a sale of all or substantially all of the assets of the Company, a merger, consolidation, or reorganization of the Company, or other changes of control of the ownership of the Company, would constitute an event of default and permit the lenders to accelerate the maturity thereof.
Such credit facilities also contain operating covenants requiring the Company to (i) maintain an aggregate minimum tangible net worth ranging from $17.5 million to $110 million, minimum liquidity, including a debt to equity ratio of not greater than 2.5 to 1 and a liquidity ratio of not less than 5%, an interest coverage ratio of at least 2.0 to 1, a marketing expense ratio of no more than 0.55 to 1, a consolidated cash flow to consolidated interest expense ratio of at least 2.0 to 1, and total tangible capital funds greater than $200 million plus 75% of net income beginning October 1999; (ii) maintain its legal existence and be in good standing in any jurisdiction where it conducts business; (iii) remain in the active management of the Resorts; and (iv) refrain from modifying or terminating certain timeshare documents. The credit facilities also include customary events of default, including, without limitation (i) failure to pay principal, interest, or fees when due, (ii) untruth of any representation of warranty, (iii) failure to perform or timely observe covenants, (iv) defaults under other indebtedness, and (v) bankruptcy.
Notes payable secured by customer notes receivable require that collections from customers be remitted to the lenders upon receipt. During 2000, the Company received credit card payments from customers that were not appropriately remitted to the lenders. As of December 31, 2000, cumulative unremitted customer credit card receipts were approximately $2.3 million. In addition, the Company is required to calculate the appropriate "Borrowing Base" for each note payable monthly. Such Borrowing Base determines whether the loans are collateralized in accordance with the applicable loan agreements and whether additional amounts can be borrowed. In preparing the monthly Borrowing Base reports for the lenders, the Company has classified certain notes as eligible for Borrowing Base that might be considered ineligible in accordance with the loan agreements. A significant portion of the potentially ineligible notes relates to cancelled notes from customers who have upgraded to a higher value product and notes that have been subject to payment concessions.
The Company has developed programs under which customers may be granted payment concessions in order to encourage delinquent customers to make additional payments. The effect of these concessions is to extend the term of the customer notes. Upon granting a concession, the Company considers the customer account to be current. Under the Company's notes payable agreements, customer notes that are less than 60 days past due are considered eligible as Borrowing Base. As of December 31, 2000, a total of $30.5 million of customer notes have been considered eligible for Borrowing Base purposes which would have been considered ineligible had payment concessions and the related reclassification as current not been granted. In addition, approximately $20.6 million of cancelled notes from customers who have upgraded to a different product have been treated as eligible for Borrowing Base purposes.
As of March 12, 2002, the Company is currently in monetary default on its senior subordinated notes. Interest of $3.5 million and $3.9 million was not paid when due on April 1, 2001 and October 1, 2001, respectively. In addition, principal was not paid when maturity was accelerated in May 2001. As of December 31, 2000, the Company is also in default with respect to its operating covenants related to each of its revolving and inventory loan agreements. See Note 2.
Principal maturities of notes payable, capital lease obligations, and senior subordinated notes, including acceleration of loans in default, are as follows at December 31, 2000 (in thousands):
Total interest expense for the years ended December 31, 1998, 1999, and 2000 was $7.0 million, $16.8 million, and $32.8 million, respectively. Interest of $2.7 million, $2.7 million, and $2.0 million was capitalized during the years ended December 31, 1998, 1999, and 2000, respectively.
During 2001, the Company identified differences between its recorded debt balances and amounts reflected in lender statements. Upon investigation of this matter, management determined that the Company failed to recognize certain customer deposits and returned customer payments processed through lender lock boxes on a timely basis. The Company could not identify the specific customers involved, but concluded that the correcting adjustments should reduce interest income, increase the provision for uncollectible notes, and increase the recorded debt balances. The effect of these adjustments on previously issued financial statements is discussed in Note 19.
As of December 31, 2000, approximately $351.6 million of customer notes receivable and $19.5 million of interval inventory were pledged as collateral.
11. COMMITMENTS AND CONTINGENCIES
In 2000, operating, general and administrative expense includes $3.5 million related to lawsuit settlements, of which $1.5 million is included in accounts payable and accrued expenses as of December 31, 2000, and was subsequently paid.
The homeowners associations of three condominium projects that a former subsidiary of the Company constructed in Missouri filed separate actions of unspecified amounts against the Company alleging construction defects and breach of management agreements. During 2000, the Company incurred $1.3 million to correct a portion of the problems alleged by the plaintiffs. At this time, the Company cannot predict the final outcome of these claims and cannot estimate the additional costs it could incur.
In October 2001, a class action was filed against the Company by plaintiffs who purchased Vacation Intervals from the Company. The plaintiffs allege that the Company failed to deliver them complete copies of the contracts for the purchase of Vacation Intervals as they did not receive a complete legal description of the resort. The plaintiffs further claim that the Company violated various provisions of the Texas Deceptive Trade Practices Act with respect to maintenance fees charged by the Company to its Vacation Interval owners. The petition alleges actual damages of $34.5 million plus consequential damages of an unspecified amount, as well as all attorneys' fees, expenses, and costs. The Company intends to vigorously defend against the claims and believes it has several defenses. The Company was only recently served with the plaintiffs' complaint and has not yet fully assessed the claims.
In February 2002, a class action was filed against the Company by a couple who purchased a Vacation Interval from the Company. The plaintiffs allege that the Company violated the Texas Government Code by charging a document preparation fee in regard to instruments affecting title to real estate, and that such fee constituted a partial prepayment that should have been credited against their note. The petition seeks recovery of the $275 document preparation fee, $825 of treble damages, and injunctions preventing the Company from engaging in such practices. The Company was only recently served with the plaintiffs' complaint and has not yet fully assessed the claims.
The Company is currently subject to other litigation arising in the normal course of its business. From time to time, such litigation includes claims regarding employment, tort, contract, truth-in-lending, the marketing and sale of Vacation Intervals, and other consumer protection matters. Litigation has been initiated from time to time by persons seeking individual recoveries for themselves, as well as, in some instances, persons seeking recoveries on behalf of an alleged class. In the judgment of the Company, none of these lawsuits or claims against the Company, either individually or in the aggregate, is likely to have a material adverse effect on the Company, its business, results of operations, or financial condition.
The Company has entered into noncancelable operating leases covering office and storage facilities and equipment, which will expire at various dates through 2009. The total rental expense incurred during the years ended December 31, 1998, 1999, and 2000 was $4.8 million, $8.0 million, and $10.2 million, respectively. The Company has also acquired equipment by entering into capital leases. The future minimum annual commitments for the noncancelable lease agreements are as follows at December 31, 2000 (in thousands):
Equipment acquired under capital leases consists of the following at December 31, 1999 and 2000 (in thousands):
Periodically, the Company enters into employment agreements with certain executive officers, which provide for minimum annual base salaries and other fringe benefits as determined by the Board of Directors of the Company. Certain of these agreements provide for bonuses based on the Company's operating results. The agreements are for varying terms of up to three years and typically can be terminated by either party upon 30 days notice, subject to severance provisions.
Certain employment agreements provide that such person will not directly or indirectly compete with the Company in any county in which it conducts its business or markets its products for a period of two years following the termination of the agreement. These agreements also provide that such persons will not influence any employee or independent contractor to terminate its relationship with the Company or disclose any confidential information of the Company.
As of December 31, 2000, the Company had construction commitments of approximately $13.3 million.
12. EQUITY
Effective April 3, 1998, the Company completed the sale of 2,000,000 shares of Company common stock at a price of $24.375 per share. On the same date, the majority shareholder of the Company sold 875,000 additional shares of Company common stock to the public. Also effective April 3, 1998, the Company completed the placement of $75 million aggregate principal amount of 10 1/2% senior subordinated notes due 2008 ("Senior Subordinated Notes"). The Senior Subordinated Notes are general unsecured obligations of the Company, ranking subordinate in right of payment to all senior indebtedness of the Company, including indebtedness under the Company's revolving credit facilities. The Company received proceeds from these two offerings in an aggregate net amount of $118.9 million. Costs incurred in connection with the offerings were approximately $4.4 million. The Company utilized the proceeds primarily for the repayment of notes payable and capital lease obligations, and its construction and acquisition programs.
During 1997, the Company established a stock option plan (the "1997 Stock Option Plan"). The 1997 Stock Option Plan provides for the award of nonqualified stock options to directors, officers, and key employees, and the grant of incentive stock options to salaried key employees. Nonqualified stock options provide for the right to purchase common stock at a specified price which may be less than or equal to fair market value on the date of grant (but not less than par value). Nonqualified stock options may be granted for any term and upon such conditions determined by the board of directors of the Company. The Company has reserved 1,600,000 shares of common stock for issuance pursuant to the Company's 1997 Stock Option Plan.
Outstanding options have a graded vesting schedule, with equal installments of shares vesting up through four years from the original grant date. These options are exercisable at prices ranging from $3.59 to $25.50 per share and expire 10 years from the date of grant.
Stock option transactions during 1998, 1999, and 2000 are summarized as follows:
For stock options outstanding at December 31, 2000:
The Company has adopted the disclosure-only provisions of Statement of Financial Standards No. 123, "Accounting for Stock- Based Compensation" ("SFAS No. 123"). The Company applies the accounting methods of Accounting Principles Board Opinion No. 25 ("APB No. 25") and related Interpretations in accounting for its stock options. Accordingly, no compensation costs have been recognized for stock options. Had compensation costs for the options been determined based on the fair value at the grant date for the awards in 1998, 1999, and 2000 consistent with the provisions of SFAS No. 123, the Company's net income (loss) and net income (loss) per share would approximate the pro forma amounts indicated below (in thousands, except per share amounts):
The weighted average fair value per common stock option granted during 1998, 1999, and 2000 were $11.58, $5.19, and $2.58, respectively. The fair value of the stock options granted are estimated on the date of grant using the Black-Scholes option-pricing model with the following weighted average assumptions: expected volatility ranging from 41.6% to 64.5% for all grants, risk-free interest rates which vary for each grant and range from 5.5% to 6.5%, expected life of 7 years for all grants, and no distribution yield for all grants.
Since May 2001, the Company's stock has traded for less than $1.00 per share.
13. RELATED PARTY TRANSACTIONS
Each timeshare owners association has entered into a management agreement, which authorizes the Management Clubs to manage the resorts. The Management Clubs, in turn, have entered into management agreements with the Company, whereby the Company manages the operations of the resorts. Pursuant to the management agreements, the Company receives a management fee equal to the lesser of 15% of gross revenues for Silverleaf Club and 10% to 15% of dues collected for owners associations within Crown Club or the net income of each Management Club; however, if the Company does not receive the aforementioned maximum fee, such deficiency is deferred for payment in the succeeding year(s), subject again to the net income limitation. The Silverleaf Club Management Agreement is effective through March 2010, and will continue year-to-year thereafter unless cancelled by either party. Crown Club consists of several individual Club agreements that have terms of two to five years with a minimum of two renewal options remaining. During the years ended December 31, 1998, 1999, and 2000, the Company recorded management fees of $2.5 million, $2.8 million, and $462,000, respectively, in management fee income.
The direct expenses of operating the resorts are paid by the Management Clubs. To the extent the Management Clubs provide payroll, administrative, and other services that directly benefit the Company, a separate allocation charge is generated and paid by the Company to the Management Clubs. During the years ended December 31, 1998, 1999, and 2000, the Company incurred $5.8 million, $10.3 million, and $155,000, respectively, of expenses under these agreements. As of January 1, 2000, certain employees were transferred from the Management Clubs to the Company. Hence, the allocation of overhead from the Management Clubs to the Company was substantially reduced in 2000. As a result of the payroll changes implemented January 1, 2000, the Company allocated overhead to the Management Clubs of $1.7 million during the year ended December 31, 2000.
The following schedule represents amounts due from (to) affiliates at December 31, 1999 and 2000 (in thousands):
In December 2000, the Company wrote-off its receivable from Silverleaf Club and incurred a charge of $7.5 million. At December 31, 2000, due to liquidity concerns and the planned reduction in future sales, the Company anticipated that future membership dues would not be sufficient to pay down the receivable. Hence, the Company's Board of Directors approved the write-off of this amount.
At December 31, 2000, the amount due to SPE primarily relates to upgrades of sold notes receivable, which was subsequently paid. Upgrades represent sold notes that are replaced by new notes when holders of said notes upgrade to a more valuable Vacation Interval.
An affiliate of a director of the Company is entitled to a 10% net profits interest from sales of certain land in Mississippi. During 2000, the affiliate of the director was paid $49,637 under this agreement. As of December 31, 2000, the Company owns approximately 14 acres of land that is subject to this net profits interest.
In 1997, the Company entered into a ten-year lease agreement with the principal shareholder for personal use of flood plain land adjacent to one of the Company's resorts in exchange for an annual payment equal to the property taxes attributable to the land. The lease has four renewal options of ten years at the option of the lessee.
In August 1997, subject to an employment agreement with an officer, the Company purchased a house for $531,000 and leased the house, with an option to purchase, to the officer for 13 months at a rental rate equal to the Company's expense for interest, insurance, and taxes, which was approximately $3,000 per month. In September 1998, the officer exercised his option to purchase the house at the end of the lease for $531,000. In March 2001, the Company forgave the remaining $48,000 balance on a note due from the officer.
In 1998, the Company incurred and made payments of $736,000 to Recreational Consultants, Inc., an entity of which an officer of the Company is the principal. Recreational Consultants, Inc. generated tours of the Company's resorts.
In June 1998, the Company entered an employment agreement, whereby the Company paid $108,000 for an employee's condominium in Branson, Missouri, upon his relocation to Dallas, Texas, and will pay $500,000 over a three-year period as compensation for and in consideration of the exclusivity of his services. Prior to becoming an employee in June 1998, the Company paid this employee's former architectural firm $246,000 during 1998 for architectural services rendered to the Company.
14. FAIR VALUE OF FINANCIAL INSTRUMENTS
The carrying value of cash and cash equivalents, other receivables, amounts due from or to affiliates, and accounts payable and accrued expenses approximates fair value due to the relatively short-term nature of the financial instruments. The carrying value of the notes receivable approximates fair value because the weighted average interest rate on the portfolio of notes receivable approximates current interest rates to be received on similar current notes receivable. The carrying value of notes payable and capital lease obligations approximates their fair value because the interest rates on these instruments are adjustable or approximate current interest rates charged on similar current borrowings.
The estimated fair value of the Company's $66.7 million Senior Subordinated Notes at December 31, 2000 was approximately $39.0 million, based on the market value of notes extinguished by the Company in December 2000. However, these notes were not traded on a regular basis and were therefore subject to large variances in offer prices. Accordingly, the estimated fair value may not be indicative of the amount at which a transaction could be completed. Also, as discussed in Note 3, the Company is in monetary default on its Senior Subordinated Notes, and is attempting to complete an Exchange
Offer whereby exchanging holders of Old Notes will receive New Notes for one half of the face amount of the Old Notes at a reduced interest rate, plus a proportional share of common equity in the Company. If the exchange is successful, the non-exchanged Old Notes will have reduced rights and will be subordinate to the New Notes, which could diminish their estimated fair value.
Due to the uncertainties surrounding the Exchange Offer, considerable judgment is required to interpret market data to develop the estimates of fair value. Accordingly, the estimates presented herein are not necessarily indicative of the amounts the Company could realize in a current market exchange. The use of different market assumptions and/or estimation methodologies may have a material effect on the estimated fair value amounts.
15. ACQUISITIONS
In May 1998, the Company consummated an agreement with Crown Resort Co., LLC ("Crown") acquiring timeshare management rights and unsold Vacation Intervals at seven resorts in Alabama, Mississippi, Pennsylvania, South Carolina, Tennessee, and Texas for approximately $4.8 million. The acquisition was accounted for under the purchase method of accounting.
In 1998, the Company acquired a golf course and undeveloped land near Atlanta, Georgia, for approximately $4.2 million, undeveloped land near Kansas City, Missouri, for approximately $1.5 million, and a tract of land in Philadelphia, Pennsylvania, for approximately $1.9 million. These acquisitions are accounted for under the purchase method of accounting.
In 1999, the Company acquired undeveloped land near The Villages Resort in Tyler, Texas, for approximately $1.5 million, undeveloped land near Holiday Hills Resort in Branson, Missouri, for approximately $500,000, and undeveloped land near Fox River Resort in Sheridan, Illinois, for approximately $805,000.
16. SUBSIDIARY GUARANTEES
All subsidiaries of the Company, except SF1, have guaranteed the $66.7 million of Senior Subordinated Notes. The separate financial statements and other disclosures concerning each guaranteeing subsidiary (each, a "Guarantor Subsidiary") are not presented herein because management determined that such information is not material to investors. The guarantee of each Guarantor Subsidiary is full and unconditional and joint and several, and each Guarantor Subsidiary is a wholly owned subsidiary of the Company, and together comprise all direct and indirect subsidiaries of the Company. As discussed in Notes 2 and 10, the Company is in monetary default related to the $66.7 million Senior Subordinated Notes. During 1998 and 2000, the Company liquidated several subsidiaries with nominal operations.
Combined summarized operating results of the Guarantor Subsidiaries for the years ended December 31, 1998, 1999, and 2000, are as follows (in thousands):
Combined summarized balance sheet information of the Guarantor Subsidiaries as of December 31, 1999 and 2000, is as follows (in thousands):
17. 401(k) PLAN
Effective January 1, 1999, the Company established the Silverleaf Resorts, Inc. 401(k) plan (the "Plan"), a qualified defined contribution retirement plan, covering employees 21 years of age or older who have completed one year of service. The Plan allows eligible employees to defer receipt of up to 15% of their compensation and contribute such amounts to various investment funds. The employee contributions vest immediately. The Company is not required by the Plan to match employee contributions, however, it may do so on a discretionary basis. The Company incurred nominal administrative costs related to maintaining the Plan and made no contributions to the Plan during the years ended December 31, 1999 and 2000.
18. SELECTED QUARTERLY FINANCIAL DATA (UNAUDITED)
Selected quarterly financial data for 1999 and 2000, which give effect to the restatement discussed in Note 19, is as follows (in thousands, except per share amounts):
Significant adjustments in the fourth quarter of 2000 -
Due to liquidity concerns experienced in the fourth quarter of 2000, the Company reduced its sales plan for future years, discontinued plans to develop certain properties, and discontinued its efforts to sell Crown intervals and to upgrade existing Crown Club members to Silverleaf Club. As a result, the Company incurred one-time charges of $15.5 million to write-down inventories based on a lower of cost or market assessment, $5.4 million to record the impairment of land and land held for sale, $3.1 million to write-off unsold Crown inventory intervals, and $922,000 to write-off Crown intangible assets established in connection with the acquisition of Crown in May 1998. The Company recorded an additional provision for uncollectible notes in the fourth quarter of approximately $46 million. In the fourth quarter of 2000, the Company also wrote-off its receivable from Silverleaf Club and incurred a charge of $7.5 million.
19. RESTATEMENT
Subsequent to the issuance of its annual and interim financial statements for the year ended December 31, 1999, and the quarterly periods in the nine month period ended September 30, 2000, the Company's management determined that accounting treatment that had been originally afforded to certain types of transactions was inappropriate. The specific matters for which adjustments have been made are described below:
Revision to Downgrade Policy - It was determined that the Company's reporting classification for downgrade transactions was inappropriate. Previously, the Company had inappropriately classified the difference between the traded Vacation Interval and the newly assumed Vacation Interval of lower value as a reduction to Vacation Interval sales. The decreased sales price from the original Vacation Interval to the downgraded Vacation Interval represents a write-off of an uncollectible note. Hence, the Company increased Vacation Interval sales and equal amounts were charged to the provision for uncollectible notes as shown below for the period restated.
Provision for Uncollectible Notes - During 2000, the Company substantially reduced two programs that were previously used to remedy defaulted notes receivable. Additionally, there was a deterioration of the U.S. economy that came to public awareness in late 2000. In connection with the Company's analysis of the adequacy of its allowance for uncollectible notes for the year ended December 31, 2000, it was determined that a significant increase to the provision for uncollectible notes
was warranted. Based on these results, the Company reexamined the adequacy of its reserve in prior periods. It was determined that the performance of the notes receivable portfolio began to deteriorate in the second quarter of 2000. Accordingly, the Company increased its allowance for uncollectible notes and the related provision for uncollectible notes for the quarters ended June 30, 2000 and September 30, 2000, as shown below.
Delayed Cancellation of Rescinded Sales - The Company identified an accumulation of rescinded Vacation Interval sales that had not been appropriately cancelled. To correct the delayed cancellation of such sales, the Company adjusted Vacation Interval sales and the direct costs associated with these sales as shown below for the periods restated.
Deferral of Sales within the Rescission Period - It was determined that the Company was immediately recognizing certain Vacation Interval sales rather than appropriately deferring such sales until the customer's legal right of rescission period had elapsed. Consequently, the Company adjusted Vacation Interval sales and the direct costs associated with these sales as shown below for the periods restated.
Incorrect Application of Membership Dues Payments - It was discovered that membership dues payments had been inappropriately applied as principal payments on customer notes receivable. This misapplication resulted in the Company recognizing Vacation Interval sales on accounts without a 10% down payment. To appropriately defer Vacation Interval sales without a 10% down payment, the Company deferred Vacation Interval sales previously recognized in the quarter ended September 30, 2000, as shown below.
Interest Income Related to Loan Amortization - In the fourth quarter of 2000, the Company determined that an over-application of principal related to certain customer accounts had occurred in 2000. To properly account for interest income during 2000, the Company recorded an adjustment to interest income for the quarters ended March 31, 2000, June 30, 2000 and September 30, 2000, as shown below, with offsetting increases to customer notes receivable.
Revision to Sampler Revenue Recognition Policy - In connection with the adoption of SAB No. 101, the Company determined that it had inappropriately accounted for customer payments associated with the sampler program as revenue in advance of fulfilling the Company's obligations or expiration of the sampler terms. As a result, the Company has modified its method of accounting for sampler sales to properly match revenues to the fulfillment of its obligations, which resulted in the adjustment of sampler sales and the direct costs associated with these sales as shown below for the periods restated.
Reconciliation of Lender Debt - It was discovered that the Company had not been appropriately reconciling debt balances and lender lock box activity related to pledged notes receivable. As a result, the Company failed to recognize certain customer deposits and returned customer payments processed through the lender lock boxes on a timely basis. The Company could not identify the specific customers involved, and determined that it would not pursue recovery of any amounts previously credited to customers in error. As a result, management concluded that the correcting adjustment should reduce interest income, increase the provision for uncollectible notes, and increase the recorded debt balances. Consequently, adjustments were made to reconcile lender debt as shown below for the periods restated.
Litigation Costs - The Company was notified by its insurance carrier that remediation work performed by the Company related to certain condominiums subject to litigation would not be covered by insurance. Prior to that time, the Company had incorrectly deferred these remediation costs under the premise that such costs would be recovered. The Company has written-off the deferred remediation costs as shown below for the periods restated.
Revision to Prepaid Customer Lists Policy - It was determined that the Company's accounting treatment for costs of acquiring marketing customer lists to be used in the leads accumulation process was inappropriate. Previously, the Company had capitalized and amortized these costs over their estimated useful lives. Subsequently, it was determined that these costs should be charged to expense as incurred. As a result, the Company charged such costs to sales and marketing expense for the quarters ended June 30, 2000 and September 30, 2000, as shown below.
Cash Flows From Operating Activities - On the consolidated statements of cash flows, customer notes receivable activity is now properly classified as an operating activity rather than an investing activity as previously reported.
A summary of the effects of these adjustments on the Company's statements of operations is as follows (in thousands):
A summary of the significant effects of the restatement on the Company's consolidated financial statements for the years ended December 31, 1998 and 1999 and as of December 31, 1999 is as follows (in thousands):
(a)-not previously presented separately
The restatement also resulted in a decrease in retained earnings of $624,000 as of January 1, 1998.
A summary of the significant effects of the restatement on the Company's unaudited consolidated financial statements for each of the fiscal 1999 quarters, and the fiscal 2000 quarters ended March 31, 2000, June 30, 2000, and September 30, 2000 is as follows (in thousands):
INDEX TO EXHIBITS