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 court 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 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 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 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. A hearing on the Plaintiffs' request for class certification will be held in November 2002.
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 ongoing. Based upon the Company's understanding of the Plaintiffs' claims, the Company believes the outcome of this litigation will not have a material adverse effect on the Company's operations or financial condition.
A further purported class action was filed 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. The Company has not yet determined 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
None.
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 closing bid prices on the Pink Sheets after that date.
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. The Common Stock has been quoted since then on the Electronic Quotation Service of Pink Sheets LLC under the symbol "SVLF." 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. As a part of the May 2, 2002 Exchange Offer, the Company agreed to use its reasonable efforts to obtain a listing of the Common Stock on the OTC Bulletin Board as soon as practicable after the closing of the Exchange Offer.
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
SELECTED CONSOLIDATED HISTORICAL FINANCIAL AND OPERATING INFORMATION
The Selected Consolidated Historical Financial and Operating Information should be read in conjunction with the Consolidated Financial Statements and notes thereto and Management's Discussion and Analysis of Financial Condition and Results of Operations appearing elsewhere in this report on Form 10-K.
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(a) Earnings (loss) per share is based on the weighted average number of shares outstanding.
(b) 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 (loss) and cash flows from operating activities (determined in accordance with generally accepted accounting principles). The following table reconciles EBITDA to net income (loss):
(c) Vacation Intervals sold during the years ended December 31, 1997, 1998, 1999, 2000, and 2001, include 1,517 biennial intervals (counted as 759 annual Vacation Intervals), 3,860 biennial intervals (counted as 1,930 annual Vacation Intervals), 5,936 biennial intervals (counted as 2,968 annual Vacation Intervals), 6,230 biennial intervals (counted as 3,115 annual Vacation Intervals), and 3,061 biennial intervals (counted as 1,531 annual Vacation Intervals), respectively.
(d) Includes annual and biennial Vacation Interval sales for one-bedroom and two-bedroom units.
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.
CLOSING OF EXCHANGE OFFER AND DEBT RESTRUCTURING
On May 2, 2002, the Company completed an exchange offer (the "Exchange Offer") commenced on March 15, 2002 regarding its 10 1/2% senior subordinated notes due 2008 (the "Old Notes"). A total of $56,934,000 in principal amount of the Company's Old Notes were exchanged for a combination of $28,467,000 in principal amount of the Company's new class of 6.0% senior subordinated notes due 2007 ("Exchange Notes") and 23,937,489 shares of the Company's common stock representing approximately 65% of the common stock outstanding immediately following the Exchange Offer. As a result of the exchange, the Company recorded a pre-tax extraordinary gain of $17.9 million in the second quarter of 2002. Under the terms of the Exchange Offer, tendering holders collectively received cash payments of $1,335,545 on May 16, 2002, and will receive a further cash payment of $334,455 on October 1, 2002. A total of $9,766,000 in principal amount of the Company's Old Notes were not tendered and remain outstanding. As a condition of the Exchange Offer, the Company paid all past due interest to non-tendering holders of its Old Notes. Under the terms of the Exchange Offer, the acceleration of the maturity date on the Old Notes which occurred in May 2001 was rescinded, and the original maturity date in 2008 for the Old Notes was reinstated. Past due interest paid to nontendering holders of the Old Notes was $1,827,806. The indenture under which the Old Notes were issued was also consensually amended as a part of the Exchange Offer.
The Company also completed amendments to its credit facilities with its principal senior lenders as well as amendments to a $100 million conduit facility through its SPE. Finalization of the Exchange Offer and the amendment of its principal credit facilities marks the completion of the Company's debt restructuring announced on March 15, 2002, which was necessitated by severe liquidity problems first announced by the Company on February 27, 2001. As a part of the debt restructuring, the Company's noteholders and senior lenders waived all previously declared events of default.
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 in accordance with Staff Accounting Bulletin No. 101 "Revenue Recognition." A sale is recognized after a binding sales contract has been executed, the buyer's price is fixed, the buyer has made a down payment of at least 10%, the statutory rescission period has expired, and collectibility is reasonably assured. 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.
Sales of notes receivable from the Company to a wholly-owned SPE that meet certain underwriting criteria occur on a periodic basis. The Company allocates the carrying amount between assets sold and retained interest based on their relative fair values at the date of sale. The gain or loss on the sale is determined based on the proceeds received and the recorded value of notes receivable sold. The investment in the SPE is recorded at fair value. 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. The Company utilized the following key assumptions to estimate the fair value of such cash flows: customer prepayment rate - 4.3%; expected accounts paid in full as a result of upgrades - 6.2%; expected credit losses - 8.1%; discount rate - 19%; base interest rate - 4.4%, 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.
The provision for uncollectible notes 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. Beginning in 2001, the Company ceased allocating a portion of the provision to operating, general and administrative expenses.
Inventories are stated at the lower of cost or net realizable 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.
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. Interest income is not recognized on notes receivable that are four-plus payments late. The Company reserves 75% of accrued interest income for notes that are three payments late, 50% for notes that are two payments late, 25% for notes that are one payment late, and 10% for all current notes.
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 sound financial condition. During this period, the Company negotiated and closed short-term secured financing arrangements with three lenders, which allowed it to operate at reduced sales levels as compared to original plans and prior years. With the exception of the Company's inability to pay interest due on the Senior Subordinated Notes, these short-term arrangements were adequate to keep the Company's unsecured creditors current on amounts owed.
Under the Exchange Offer that was closed on May 2, 2002, $56,934,000 in principal amount of the Company's 10 1/2% senior subordinated notes were exchanged for a combination of $28,467,000 in principal amount of the Company's new class of 6.0% senior subordinated notes due 2007 and 23,937,489 shares of the Company's common stock, representing approximately 65% of the common stock outstanding after the Exchange Offer. Under the terms of the Exchange Offer, tendering holders received cash
payments of $1,335,545 on May 16, 2002, and $334,455 on October 1, 2002. A total of $9,766,000 in principal amount of the Company's 10 1/2% notes were not tendered and remain outstanding. As a condition of the Exchange Offer, the Company has paid all past due interest to non-tendering holders of its 10 1/2% notes. Under the terms of the Exchange Offer, the acceleration of the maturity date on the 10 1/2% notes which occurred in May 2001 has been rescinded, and the original maturity date in 2008 for the 10 1/2% notes has been reinstated. Past due interest paid to non-tendering holders of the 10 1/2% notes was $1,827,806. The indenture under which the 10 1/2% notes were issued was also consensually amended as a part of the Exchange Offer.
Management has also negotiated two-year revolving, three-year term out arrangements for $214 million with its three principal secured lenders, which were closed at the same time as of the Exchange Offer. In addition, the Company amended its $100 million off-balance-sheet credit facility through the Company's SPE. Under these revised credit arrangements, two of the three creditors converted $42.1 million of existing debt to a subordinated Tranche B. Tranche A is secured by a first lien on currently pledged notes receivable. Tranche B is secured by a second lien on the notes, a lien on resort assets, and 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 Silverleaf Finance I, Inc., the Company's SPE. Among other aspects of these revised arrangements, the Company will be required to operate within certain parameters of a revised business model and satisfy the financial covenants set forth in the Amended Senior Credit Facilities, 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, notes receivable delinquency rate below 25%, a minimum interest coverage ratio of 1.1 to 1.0 (increasing to 1.25 to 1 in 2003), and positive net income. However, such results cannot be assured.
Due to the uncertainties mentioned above, the independent auditors report on the Company's financial statements for the period ended December 31, 2001 contains an explanatory paragraph concerning the Company's ability to continue as a going concern.
Assuming that the Company's financial performance in future periods improves substantially as projected in its business model, the Company believes it will have adequate financing to operate for the two-year revolving term of the proposed financing with the senior lenders. At that time, management will be required to replace or renegotiate the revolving arrangements subject to availability.
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, 1999, 2000, and 2001, the Company's operating activities reflected net cash used in operating activities of $121.0 million, $62.2 million, and $23.9 million, respectively. In 2001, cash used in operating activities decreased compared to 2000 as a result of a decrease in notes receivable financed and income tax refunds received during the year. The decrease in cash used in operating activities in 2000 compared to 1999 is primarily the result of $62.9 million in proceeds from sales of notes receivable.
Net cash provided by financing activities for the years ended December 31, 1999, 2000, and 2001 was $124.9 million, $67.2 million, and $24.9 million, respectively. In 2001, the decrease in cash provided by financing activities compared to 2000 is primarily the result of a $93.3 million decrease in borrowings against pledged notes receivable, offset by a $51.0 million decrease in payments on borrowings against pledged notes receivable. 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. At December 31, 2001, the Company's revolving credit facilities provided for loans of up to $289.8 million, of which approximately $287.2 million of principal and interest related to advances under the credit facilities was outstanding. For the year ended December 31, 2001, the weighted average cost of funds for all borrowings, including the senior subordinated debt, was 8.1%. 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 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. During 2001, the Company made no sales of notes receivable to the SPE.
At December 31, 2001, the SPE held notes receivable totaling $50.4 million, with related borrowings of $43.6 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, 2001.
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 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 during 2001 and $1.6 million during 2002 as the result of the carryback of its 2000 AMT loss to 1999, 1998, and 1997.
The net operating losses ("NOL") expire between 2007 through 2021. Realization of the deferred tax assets arising from NOL 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 NOL from normal operations. 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.
Due to the Exchange Offer described in Footnote 3 of the financial statements, an ownership change within the meaning of Section 382(g) of the Internal Revenue Code ("the Code") has occurred. As a result, a portion of the Company's NOL is 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 three-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.
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, 1999, 2000, and 2001 was $10.5 million, $3.1 million, and $1.6 million, respectively. In 2001 and 2000, the cash used in investing activities decreased compared to 2000 and 1999, respectively, due to reduced purchases of property and equipment. In 1999, cash used in investing activities included proceeds from property sales, offset by 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. The Company evaluates sites for additional new resorts or acquisitions on an ongoing basis. As of December 31, 2001, the Company had construction commitments of approximately $7.8 million. Certain debt agreements include restrictions on the Company's ability to pay dividends based on minimum levels of net income and cash flow. The payment of dividends might also be restricted by the Texas Business Corporation Act.
RESULTS OF OPERATIONS
The following table sets forth certain operating information for the Company.
RESULTS OF OPERATIONS FOR THE YEARS ENDED DECEMBER 31, 2001 AND DECEMBER 31,
Revenues
Revenues in 2001 were $191.3 million, representing a $94.5 million, or 33.1%, decrease compared to revenues of $285.8 million for the year ended December 31, 2000. In February 2001, the Company failed to secure a new credit facility with its largest secured creditor, which created significant liquidity concerns. In addition, the Company's three primary secured lenders have only provided the Company sufficient secured financing to sell at rates substantially reduced from 1999 and 2000 levels.
As a result, Vacation Intervals sales decreased $95.4 million to $139.4 million, down from $234.8 million in 2000. For the year ended December 31, 2001, the number of Vacation Intervals sold, exclusive of in-house Vacation Intervals, decreased 39.9% to 9,741 from 16,216 in 2000; and the average price per interval remained fairly unchanged at $9,688 versus $9,768 in the same period of 2000. Total interval sales for 2001 included 3,061 biennial intervals (counted as 1,531 Vacation Intervals) compared to 6,230 biennial intervals (counted as 3,115 Vacation Intervals) in 2000. During 2001, 10,576 in-house Vacation Intervals were sold at an average price of $4,254, compared to 16,112 in-house Vacation Intervals sold at an average price of $4,741 during the year ended December 31, 2000.
Sampler sales increased to $3.9 million in 2001 compared to $3.6 million in 2000. Consistent with the overall decrease in Company operations, fewer samplers were sold in 2001 compared to 2000. However, sampler sales are not recognized as revenue until the Company's obligation has elapsed, which often does not occur until the sampler contract expires eighteen months after the sale is consummated. Hence, a significant portion of sampler sales recognized in 2001 relate to 2000 sales.
Interest income increased 9.0% to $41.2 million for the year ended December 31, 2001 from $37.8 million for 2000. This increase primarily resulted from an increase in notes receivable, net of allowance for doubtful notes, in 2001 compared to 2000.
Management fee income, which consists of management fees collected from the resorts' management clubs, cannot exceed the management clubs' net income. Management fee income increased $2.1 million for the year ended December 31, 2001 versus the same period of 2000, due primarily to decreased operating expenses at the management clubs in 2001 versus 2000.
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 decreased $578,000 to $4.3 million for the year ended December 31, 2001, compared to $4.9 million for the year ended December 31, 2000. The decrease relates to a $317,000 gain associated with the sale of land recognized in the third quarter of 2000 and to the discontinuance of condominium rentals.
Gain on sale of notes receivable was $0 for the year ended December 31, 2001, compared to $4.3 million in 2000, which 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 decreased to 19.6% in 2001 from 25.2% in 2000. 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 2000. Excluding these items, cost of sales as a percentage of sales increased as the Company's sales mix has shifted to more recently constructed units, which were built at a higher average cost per Vacation Interval.
Sales and Marketing
Sales and marketing costs as a percentage of total sales increased to 54.9% for the year ended December 31, 2001, from 52.6% for 2000. As a result of the aforementioned liquidity issues, the Company made several changes during 2001, including the closure of three outside sales offices, closing three telemarketing centers, discontinuing certain lead generation programs, and reducing headcount in both sales and marketing functions. Despite the cost saving measures, sales and marketing costs as a percentage of total sales increased due to the substantial decrease in sales and $2.0 million of nonrecurring transition costs associated with these changes.
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 should facilitate marketing to customers who management believes are more likely to be a good credit risk.
Provision for Uncollectible Notes
The provision for uncollectible notes as a percentage of Vacation Interval sales decreased to 21.8% for the year ended December 31, 2001 from 46.3% for 2000. This decrease is primarily attributable to the deterioration of the economy that came to public awareness in late 2000 and the Company's decision to substantially reduce two programs in 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. In late 2000, the downgrade program was reduced as it became apparent that this program did not significantly reduce delinquencies. As a result of these changes, the Company recognized additional reserves in 2000.
Due to the high level of defaults experienced in customer receivables throughout 2001, the provision for uncollectible notes remained relatively high during 2001. Management believes the high provision percentage remained necessary in 2001 because of continuing economic concerns and customers concerned about the Company's liquidity issues began defaulting on their notes after the Company's liquidity announcement in February 2001. Management will continue its current collection programs and seek new programs to reduce note defaults. However, there can be no assurance that these efforts will be successful.
Operating, General and Administrative
The Company substantially reduced its employee headcount in 2001 to align its salary expense with its reduced sales levels. However, total operating, general and administrative expenses as a percentage of total revenues increased to 18.5% in 2001 from 12.9% in 2000. Even though certain operating, general and administrative expenses were reduced as part of the Company's downsizing efforts in 2001, total operating, general and administrative expense only decreased by $1.4 million for the year ended December 31, 2001, as compared to 2000. This was due primarily to (i) $4.0 million of professional fees for financial consulting and
legal fees of the Company and certain of its principal creditors incurred in 2001 associated with the restructuring of the Company's debt, and (ii) $1.2 million in auditing fees incurred in 2001.
Depreciation and Amortization
Depreciation and amortization expense as a percentage of total revenues increased to 3.4% in 2001 from 2.6% in 2000, due to the decrease in revenues. Overall, depreciation and amortization expense decreased $1.1 million for the year ended December 31, 2001, as compared to 2000, primarily due to the write-off of $1.3 million of fixed assets previously used in the sales and marketing functions in the first quarter of 2001 and a general reduction in capital expenditures in 2001.
Impairment Loss of Long-Lived Assets
The Company recognized an impairment loss of long-lived assets of $5.4 million in 2001, compared to $6.3 million in 2000. The 2001 impairment loss primarily consisted of a $1.3 million write-off of fixed assets related to the closure of three outside sales offices and three telemarketing centers, a $1.4 million write-off of prepaid marketing costs related to the discontinuance of certain lead generation programs, a $230,000 loss related to the renegotiation and transfer of a capital lease to Silverleaf Club, and a $2.3 million impairment to write-down both corporate planes to their estimated sales prices.
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 model.
Interest Expense
Interest expense as a percentage of interest income remained relatively flat at 84.9% for the year ended December 31, 2001, compared to 86.6% for the year ended December 31, 2000. In 2001, the Company incurred $3.3 million of costs related to restructuring the Company's debt, which offset the decrease in the Company's weighted average cost of borrowing from 9.6% in 2000 to 8.1% in 2001.
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.
Loss before Benefit for Income Taxes and Extraordinary Item
Loss before benefit for income taxes and extraordinary item was a loss of $27.3 million for the year ended December 31, 2001, as compared to a loss of $98.5 million for the year ended December 31, 2000, as a result of the aforementioned operating results.
Benefit for Income Taxes
Benefit for income taxes as a percentage of loss before benefit for income taxes and extraordinary item was 0.3% for the year ended December 31, 2001, as compared to 37.1% for 2000. The decrease in the effective income tax rate is the result of the 2001 projected income tax benefit being reduced by the effect of a valuation allowance, which reduces the projected net deferred tax assets to zero due to the unpredictability of recovery.
Extraordinary Item
There were no extraordinary items during the year ended December 31, 2001. 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.
Net Loss
Net loss was $27.2 million for the year ended December 31, 2001, as compared to $59.9 million for the year ended December 31, 2000, as a result of the aforementioned operating results.
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 Owned 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 model.
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 from losses incurred.
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.
FUTURE CASH PAYMENTS
Principal maturities of notes payable, capital lease obligations, and senior subordinated notes, including acceleration of loans in default, are as follows at December 31, 2001 (in thousands):
Considering the debt restructuring completed in May 2002, principal maturities of notes payable, capital lease obligations, and senior subordinated notes are as follows at December 31, 2001 (in thousands):
The future minimum annual commitments for the noncancelable lease agreements are as follows at December 31, 2001 (in thousands):
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. 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. SFAS No. 140 is to be applied prospectively with certain exceptions. The Company adopted the new disclosures required under SFAS No. 140 as of December 31, 2000. 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 was effective for the Company for the quarter ending March 31, 2002. The adoption of SFAS No. 144 in 2002 did not have a material impact on the Company's results of operations, financial position, or cash flows.
SFAS No. 145 - In April 2002, the Financial Accounting Standards Board ("FASB") issued Statement of Financial Accounting Standards No. 145, "Rescission of FASB Statements No. 4, 44, and 64, Amendment to FASB Statement No. 13, and Technical Corrections" ("SFAS No. 145"). SFAS No. 145 eliminates the current requirement that gains and losses on debt extinguishment must be classified as extraordinary items in the income statement. Instead, such gains and losses will be classified as extraordinary items only if they are deemed to be unusual and infrequent, in accordance with the current GAAP criteria for extraordinary classification. In addition, SFAS No. 145 eliminates an inconsistency in lease accounting by requiring that modifications of capital leases that result in reclassification as operating leases be accounted for consistent with sale-leaseback accounting rules. SFAS No. 145 also contains other non-substantive corrections to authoritative accounting literature. The changes related to debt extinguishment will be effective for fiscal years beginning after May 15, 2002, and the changes related to lease accounting will be effective for transactions occurring after May 15, 2002. The adoption of SFAS No. 145 will require the Company to reclassify its extraordinary gains to ordinary.
SFAS No. 146 - In June 2002, the Financial Accounting Standards Board ("FASB") issued Statement of Financial Accounting Standards No. 146, "Accounting for Costs Associated with Exit or Disposal Activities" ("SFAS No. 146"). SFAS No. 146 supersedes previous accounting guidance, principally Emerging Issues Task Force (EITF) Issue No. 94-3. SFAS No. 146 requires that the liability for costs associated with an exit or disposal activity be recognized when the liability is incurred. Under EITF No. 94-3, a liability for an exit cost was recognized at the date of a company's commitment to an exit plan. SFAS No. 146 also establishes that the liability should initially be measured and recorded at fair value. Accordingly, SFAS No. 146 may affect the timing of recognizing future restructuring costs as well as the amount recognized. SFAS No. 146 is effective after fiscal years beginning after December 31, 2002. The adoption of SFAS No. 146 will not have any immediate impact on the Company's results of operations, financial position or cash flows.
ITEM 7A.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
As of and for the year ended December 31, 2001, the Company had no significant derivative financial instruments or foreign operations. Interest on the Company's notes receivable portfolio, senior subordinated debt, capital leases, and miscellaneous notes is fixed, whereas interest on the Company's primary loan agreements, which totaled $286 million at December 31, 2001, is variable. The impact of a one-point interest rate change on the outstanding balance of variable-rate financial instruments at December 31, 2001, on the Company's annual results of operations would be approximately $2.9 million. In addition, if interest rates increase, the fair market value of the Company's fixed-rate notes will decline, which may negatively impact the Company's ability to sell new notes.
ITEM 8.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
See the information set forth on Index to Consolidated Financial Statements appearing on page of this report on Form 10-K.
ITEM 9.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
The information required by this Item 9 is incorporated by reference to the information provided by the Company in its Form 8-K dated June 25, 2002.
PART III
MANAGEMENT
ITEM 10.
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
DIRECTORS AND EXECUTIVE OFFICERS OF THE COMPANY AT DECEMBER 31, 2001
The following table sets forth certain information concerning each person who was a director or executive officer of the Company as of December 31, 2001.
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* resigned as a director effective May 15, 2002
** resigned as an officer effective December 31, 2001
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. Ms. Brayfield resigned as a director on May 15, 2002.
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 Government 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 government relations. Mr. Franks served as the President of ARDA from February 1991 through July 1997. Mr. Franks resigned as an executive officer of the Company effective December 31, 2001.
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.
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.
DARLA CORDOVA, was elected as Vice President -- Employee and Marketing Services in May 2001. Prior to that time, Ms. Cordova served as Controller - Sales and Marketing.
LELORI ("BUZZ") MARCONI was elected as Vice President -- Marketing Operations in August 2001. Prior to that time, Mr. Marconi served as Call Center Director since 1997.
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 has 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 and serves on the Board of Directors of Leisure and Recreation Concepts, Inc. Mr. Jenkins also serves as President of the Dallas Summer Musicals, Inc., and the Broadway Contemporary Series. Mr. Jenkins resigned as a director on May 15, 2002.
RECONSTITUTION OF BOARD OF DIRECTORS AFTER DECEMBER 31, 2001
The composition of the Company's Board of Directors has changed materially since December 31, 2001. One of the principal conditions of the Exchange Offer consummated on May 2, 2002, was a reconstitution of the Company's existing Board of Directors to add three new independent directors. On May 16, 2002, three new independent directors were added to the Board of Directors in accordance with the terms of the Exchange Offer. Messrs. Mead and Francis remain as two of the Company five directors.
The three new directors who joined Messrs. Mead and Francis on the Board on May 16, 2002 are:
J. RICHARD BUDD III, was elected as a director of the Company in May 2002 under the terms of the Exchange Offer. Since January 2001, Mr. Budd has been a partner in the restructuring advisory firm of Marotta Gund Budd & Dzera, LLC. From 1998 until 2001, Mr. Budd served as an independent advisor to troubled companies and to creditors of troubled companies. From 1996 to 1998 Mr. Budd was Senior Vice President of Metallurg, Inc., an international specialty metals producer. Mr. Budd is also a director of APW, Ltd.
HERBERT B. HIRSCH, was elected as a director of the Company in May 2002 under the terms of the Exchange Offer. From 1988 to January 2002, Mr. Hirsch served as Senior Vice President and Chief Financial Officer of Mego Financial Corp., a developer and operator of timeshare resort properties.
R. JANET WHITMORE, was elected a director of the Company in May 2002 under the terms of the Exchange Offer. Ms. Whitmore has provided consulting services to Divi Resorts, a resort and timeshare sales and marketing company in the Caribbean, since 2000. From 1976 to 2000, Ms. Whitmore was employed by Mobil Corporation in various engineering and financial positions, including Controller of Global Petrochemicals and Chief Financial Analyst.
Additional material changes to the Company's corporate governance structure also occurred on May 16, 2002, including abolition of the executive committee of the Board of Directors and designation of new committee assignments for the Board's other two principal standing committees, the audit committee and the compensation committee.
Since May 16, 2002, the members of the audit committee have been Ms. Whitmore and Messrs. Budd and Francis. Mr. Budd serves as the chairman of the audit committee.
The composition of the compensation committee of the Board also changed on May 16, 2002. Ms. Whitmore now serves as chairman of the compensation committee. The other two members of the compensation committee are Messrs. Budd and Hirsch.
ITEM 11.
ITEM 11. EXECUTIVE COMPENSATION
SUMMARY COMPENSATION TABLE
The following table sets forth the annual base salary and other annual compensation earned in 1999, 2000 and 2001 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.
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, currently $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.
Effective May 24, 2001, Ms. Cordova entered into a one-year employment agreement with the Company which provides for an annual base salary of $107,000, 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 May 31, 2001, Mr. Jones entered into a one-year employment agreement with the Company which provides for an annual base salary of $150,000, 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 May 24, 2001, Mr. Lahart entered into a one-year employment agreement with the Company which provides for an annual base salary of $100,000, plus an incentive bonus based on performance, 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 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.
The agreements with Ms. Brayfield, Ms. Cordova and Messrs. Jones and Lahart also provide that each employee shall be entitled to severance pay equal to six months of his or her then current salary if his or her services are terminated within a year of a change of control of the Company. A "Change of Control" shall be deemed to have occurred if either (i) Robert E. Mead ceases to own a majority of the issued and outstanding common stock of the Company or (ii) the Company files a petition in a court of bankruptcy or is adjudicated a bankrupt. Each of the agreements also provides that such employees will not (i) influence any employee or independent contractor to terminate its relationship with the Company or (ii) disclose any confidential information of the Company at any time.
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, 2001. No options were granted to and no options were exercised during 2001 by any of the Named Executive Officers.
OPTIONS/SARS EXERCISES AND DECEMBER 31, 2001 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, 2001.
(b) As of January 1, 2002, Mr. Franks is 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, 2001 by (i) those persons known to the Company to be the beneficial owners of more than five percent of the outstanding shares, (ii) each current 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 111,250 shares which options are exercisable within sixty days from the date hereof.
(e) Comprised of options to purchase shares which options are exercisable within sixty days from the date hereof.
(f) Includes options to purchase 45,000 shares which options are exercisable within sixty days from the date hereof.
(g) Includes options to purchase 53,334 shares which options are exercisable within sixty days from the date hereof.
(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 January 30, 2002.
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, 1999, 2000, and 2001, the Company recorded management fees of $2.8 million, $462,000, and $2.5 million, 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, 1999, 2000, and 2001, the Company incurred $10.3 million, $155,000, and $147,000, 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 and $1.7 million during the years ended December 31, 2000 and 2001, respectively.
The following schedule represents amounts due from (to) affiliates at December 31, 2000 and 2001 (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.
During 2001, Silverleaf Club entered into a loan agreement for $1.8 million, whereby the Company guaranteed such debt with certain of its assets. As of December 31, 2001, Silverleaf Club's related note payable balance was $1.7 million.
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. During 2001, the Company sold additional parcels of this land and accrued a liability of $17,286 to the affiliate. As of December 31, 2001, the Company owns approximately 11 acres of land that is subject to this net profits interest.
In 1997, the Company, as lessor, entered into a ten-year lease agreement with an individual who is an executive officer and director of the Company for personal recreational use of undeveloped 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 undeveloped flood plain land. These property taxes were approximately $7,500 for the year ended December 31, 2001. 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 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 paid $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, 1999.
(c) The exhibits required by Item 601 of Regulation S-K have been listed in Item 14(a) above. The exhibits listed in Item 14(a) above are either (a) filed with this report, or (b) have previously been filed with the SEC and are incorporated herein by reference to the particular previous filing.
(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, Chairman and 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 Chairman and 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
Board of Directors Silverleaf Resorts, Inc.
We have audited the accompanying consolidated balance sheet of Silverleaf Resorts, Inc. as of December 31, 2001 and the related consolidated statement of operations, stockholders' equity, and cash flows for the year then ended. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audit.
We conducted our audit in accordance with auditing standards generally accepted in the United States 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 audit provides a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Silverleaf Resorts, Inc. at December 31, 2001, and the results of its operations and its cash flows for the year then ended in conformity with accounting principles generally accepted in the United States of America.
The accompanying financial statements have been prepared assuming that the Company will continue as a going concern. As discussed in Note 2 to the financial statements, the Company has continued to incur losses from operations and negative cash flow and has a retained deficit. This raises substantial doubt about the Company's ability to continue as a going concern. While the Restructuring Plan completed May 2, 2002 is intended to provide the Company with a sufficient level of liquidity, there is no certainty that the Company will be able to comply with the restructured terms of the loan agreements. Management's plans in regard to 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.
/s/ BDO Seidman, LLP Dallas, Texas September 12, 2002
INDEPENDENT AUDITORS' REPORT
To the Shareholders of Silverleaf Resorts, Inc.
We have audited the accompanying consolidated balance sheet of Silverleaf Resorts, Inc. and subsidiaries (the "Company") as of December 31, 2000, and the related consolidated statements of operations, shareholders' equity, and cash flows for each of the two 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 for the year ended December 31, 1999 present fairly, in all material respects, the results of operations and cash flows of Silverleaf Resorts, Inc. and subsidiaries for the year ended December 31, 1999 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.
/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, 1999, 2000, AND 2001
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 Owned 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 Owned 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 Owned Resorts. All costs of operating the Existing Owned 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 Owned 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, 1999, 2000, and 2001 reflect the operations of the Company and its wholly-owned subsidiaries, 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. VLI was liquidated in 2000.
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 and 2001, the Company incurred net losses of $59.9 million and $27.2 million, respectively. It has also experienced negative cash flows from operating activities of $121.0 million, $62.2 million, and $23.9 million during the years ended December 31, 1999, 2000, and 2001, respectively. As discussed in Note 3, at December 31, 2001, the Company was in monetary default on its 10 1/2% senior subordinated notes. The Company was also in non-monetary default in connection with its loan agreements with its three principal secured lenders, and was in default with a fourth non-revolving secured lender due to under-collateralization. These factors, among others, indicated that at December 31, 2001, the Company might 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 refinancing and restructuring transactions related to its debt to provide liquidity to the Company. However, the terms of the 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 and 2001. 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 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, which continued throughout 2001, the Company's provision for uncollectible notes was relatively high as a percentage of Vacation Interval sales during 2000 and 2001. 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.
While the Company announced the completion of its restructuring and refinancing transactions on May 2, 2002, the Company's ability to continue as a going concern is dependent on other factors as well, including the achievement of the improvements to the Company's operations described above. In addition, the Amended Senior Credit Facilities require the Company to satisfy certain financial covenants. Management believes that if the improvements to its operations are successful, the Company will be able to improve its operating results to achieve compliance with the financial covenants during the term of the Amended Senior Credit Facilities. However, the Company's plan to utilize certain of its assets, predominantly inventory, extends for periods of up to fifteen years. Accordingly, the Company will need to either extend the Amended Senior Credit Facilities or obtain new sources of financing through the issuance of other debt, equity, or collateralized mortgage-backed securities, the proceeds of which would be used to refinance the debt under the Amended Senior Credit Facilities, finance mortgages receivable, or for other purposes. The Company may not have these additional sources of financing available to it at the times when such financings are necessary.
3. 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 sound financial condition. During this period, the Company negotiated and closed short-term secured financing arrangements with three principal secured lenders, which allowed it to operate at reduced sales levels as compared to original plans and prior years. With the exception of the Company's inability to pay interest due on the Senior Subordinated Notes, these short-term arrangements were adequate to keep the Company's unsecured creditors current on amounts owed.
Until the May 2, 2002 closing of the Company's debt restructuring plan, the Company remained in default under its agreements with its three principal 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 complied with the terms of the short-term financing arrangements with these lenders. These short term arrangements were due to expire on March 31, 2002, but were extended to allow for the closing of the Company's debt restructuring plan on May 2, 2002. Under the Exchange Offer that was closed on May 2, 2002, $56,934,000 in principal amount of the Company's 10 1/2% senior subordinated notes were exchanged for a combination of $28,467,000 in principal amount of the Company's new class of 6.0% senior subordinated notes due 2007 and 23,937,489 shares of the Company's common stock, representing approximately 65% of the common stock outstanding after the Exchange Offer. As a result of the exchange, the Company recorded a pre-tax extraordinary gain of $17.9 million in the second quarter of 2002. Under the terms of the Exchange Offer, tendering holders collectively received cash payments of $1,335,545 on May 16, 2002, and a further payment of $334,455 on
October 1, 2002. A total of $9,766,000 in principal amount of the Company's 10 1/2% notes were not tendered and remain outstanding. As a condition of the Exchange Offer, the Company has paid all past due interest to non-tendering holders of its 10 1/2% notes. Under the terms of the Exchange Offer, the acceleration of the maturity date on the 10 1/2% notes which occurred in May 2001 has been rescinded, and the original maturity date in 2008 for the 10 1/2% notes has been reinstated. Past due interest paid to non-tendering holders of the 10 1/2% notes was $1,827,806. The indenture under which the 10 1/2% notes were issued was also consensually amended as a part of the Exchange Offer. Prior to the closing of its Exchange Offer on May 2, 2002, the Company had been in monetary default with respect to the interest owed on its 10 1/2% notes since May, 2001.
As a result of the significant discount on the Company's notes tendered in the Exchange Offer, the Company accounted for the debt exchange in accordance with Statement of Financial Accounting Standards No. 15 "Accounting by Debtors and Creditors for Troubled Debt Restructurings" ("SFAS No. 15"). Under SFAS No. 15, the Company recorded the fair value of equity issued and established a total liability relating to the notes issued in the exchange equal to the aggregate principal amount plus all interest payable over the term of the notes. Under SFAS No. 15, the Company will not record interest expense in future periods for the cash interest required to be paid to the note holders. All future cash interest payments on the notes will reduce the $8.5 million accrued liability referred to above.
Management has also negotiated two-year revolving, three-year term out arrangements for $214 million with its three principal secured lenders, which were closed at the same time as of the Exchange Offer. In addition, the Company amended its $100 million off-balance-sheet credit facility through the Company's SPE. Under these revised credit arrangements, two of the three creditors converted $42.1 million of existing debt to a subordinated Tranche B. Tranche A is secured by a first lien on currently pledged notes receivable. Tranche B is 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 Silverleaf Finance I, Inc., the Company's SPE. Among other aspects of these revised arrangements, the Company will be required to operate within certain parameters of a revised business model and satisfy the financial covenants set forth in the Amended Senior Credit Facilities, 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, notes receivable delinquency rate below 25%, a minimum interest coverage ratio of 1.1 to 1.0 (increasing to 1.25 to 1 in 2003), and positive net income. However, such results cannot be assured.
Assuming that the Company's financial performance in future periods improves substantially as projected in its business model, the Company believes it will have adequate financing to operate for the two-year revolving term of the credit arrangements with the senior lenders. At that time management will be required to replace or renegotiate the revolving arrangements subject to availability.
4. SIGNIFICANT ACCOUNTING POLICIES SUMMARY
Principles of Consolidation -- The consolidated financial statements include the accounts of the Company and its wholly-owned subsidiaries, excluding Silverleaf Finance I, Inc. (the Company's SPE). 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 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 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. Interest income is accrued on notes receivable, net of an estimated amount that will not be collected, until the individual notes receivable become 90 days delinquent. Once a note receivable becomes 90 days delinquent, the accrual of additional interest income ceases until collection is deemed 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 wholly-owned SPE that meet certain underwriting criteria occur on a periodic basis. The Company allocates the carrying amount between the assets sold and retained interest based on the relative fair values at date of sale. The gain or loss on the sale is determined based on the proceeds received and the recorded value of notes receivable sold. The investment in the SPE is recorded at fair value. 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. The Company utilized the following key assumptions to estimate the fair value of such cash flows: customer prepayment rate - 4.3%; expected accounts paid in full as a result of upgrades - 6.2%; expected credit losses - 8.1%; discount rate - 19%; base interest rate - 4.4%, 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 -- 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. Beginning in 2001, the Company ceased allocating a portion of the provision to operating, general and administrative expenses.
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, other than goodwill, 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, 1999, 2000, and 2001:
Outstanding stock options were not dilutive because the exercise price for such options substantially exceeded the market price for the Company's shares for the years ended December 31, 2000 and 2001, respectively.
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.
Recent Accounting Pronouncements --
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. SFAS No. 140 is to be applied prospectively with certain exceptions. The Company adopted the new
disclosures required under SFAS No. 140 as of December 31, 2000. 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 was effective for the Company for the quarter ending March 31, 2002. The adoption of SFAS No. 144 in 2002 did not have a material impact on the Company's results of operations, financial position, or cash flows.
SFAS No. 145 - In April 2002, the Financial Accounting Standards Board ("FASB") issued Statement of Financial Accounting Standards No. 145, "Rescission of FASB Statements No. 4, 44, and 64, Amendment to FASB Statement No. 13, and Technical Corrections" ("SFAS No. 145"). SFAS No. 145 eliminates the current requirement that gains and losses on debt extinguishment must be classified as extraordinary items in the income statement. Instead, such gains and losses will be classified as extraordinary items only if they are deemed to be unusual and infrequent, in accordance with the current GAAP criteria for extraordinary classification. In addition, SFAS No. 145 eliminates an inconsistency in lease accounting by requiring that modifications of capital leases that result in reclassification as operating leases be accounted for consistent with sale-leaseback accounting rules. SFAS No. 145 also contains other non-substantive corrections to authoritative accounting literature. The changes related to debt extinguishment will be effective for fiscal years beginning after May 15, 2002, and the changes related to lease accounting will be effective for transactions occurring after May 15, 2002. The adoption of SFAS No. 145 will require the Company to reclassify its extraordinary gains to ordinary.
SFAS No. 146 - In June 2002, the Financial Accounting Standards Board ("FASB") issued Statement of Financial Accounting Standards No. 146, "Accounting for Costs Associated with Exit or Disposal Activities" ("SFAS No. 146"). SFAS No. 146 supersedes previous accounting guidance, principally Emerging Issues Task Force (EITF) Issue No. 94-3. SFAS No. 146 requires that the liability for costs associated with an exit or disposal activity be recognized when the liability is incurred. Under EITF No. 94-3, a liability for an exit cost was recognized at the date of a company's commitment to an exit plan. SFAS No. 146 also establishes that the liability should initially be measured and recorded at fair value. Accordingly, SFAS No. 146 may affect the timing of recognizing future restructuring costs as well as the amount recognized. SFAS No. 146 is effective after fiscal years beginning after December 31, 2002. The adoption of SFAS No. 146 will not have any immediate effect 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.
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, 2001 was approximately 13.7%. In connection with the sampler program, the Company routinely enters into notes receivable with terms of 10 months. Notes receivable from sampler sales were $3.7 million and $1.4 million at December 31, 2000 and 2001, respectively, and are non-interest bearing.
In connection with promotional sales to certain customers, the Company entered into non-interest bearing notes receivable of $1.5 million and $443,000 for the years ended December 31, 2000 and 2001, respectively. The Company had a remaining note discount of $940,000 and $550,000 for these notes receivable in aggregate as of December 31, 2000 and 2001, 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, 2001 (in thousands):
There were no notes sold with recourse during the years ended December 31, 1999, 2000, and 2001. Outstanding principal maturities of notes receivable sold with recourse as of December 31, 2000 and 2001 were $817,000 and $366,000, 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. 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. During 2001, the Company made no sales of notes receivable to the SPE.
At December 31, 2001, the SPE held notes receivable totaling $50.4 million, with related borrowings of $43.6 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, 2001, $6.7 million of notes receivable, net of accounts charged off, were considered delinquent. An additional $57.6 million of notes would have been considered to be delinquent had the Company not granted payment concessions to the customers, which brings a delinquent note current and extends the maturity date if two consecutive payments are made. The activity in the allowance for uncollectible notes is as follows for the years ended December 31, 1999, 2000, and 2001 (in thousands):
In 2000 and 2001, 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.
7. INVENTORIES
Inventories consist of the following at December 31, 2000 and 2001 (in thousands):
Due to liquidity issues experienced in 2000 and early 2001, 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.
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, 2000 and 2001 (in thousands):
Depreciation and amortization expense for the years ended December 31, 1999, 2000, and 2001 was $5.7 million, $7.5 million, and $6.5 million, respectively, which included amortization expense related to intangible assets included in prepaid and other assets of $311,000, $308,000, and $0 in 1999, 2000, and 2001, respectively.
Due to liquidity concerns experienced in the fourth quarter of 2000, the Company recorded an impairment loss of long-lived assets of $6.3 million, which includes 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 as a result of the Company's plan to discontinue development of certain properties and $922,000 to write-off intangible assets associated with the discontinuance of sales efforts related to Crown intervals.
In 2001, the Company recorded an impairment loss of $5.4 million, which primarily represents a $1.3 million write-off of fixed assets related to the closure of three sales offices and three telemarketing centers, a $1.4 million write-off of prepaid booth rentals and marketing supplies, $2.3 million related to the write-down of two Company airplanes to their estimated sales prices less costs to sell, and a $230,000 loss related to a lease termination.
9. INCOME TAXES
Income tax expense (benefit) consists of the following components for the years ended December 31, 1999, 2000, and 2001 (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, 1999, 2000, and 2001 is as follows (in thousands):
Deferred income tax assets and liabilities as of December 31, 2000 and 2001 are as follows (in thousands):
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, 2001.
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 during 2001 and $1.6 million during 2002 as the result of the carryback of its 2000 AMT loss to 1999, 1998, and 1997. 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 2021. Realization of the deferred tax assets arising from NOL 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 NOL as a result of normal operations. 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.
Due to the Exchange Offer described in Note 3, an ownership change within the meaning of Section 382(g) of the Internal Revenue Code ("the Code") has occurred. As a result, a portion of the Company's NOL is 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 three-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, 2001 (in thousands):
10. DEBT
Notes payable, capital lease obligations, and senior subordinated notes as of December 31, 2000 and 2001 are as follows (in thousands):
At December 31, 2001, LIBOR rates were from 1.86% to 1.90%, and the Prime rate was 5.0%.
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.
Upon completion of the debt restructuring described in Note 3, the operating covenants described at (i) above were replaced by new operating covenants that require that the Company maintain 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, notes receivable delinquency rate below 25%, a minimum interest coverage ratio of 1.1 to 1.0 (increasing to 1.25 to 1 in 2003), and positive net income. As of September 30, 2002, the Company was in compliance with these operating covenants. However, such future results cannot be assured.
Notes payable secured by customer notes receivable require that collections from customers be remitted to the lenders upon receipt. 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 and 2001, a total of $30.5 million and $53.3 million of customer notes, respectively, 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, as of December 31, 2000 and 2001, approximately $20.6 million and $247,000, respectively, of cancelled notes from customers who have upgraded to a different product have been treated as eligible for Borrowing Base purposes.
Principal maturities of notes payable, capital lease obligations, and senior subordinated notes, including acceleration of loans in default, are as follows at December 31, 2001 (in thousands):
Considering the debt restructuring described in Note 3, principal maturities of notes payable, capital lease obligations, and senior subordinated notes are as follows at December 31, 2001 (in thousands):
Total interest expense for the years ended December 31, 1999, 2000, and 2001 was $16.8 million, $32.8 million, and $35.0 million, respectively. Interest of $2.7 million, $2.0 million, and $1.2 million was capitalized during the years ended December 31, 1999, 2000, and 2001, respectively.
As of December 31, 2001, eligible customer notes receivable with a face amount of $319.0 million and interval inventory of $19.3 million were pledged as collateral.
11. COMMITMENTS AND CONTINGENCIES
In 2000, operating, general and administrative expense includes $3.5 million related to lawsuit settlements.
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 and has not accrued any additional costs. 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 has not yet fully assessed the claims, and accordingly has not recorded an accrual for this case.
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, 1999, 2000, and 2001 was $8.0 million, $10.2 million, and $3.6 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, 2001 (in thousands):
Equipment acquired under capital leases consists of the following at December 31, 2000 and 2001 (in thousands):
During 2001, Silverleaf Club entered into a loan agreement for $1.8 million, whereby the Company guaranteed such debt with certain of its assets. As of December 31, 2001, Silverleaf Club's related note payable balance was $1.7 million.
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, 2001, the Company had construction commitments of approximately $7.8 million.
12. EQUITY
The Company's 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 its 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 1999, 2000, and 2001 are summarized as follows:
For stock options outstanding at December 31, 2001:
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 1999, 2000, and 2001 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 1999 and 2000 were $6.82 and $3.42, respectively. There were no stock options granted in 2001. 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 120.8% to 146.0% 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.
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, 1999, 2000, and 2001, the Company recorded management fees of $2.8 million, $462,000, and $2.5 million, 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, 1999, 2000, and 2001, the Company incurred $10.3 million, $155,000, and $147,000, 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 and $1.7 million during the years ended December 31, 2000 and 2001, respectively.
The following schedule represents amounts due from (to) affiliates at December 31, 2000 and 2001 (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.
During 2001, Silverleaf Club entered into a loan agreement for $1.8 million, whereby the Company guaranteed such debt with certain of its assets. As of December 31, 2001, Silverleaf Club's related note payable balance was $1.7 million.
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. During 2001, the Company sold additional parcels of this land and accrued a liability of $17,286 to the affiliate. As of December 31, 2001, the Company owns approximately 11 acres of land that is subject to this net profits interest.
In 1997, the Company entered into a ten-year lease agreement with a principal shareholder who is the CEO of the Company 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. These property taxes were approximately $7,500 for the year ended December 31, 2001. 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 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 paid $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, 2001 was approximately $41.8 million, based on the market value of notes exchanged in the Exchange Offer described in Note 3. 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. As described in Note 3, the majority of the $66.7 million senior subordinated notes were converted to common stock and a new class of senior subordinated notes on May 2, 2002.
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 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. During 2000, the Company liquidated several subsidiaries with nominal operations.
Combined summarized operating results of the Guarantor Subsidiaries for the years ended December 31, 1999, 2000, and 2001, are as follows (in thousands):
Combined summarized balance sheet information of the Guarantor Subsidiaries as of December 31, 2000 and 2001, 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 six months 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, 2000, and 2001.
18. SELECTED QUARTERLY FINANCIAL DATA (UNAUDITED)
Selected quarterly financial data for 2000 and 2001 is set forth below 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. SUBSEQUENT EVENTS
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 has not yet fully assessed the claims and has not recorded a an accrual for this case.
In May 2002, the Company completed the restructuring of its debt as described in Note 3.
During 2002, the Company sold $69.3 million of notes receivable to the SPE and recognized pre-tax gains of $5.3 million. The SPE funded these purchases through advances under a credit agreement arranged for this purpose. In connection with these sales, the Company received cash consideration of $57.2 million, which was used to pay down borrowings under its revolving loan facilities.
INDEX TO EXHIBITS