FORM 10-Q
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended June 30, 1997
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OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934.
For the transition period from _____________________ to _____________________
Commission file number 0-20832
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DEGEORGE FINANCIAL CORPORATION
(formerly MILES HOMES, INC.)
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(Exact name of registrant as specified in its charter)
Delaware 41-1625724
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(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
99 Realty Drive, Cheshire, Connecticut 06410
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(Address of principal executive offices) (Zip Code)
(203) 699 - 3400
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(Registrant's telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days.
Yes X No
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Shares of Common Stock outstanding as of August 19, 1997: 10,810,193
DEGEORGE FINANCIAL CORPORATION
INDEX TO FORM 10-Q
PART I. FINANCIAL INFORMATION PAGE NO.
ITEM 1. FINANCIAL STATEMENTS:
Consolidated Balance Sheets as of June 30, 3
1997 and December 31, 1996
Consolidated Statements of Operations for the three 4
and six months ended June 30, 1997 and 1996
Consolidated Statements of Cash Flows for the six 5
months ended June 30, 1997 and 1996
Notes to Consolidated Financial Statements 6-12
ITEM 2. Management's Discussion and Analysis of Financial 13-18
Condition and Results of Operations
PART II. OTHER INFORMATION
ITEM 5. OTHER INFORMATION 19
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K 19
2
DEGEORGE FINANCIAL CORPORATION
CONSOLIDATED BALANCE SHEETS
($ IN THOUSANDS)
(Unaudited)
June 30, December 31,
1997 1996
---------- ----------
ASSETS
Cash and cash equivalents $ 1,809 $ 3,737
Notes receivable, net 68,943 26,726
Receivable from related parties 1,094 1,047
Inventory 4,745 7,833
Prepaid expenses and other assets 5,475 4,158
Deposits 11,153 19,249
Mortgage servicing rights 1,434 5,982
Senior Bond collateral fund 2,857 3,008
Real estate owned 8,164 6,576
Property, plant and equipment, net 11,449 12,191
Property held for sale, net 277 417
Assets of discontinued operations 1,497 2,549
Deferred income taxes 336 336
Intangible assets, net 1,780 2,006
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Total assets $ 121,013 $ 95,815
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LIABILITIES AND STOCKHOLDERS' EQUITY
Accounts payable $ 8,598 $ 7,053
Accrued construction costs and unearned
income on sold notes receivable 8,470 28,857
Accrued expenses 4,315 4,399
Customer deposits 901 821
Collateralized notes receivable 49,368 -
12% Senior notes 43,806 43,738
Notes payable 4,009 3,527
Capital lease obligations - 925
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Total liabilities 119,467 89,320
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Commitments and contingencies (Note 8)
Stockholders' equity:
Common Stock; par value $.10, 25,000,000 shares
authorized, 10,810,193 shares outstanding 1,081 1,081
Paid in capital 47,384 47,384
Accumulated deficit (46,919) (41,970)
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Total stockholders' equity 1,546 6,495
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Total liabilities and stockholders' equity $ 121,013 $ 95,815
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See accompanying notes to consolidated financial statements
3
DEGEORGE FINANCIAL CORPORATION
CONSOLIDATED STATEMENTS OF OPERATIONS
($ IN THOUSANDS EXCEPT PER SHARE DATA)
(Unaudited)
Three months ended Six months ended
June 30, June 30,
----------------------------- -----------------------------
1997 1996 1997 1996
------------ ------------ ------------ ------------
Services income:
Contract fee income $ 8,054 $ - $ 8,054 $ -
Net financial services income 2,734 1,235 3,793 2,332
------------ ------------ ------------ ------------
Total services income 10,788 1,235 11,847 2,332
------------ ------------ ------------ ------------
Housing income:
Net standard housing revenue 3,098 23,267 16,625 31,788
Construction revenue 2,976 1,963 5,435 3,029
Cost of sales (5,404) (15,215) (16,694) (22,115)
------------ ------------ ------------ ------------
Housing income, net 670 10,015 5,366 12,702
------------ ------------ ------------ ------------
Total income 11,458 11,250 17,213 15,034
Operating expenses:
Selling 3,380 3,563 7,275 6,140
General & administrative 4,570 3,950 8,435 7,658
Provision for credit losses 311 712 474 1,071
Other interest expense 1,579 1,569 3,166 3,162
Other (income) expense 651 (341) 993 (553)
Distribution center closing costs 1,819 - 1,819 -
------------ ------------ ------------ ------------
Income (loss) from continuing operations
before income taxes (852) 1,797 (4,949) (2,444)
Income tax benefit (provision) - - - -
------------ ------------ ------------ ------------
Income (loss) from continuing operations (852) 1,797 (4,949) (2,444)
Discontinued operations-Patwil Homes, Inc.
Income (loss) from operations - 310 - 622
------------ ------------ ------------ ------------
Net income (loss) $ (852) $ 2,107 $ (4,949) $ (1,822)
------------ ------------ ------------ ------------
------------ ------------ ------------ ------------
Earnings per common share:
Income (loss) from continuing operations (0.08) 0.16 (0.46) (0.23)
Income (loss) from discontinued operations - 0.03 - 0.06
------------ ------------ ------------ ------------
Net income (loss) $ (0.08) $ 0.19 $ (0.46) $ (0.17)
------------ ------------ ------------ ------------
------------ ------------ ------------ ------------
Weighted average number of common shares outstanding 10,810,193 10,810,193 10,810,193 10,810,193
------------ ------------ ------------ ------------
------------ ------------ ------------ ------------
See accompanying notes to consolidated financial statements
4
DEGEORGE FINANCIAL CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE SIX MONTHS ENDING JUNE 30, 1997 AND 1996
($ IN THOUSANDS)
(Unaudited)
1997 1996
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CASH FLOWS FROM OPERATING ACTIVITIES
Net income (loss) $ (4,949) $ (1,822)
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Adjustments to reconcile net income (loss) to
net cash provided by operating activities:
Depreciation and amortization 5,350 5,092
Provision for credit losses 474 1,071
Provision for sales promotions and incentives 334 1,472
Loss (gain) on sale of property, plant and equipment 101 (444)
Loss (gain) from discontinued operations - (622)
Decrease (increase) in other operating assets (Note 6) (28,931) (78,933)
Increase (decrease) in other operating liabilities (Note 6) (18,846) 9,646
---------- ----------
Total adjustments (41,518) (62,718)
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Net cash provided (used) by operating activities of:
Continuing operations (46,467) (64,540)
Discontinued operations 1,052 385
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Net cash provided (used) by operating activities (45,415) (64,155)
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CASH FLOWS FROM INVESTING ACTIVITIES
Proceeds from sales of property, plant and equipment 1,269 6,730
Purchase of property, plant and equipment (996) (3,191)
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Net cash provided (used) by investing activities 273 3,539
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CASH FLOWS FROM FINANCING ACTIVITIES
Proceeds from financing of construction loans receivable,
net of discounting 45,328 -
Proceeds (repurchases) from sales of construction loans receivable,
net of discounting (1,671) 59,910
Principal payments on notes payable - other (191) -
Borrowings on notes payable - other 673 57
Principal payments on capital leases (925) (218)
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Net cash provided (used) by financing activities 43,214 59,749
---------- ----------
Net change in cash and cash equivalents (1,928) (867)
Cash and cash equivalents - beginning of the period 3,737 2,838
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Cash and cash equivalents - end of the period $ 1,809 $ 1,971
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Supplemental disclosures of cash flow information:
Interest paid $ 6,785 $ 2,913
Income taxes paid (refunded), net $ 68 $ (23)
See accompanying notes to consolidated financial statements
5
DEGEORGE FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
NOTE 1 -- BASIS OF PRESENTATION:
The accompanying unaudited consolidated financial statements have been
prepared in accordance with Form 10-Q instructions and in the opinion of
management, contain all adjustments (consisting of only normal recurring
accruals) necessary to present fairly the financial position as of June 30,
1997, the results of operations for the three and six months ended June 30, 1997
and 1996 and cash flows for the six months ended June 30, 1997 and 1996 of the
Company. The results of operations for the three and six months ended June 30,
1997 are not necessarily indicative of the results to be expected for the full
year. These results have been determined on the basis of generally accepted
accounting principles and practices applied consistently with those used in the
preparation of the Company's 1996 Annual Report on Form 10-K.
DeGeorge Financial Corporation (the "Company") is a holding company whose
significant assets are its investment in its wholly owned operating subsidiaries
DeGeorge Home Alliance, Inc. ("DeGeorge"), and its wholly owned subsidiary,
Plymouth Capital Company, Inc. ("Plymouth Capital"); DeGeorge Homes of Florida,
Inc. ("DeGeorge/Florida") and DeGeorge Homes of New England, Inc. ("DeGeorge/New
England"). Pursuant to a vote of a majority of its stockholders at the Annual
Meeting of Stockholders on November 7, 1996, the name of the Company was changed
to DeGeorge Financial Corporation from Miles Homes, Inc. DeGeorge, formerly
Miles Homes Services, Inc., changed its name on October 29, 1996. The combined
assets, liabilities, earnings and equity of DeGeorge, Plymouth Capital,
DeGeorge/Florida and DeGeorge/New England are substantially equivalent to the
assets, liabilities, earnings and equity of the Company on a consolidated basis.
Accordingly, separate financial statements and other disclosures concerning
DeGeorge, Plymouth Capital, DeGeorge/Florida and DeGeorge/New England are not
deemed to be material to investors. During 1996, the Company essentially
completed the phase out of operations for its wholly owned subsidiary, Patwil
Homes, Inc. ("Patwil Homes"). See "Note 9 - Discontinued Operations".
On April 14, 1995 the Company entered into a Construction Loan Purchase
and Servicing Agreement ("the Construction Loan Agreement") with a mortgage
financing company under which the Company may transfer, at its discretion and
subject to certain criteria, all of its construction loans. The Construction
Loan Agreement was amended in March 1997 (the "March 1997 Amendment") and
June 1997 (the "June 1997 Amendment"). The March 1997 Amendment revised the
provisions of the minimum tangible net worth covenant. The June 1997
Amendment revised certain other provisions, including a reduction in the
holdback deposit requirement from 12% to 8% and a change in the benchmark for
computing the cost of funds, from prime plus 1 1/2% to three month LIBOR plus
3% (10% and 8.81%, respectively, at June 30, 1997), effectively reducing the
Company's cost of funds 119 basis points as of June 30, 1997. The June 1997
Amendment also extended the term of the Construction Loan Agreement to
June 1, 1999.
Effective January 1, 1997, the Company adopted Statement of Financial
Accounting Standards No. 125, "Accounting for Transfers and Servicing of
Financial Assets and Extinguishments of Liabilities" ("FAS 125"). Under FAS
125, the Company is accounting for the transfer of its notes receivable under
the Construction Loan Agreement as a pledge of collateral in a borrowing
arrangement for all transactions occurring after December 31, 1996. Although
there is no difference in substance or form for sales of notes receivable that
occurred prior to January 1, 1997 to those that transferred after December 31,
1996, the transactions that occurred prior to 1997 retain their sale
characteristics since FAS 125 proscribes retroactive application to transactions
occurring before January 1, 1997. Thus, transactions occurring
6
prior to 1997 are not included in construction loans underwritten or
collateralized notes receivable while all transactions that occurred after
December 1996 are reflected as such in the balance sheet as of June 30, 1997.
During the second quarter of 1997, the Company introduced local purchase
of building materials in the customer's locality. As a result of the
Company's change in business operations, DeGeorge has adopted the method of
recording its service fees (contract fee income) ratably over the service
period based on the ratio of services performed at the time of sale and
thereafter to total services performed over the service period. Contract fee
income commences upon the closing of the construction loan, which is the
confirmed point of sale for DeGeorge. Since the Company no longer takes title
to materials in the customary distribution process, cost of sales (which had
included the cost of materials, warehousing, material handling and shipping)
has been eliminated for DeGeorge core business activities. Certain other
costs (e.g. construction support services), formerly included in cost of
sales, have been reclassified to general and administrative expenses.
Revenue and cost of sales for residual DeGeorge shipments from distribution
centers during the second quarter of 1997 are reported in a manner consistent
with prior periods.
Results of operations for the second quarter of 1997 reflect the impact
of changes in the Company's business operations. In order to provide a
useful comparison of results of operations for the quarters and six month
periods ended June 30, 1997 and 1996, total income has been recast to reflect
the contribution to margin for the services sector of operations, which is
the predominant business of the Company, and the housing sector, which
reflects the results of operations for turnkey construction activities,
including DeGeorge/Florida and DeGeorge/New England. For comparative
purposes, the prior period results for turnkey activities have been
segregated from net housing revenue, as previously termed, and reclassified
to construction revenue. Accordingly, net standard housing revenue reflects
the results of DeGeorge shipments from distribution centers. Cost of sales has
been repositioned to illustrate the contribution to margin from housing
activity, which is consistent with the presentation of services income.
During the second quarters and six month periods of 1997 and 1996, cost of
sales includes the combined activities of distribution center shipments as
well as turnkey construction costs.
As a result of the change in business operations, income from Company
activities is reflected on a fee income basis. Contract fee income includes
services to customers for advisory and support services (e.g. planning,
budgeting, materials scheduling). Net financial services income continues to
reflect net interest charges to customers on construction loans, net loan
servicing income, loan origination fees and customer insurance placement fees.
Interest income on deposits, previously reflected in other income/expense, has
been reclassified to net financial services income. Other than recasting the
presentation of results of operations to properly reflect current business
operations, no restatement of results of operations for prior periods has been
made.
Certain information and footnote disclosures normally included in financial
statements presented in accordance with generally accepted accounting principles
have been condensed or omitted. It is suggested that the accompanying
consolidated financial statements be read in conjunction with the financial
statements and notes thereto incorporated by reference in the Company's Annual
Report on Form 10-K.
Certain reclassifications have been made to the financial statements for
the three and six months ended June 30, 1996 to conform to the presentation for
the three and six months ended June 30, 1997.
7
NOTE 2 -- NOTES RECEIVABLE:
Notes receivable at June 30, 1997 and December 31, 1996 are as follows (in
thousands):
JUNE 30, DECEMBER 31,
1997 1996
--------- ------------
Construction loans underwritten $109,545 $43,452
Less: unfunded loan obligations (33,722) (6,315)
unearned income (4,979) (8,757)
-------- -------
70,844 28,380
Less:
Allowance for sales promotions and incentives (714) (878)
Allowance for credit losses (1,028) (675)
Deferred loan processing fees, net (159) (101)
-------- -------
Notes receivable, net $ 68,943 $26,726
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-------- -------
At June 30, 1997, $49.4 million of construction loans underwritten
have been pledged as collateral under the Construction Loan Agreement. Loans
transferred prior to January 1, 1997, the balance of which was $117.3 million
at June 30, 1997, continue to retain their sale characteristics and are not
included in notes receivable.
NOTE 3 -- TRANSFER AND SERVICING OF NOTES RECEIVABLE:
Amounts owed to the Company under the holdback provisions of the
Construction Loan Agreement are included in deposits, which are stated net of
estimated credit losses on construction loans sold at June 30, 1997 and December
31, 1996, as follows (in thousands):
JUNE 30, DECEMBER 31,
1997 1996
--------- ------------
Holdback $ 13,752 $22,370
Allowance for estimated credit losses (2,957) (3,542)
-------- -------
Net holdback (included in deposits) $ 10,795 $18,828
-------- -------
-------- -------
Mortgage servicing rights on receivables transferred prior to January 1,
1997 (sales) at June 30, 1997 is as follows (in thousands):
JUNE 30,
1997
--------
Balance, beginning of year $ 5,982
Originated on transfers -
Less : Amortization (4,548)
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Mortgage servicing rights $ 1,434
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Prepaid interest on receivables transferred after December 31, 1996
(financings) at June 30, 1997 is as follows (in thousands):
JUNE 30,
1997
--------
Balance, beginning of year $ -
Originated on transfers 4,040
Less : Amortized interest expense (967)
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Prepaid interest (included in prepaid expenses
and other assets) $ 3,073
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8
NOTE 4 -- INVENTORY:
Inventory at June 30, 1997 and December 31, 1996 is as follows (in
thousands):
JUNE 30, DECEMBER 31,
1997 1996
-------- ------------
Raw materials $ - $ 4,241
Construction in progress and model homes 4,745 3,592
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Inventory $ 4,745 $ 7,833
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NOTE 5-- INCOME TAXES:
Significant components of deferred income taxes at June 30, 1997 and
December 31, 1996 are as follows (in thousands):
JUNE 30, DECEMBER 31,
1997 1996
---------- ------------
Credit and refinancing allowances $ 2,490 $ 2,544
Goodwill 1,754 1,832
Net operating loss carryforward 8,772 7,012
Other, net 3,006 2,649
--------- --------
Total gross deferred tax assets 16,022 14,037
Less: valuation allowance (15,686) (13,701)
--------- --------
Deferred income taxes $ 336 $ 336
--------- --------
--------- --------
At June 30, 1997 and December 31, 1996, the Company had net operating loss
carryforwards for federal income tax purposes of $21.9 million and $17.5
million, respectively, which will fully expire by the year 2012.
Income tax benefit (provision) for the three and six months ended June 30,
1997 and 1996 are as follows (in thousands):
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30 JUNE 30
---------------------- -----------------
1997 1996 1997 1996
---- ---- ---- ----
Statutory U.S. tax rate $ 304 $ (630) $ 1,691 $ 812
State taxes, net of federal income
tax benefit 53 (111) 298 143
Effect of temporary differences (4) - (4) -
Valuation allowance (353) 741 (1,985) (955)
----- ------- ------- ------
Income tax benefit (provision) $ -0- $ -0- $ -0- $ -0-
----- ------- ------- ------
----- ------- ------- ------
For the six months ended June 30, 1997, the Company did not record a tax
provision or benefit. The six month net loss of $4.9 million resulted in an
increase in net operating loss carryforwards and a corresponding increase in the
valuation reserve of $2.0 million.
9
NOTE 6-- CONSOLIDATED STATEMENTS OF CASH FLOWS:
Changes in other operating assets and liabilities in the Consolidated
Statements of Cash Flows are as follows (in thousands):
SIX MONTHS ENDED
JUNE 30
------------------------
1997 1996
---- ----
Decrease (increase) in:
Notes receivable $(37,314) $(59,689)
Receivable from related parties (47) (531)
Inventory 3,088 (2,880)
Prepaid expenses and other assets (1,317) (5,075)
Deposits 8,096 (2,814)
Mortgage servicing rights - (5,427)
Senior Bond collateral fund 151 -
Real estate owned (1,588) (2,517)
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Total decrease (increase) in other
operating assets $(28,931) $(78,933)
-------- --------
-------- --------
Increase (decrease) in:
Accounts payable and accrued expenses $ 1,461 $ (4,205)
Accrued construction costs and unearned
income on sold notes receivable (20,387) 13,331
Customer deposits 80 520
-------- --------
Total increase (decrease) in other operating
liabilities $(18,846) $ 9,646
-------- --------
-------- --------
NOTE 7-- SUMMARIZED FINANCIAL INFORMATION:
Summarized financial information of DeGeorge as of June 30, 1997 and
December 31, 1996 and for the three and six months ended June 30, 1997 and 1996
is as follows (in thousands):
JUNE 30, DECEMBER 31,
1997 1996
-------- ------------
Total assets $159,407 $100,743
Total liabilities 152,146 88,083
Total assets include intercompany receivables of $24.3 million and $25.2
million, respectively, at June 30, 1997 and December 31, 1996.
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30 JUNE 30
------------------ -----------------
1997 1996 1997 1996
---- ---- ---- ----
Total income $11,143 $11,073 $16,584 $14,755
Net income (loss) (731) 1,763 (4,625) (1,891)
10
NOTE 8-- COMMITMENTS AND CONTINGENCIES:
There has been no significant change in the status of lawsuits or
commitments described in Note 13 to the Consolidated Financial Statements
contained in the Company's 1996 Annual Report on Form 10-K, except as follows:
Effective May 1, 1997, the operating lease for the Denver distribution
facility was terminated. This lease had originally extended to February 28,
2000. As a result of the cancellation of this lease, future minimum lease
obligations have been reduced by $447,000.
NOTE 9-- DISCONTINUED OPERATIONS:
Summarized below are the assets of discontinued operations (in thousands):
JUNE 30, DECEMBER 31,
1997 1996
-------- ------------
Cash $ 263 $ 695
Notes receivable 80 182
Inventory 211 357
Prepaid expenses and other assets 106 124
Costs of uncompleted contracts in excess
of related billings 306 349
Assets held for sale, net 531 842
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Assets of discontinued operations $1,497 $2,549
------ ------
------ ------
Condensed income (loss) from discontinued operations for the three and six
months ended June 30, 1997 and 1996 is as follows (in thousands):
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30 JUNE 30
------------------ -----------------
1997 1996 1997 1996
---- ---- ---- ----
Net revenues $ - $ 2,295 $ 171 $ 5,305
Cost of sales (13) (1,948) (163) (4,645)
Selling, general and administrative
expenses (46) (37) (120) (38)
----- ------- ------ -------
Discontinued operations -
income (loss) $ (59) $ 310 $ (112) $ 622
----- ------- ------ -------
----- ------- ------ -------
Loss from discontinued operations for the three and six months ended June
30, 1997 is reflected in other (income) expense.
NOTE 10 -- SIGNIFICANT TRANSACTIONS:
During the second quarter of 1997, the Company closed its distribution
facilities and changed its method of providing for the delivery of materials to
customers' building sites. In connection with this change, the Company sold, on
April 18, 1997, its owned distribution facility in Owatonna, Minnesota for $1.1
million in cash, part of which was used to retire a capital lease with an
outstanding principal balance of $810,000. In addition to the sale of its
Owatonna facility, the Company's obligations under the lease for its Denver,
Colorado distribution facility terminated effective May 1, 1997 by mutual
agreement with the lessor.
11
Effective June 1, 1997, the Construction Loan Agreement was amended
to include an extension of the term to June 1, 1999, a reduction in the
holdback deposit requirement and a reduction in the cost of funds. See "Note
1 - Basis of Presentation" for further discussion of these changes.
NOTE 11 -- SUBSEQUENT EVENTS:
On July 18, 1997, Price Waterhouse LLP ("Price") resigned as the auditor
for the Company. In connection with Price's audit for the two most recent
fiscal years, and the subsequent interim periods preceding the resignation of
Price, there were no reportable disagreements on any matter of accounting
principles or practices, financial statement disclosure or auditing scope or
procedure which disagreement, if not resolved to the satisfaction of Price,
would have caused Price to make a reference to the subject matter of the
disagreement in connection with its report. The Company filed a Form 8-K with
the Securities and Exchange Commission on July 25, 1997 relating to this matter.
On July 31, 1997, the Company sold its one-half interest in a jet aircraft
for $1.45 million in cash. In January 1996, the Company paid $1.5 million plus
transaction fees for its half-interest in the aircraft and has paid for certain
upgrades to the aircraft during its period of ownership. At the time of
sale, the Company recognized a loss of $50,000 on the original purchase price
and a write-off of $114,000, net of depreciation, of transaction fees and
improvements.
12
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
RESULTS OF OPERATIONS
OVERVIEW
The following discussion makes various comparisons relevant to the
results of operations of the Company for the three and six months
ended June 30, 1997 and 1996 with regard to continuing and
discontinued operations. Discontinued operations relate to the phase
out of operations for Patwil Homes, which was essentially completed
during 1996. Loss from discontinued operations during 1997 is
included in other (income) expense. Except where noted, all
references herein are to continuing operations.
CHANGES IN BUSINESS OPERATIONS
During the second quarter of 1997, the Company introduced local
purchase of building materials in the customer's area. Local
purchasing enables DeGeorge to timely meet its customers' building
materials needs by arranging for direct delivery from local vendors
to customers' building sites. This approach eliminates the process of
purchasing and warehousing building materials for later delivery to
customers from Company owned or leased distribution centers, which
locations restricted the Company's ability to expand its sales areas
and burdened the Company with escalating shipping and fixed facilities
costs. Accordingly, DeGeorge closed all three of its distribution
centers in the second quarter of 1997 and began servicing customers
through local vendors at that time.
The change to local purchase represents the final phase of the
Company's transition into its new business of providing single-
source construction financing and comprehensive support services to
qualified entry-level and move-up buyers. Prior changes have included
the standardization of its product, the relocation and restructuring
of Company operations and the expansion of its selling and marketing
activities through long-form television information commercial
("infomercial") airings, direct mail campaigns and increased sales
representative concentrations in selected markets.
As a result of the Company's change in business operations, DeGeorge
has adopted the method of recording its service fees (contract fee
income) ratably over the service period based on the ratio of services
performed at the time of sale and thereafter to total services
performed over the service period. Contract fee income commences
upon the closing of the construction loan, which is the confirmed
point of sale for DeGeorge. Since the Company no longer takes title
to materials in the customary distribution process, cost of sales
(which had included the cost of materials, warehousing, material
handling and shipping) has been eliminated for DeGeorge core
business activities. Certain other costs (e.g. construction support
services), formerly included in cost of sales, have been reclassified
to general and administrative expenses. Revenue and cost of sales for
residual DeGeorge shipments from distribution centers during the
second quarter of 1997 are reported in a manner consistent with prior
periods. All remaining inventory on hand at March 31, 1997, was
liquidated during the second quarter of 1997.
CHANGES IN PRESENTATION OF OPERATING RESULTS
Results of operations for the second quarter of 1997 reflect the
impact of changes in the Company's business operations. In order to
provide a useful comparison of results of operations for the quarters
and six month periods ended June 30, 1997 and 1996, total income has
been recast to reflect the contribution to margin for the services
sector of operations, which
13
is the predominant business of the Company, and the housing sector,
which reflects the results of operations for turnkey construction
activities, including DeGeorge/Florida and DeGeorge/New England. For
comparative purposes, the prior period results for turnkey activities
have been segregated from net housing revenue, as previously termed,
and reclassified to construction revenue. Accordingly, net standard
housing revenue reflects the results of DeGeorge shipments from
distribution centers. Cost of sales has been repositioned to
illustrate the contribution to margin from housing activity, which is
consistent with the presentation of services income. During the
second quarters and six month periods of 1997 and 1996, cost of sales
includes the combined activities of distribution center shipments as
well as turnkey construction costs.
As a result of the change in business operations, income from Company
activities is reflected on a fee income basis. Contract fee income
includes services to customers for advisory and support services (e.g.
planning, budgeting, materials scheduling). Net financial services
income continues to reflect net interest charges to customers on
construction loans, net loan servicing income, loan origination fees
and customer insurance placement fees. Interest income on deposits,
previously reflected in other income/expense, has been reclassified
to net financial services income. Other than recasting the
presentation of results of operations to properly reflect current
business operations, no restatement of results of operations for prior
periods has been made.
INCOME
Total income for the second quarter ended June 30, 1997 increased to
$11.5 million from $11.3 million for the same period in 1996, an
increase of $200,000. During the second quarter of 1997, net
financial services income increased $1.5 million over the quarter
ended June 30, 1996, principally due to an increase of $900,000 in net
loan servicing and interest income on construction loans transferred,
plus an increase of $400,000 in interest income on an expanded
portfolio of retained construction loans and an increase of $200,000
relating to fees earned on permanent mortgage originations placed by
Plymouth Capital. Total income from DeGeorge core business activities
was down $1.1 million during comparative second quarters, to $8.4
million from $9.5 million, primarily due to a decrease in the volume
of orders recorded in the first quarter of 1997 as a result of changes
to the field sales structure in the latter part of 1996, the impact of
which was reflected in the second quarter results of operations.
For the six months ended June 30, 1997, total income increased by $2.2
million, to $17.2 million from $15.0 million, over the comparable
period in 1996. Net financial services income reflects $1.5 million
of the increase in total income, of which $1.3 million relates to an
increase in net loan servicing and interest income on construction
loans transferred. Permanent mortgage originations contributed an
additional $400,000 to the increase in total income. The increase in
net financial services income was offset by a $200,000 decrease in
other interest income for the six month period. Total income from
DeGeorge core business activities was up $600,000 on a year-to-date
basis, to $12.6 million in 1997 from $12.0 million in 1996.
COST OF SALES
Cost of sales includes the cost of materials, warehousing, shipping
and material handling for shipments of DeGeorge product from
distribution centers as well as costs of construction for turnkey
housing activity. Effective with the change to local purchase of
building materials, DeGeorge closed its distribution centers and
ceased all warehousing and handling activities, thereby eliminating
the majority of its cost of sales. On an on-going basis, cost of
sales will continue to reflect the cost of construction for turnkey
projects and will be reflected as an offset to construction revenue in
the statement of operations.
14
SELLING EXPENSES
Selling expenses during the second quarter decreased by $200,000, to
$3.4 million in 1997 from $3.6 million in 1996. The second quarter
net decrease includes a $1.2 million reduction in commissions to sales
representatives attributable to restructured commission plans and
reduced sales volume, which decrease was offset by an increase of
$500,000 in costs related to airings of the Company's infomercial, an
increase of $300,000 in costs pertaining to permanent mortgage
origination activities of Plymouth Capital and an increase of
$200,000 in direct marketing expansion costs.
For the six months ended June 30, 1997, selling expenses increased
$1.1 million, to $7.3 million in 1997 from $6.2 million in 1996. This
increase is primarily attributable to an increase of $2.0 million in
direct response advertising costs, of which $1.6 million pertained to
costs incurred for initial and subsequent airings of its infomercial,
which amount includes the write-off of $700,000 of production costs
that were included in prepaid expenses and other assets at December
31, 1996. The increase in selling expenses for the six month period
also includes $300,000 in costs pertaining to permanent mortgage
origination activities and $300,000 in direct marketing expansion
costs, which were offset by $1.2 million of reduced commission
expenses and $300,000 of reduced recruitment costs and savings
achieved through the elimination of reimbursed expenses to sales
representatives.
At June 30, 1997 and 1996, respectively, DeGeorge had 187 and 123
full-time sales representatives.
GENERAL AND ADMINISTRATIVE
General and administrative expenses were $4.6 million and $4.0
million, respectively, for the three months ended June 30, 1997 and
1996, and $8.4 million and $7.6 million, respectively, for the
comparative six month periods. The $600,000 and $800,000 increases
in the second quarter and six month period are attributable to:
(i) increases of $200,000 and $300,000, respectively, in facilities
charges from expanded operations at the Company's headquarters to
replace services previously provided at the closed distribution
centers; (ii) increases of $300,000 and $300,000, respectively,
in personnel costs attributable to increased staffing for
improvements in processing and information technology and
relocation costs incurred in recruiting key managers, and (iii)
$100,000 and $200,000, respectively, of accrued legal fees in
connection with the pending action against former employees of the
Company.
INTEREST EXPENSE
Interest expense for the second quarters and six month periods of 1997
and 1996 was unchanged at $1.6 million and $3.2 million, respectively.
For the three and six months ended June 30, 1997, interest expense
includes $1.3 million and $2.7 million, respectively, of interest
charges related to the 12% Senior Notes due 2001.
OTHER (INCOME) EXPENSE
Other expense for the quarter and six months ended June 30, 1997 was
$700,000 and $1.0 million, respectively, as compared to other income
of $300,000 and $500,000, respectively, for the similar periods in
1996. During the three and six month periods in 1996, the Company had
recorded a gain of $600,000 on the sale of its distribution facility
in Mountaintop, Pennsylvania.
15
Also during 1996, the Company had reflected in the six month period a
gain of $200,000 from the sale of fixed assets, principally on the
sale of the Plymouth, Minnesota facility. During 1997, the Company
recorded in the second quarter and six month period, respectively,
$200,000 and $300,000, of non-recurring customer accommodations in
connection with the conversion to local purchase. The 1997 year-
to-date expense also includes a $100,000 loss from discontinued
operations, which was reported separately in 1996.
DISTRIBUTION CENTER CLOSING COSTS
During the second quarter of 1997, DeGeorge closed its distribution
centers in Owatonna, Minnesota, Denver, Colorado and Ft. Wayne,
Indiana. The closing of these facilities resulted in a net non-
recurring charge of $1.8 million for the second quarter and six month
period ending June 30, 1997, which includes the write-off of $500,000
of inventory capitalization, the write-off of $300,000 of leasehold
improvements, the payment of $400,000 in severance, wages and benefits
related to the shut-down of facilities and losses of $500,000 and
$300,000, respectively, on the disposal of inventory and equipment.
An offsetting $200,000 gain was recorded on the sale of the Company's
distribution center in Owatonna, Minnesota. The Owatonna facility
was sold for $1.1 million in cash on April 18, 1997, part of which
was used to retire a capital lease with an outstanding principal
balance of $800,000 plus closing costs.
INCOME TAXES
On January 1, 1993, the Company adopted FAS 109 which provides for the
recognition of deferred tax assets and liabilities based on expected
future tax consequences of events that have been recognized in the
Company's financial statements. As of December 31, 1996, the Company
had accumulated a gross deferred tax asset of $14.0 million, against
which the Company had recorded a valuation allowance of $13.7 million,
resulting in the recognition of deferred income taxes of $300,000.
During the quarter and six months ended June 30, 1997, the Company did
not record a tax provision or tax benefit. The six month net loss of
$4.9 million resulted in an increase in net operating loss
carryforwards and a corresponding increase in the valuation reserve of
$2.0 million.
The Company presently has a September 30 fiscal year end for tax
reporting purposes. The Company has requested and the Internal
Revenue Service has approved a change in the tax year end to December
31. At June 30, 1997 and December 31, 1996, the Company had net
operating loss carryforwards for federal income tax purposes of $21.9
million and $17.5 million, respectively, which will fully expire by
the year 2012.
NET INCOME (LOSS)
Net loss for the quarter ended June 30, 1997 was $900,000, or $0.08
per share, as compared to net income of $2.1 million, or $0.19 per
share, for the second quarter of 1996. The results of operations for
the second quarter of 1996 includes income from discontinued
operations of $300,000, or $0.03 per share.
For the six months ended June 30, 1997, net loss was $4.9 million, or
$0.46 per share, as compared to a net loss of $1.8 million, or $0.17
per share, for the similar period in 1996. The prior year results
includes income from discontinued operations of $600,000, or $0.06 per
share. For the six months ended June 30, 1997, the Company recorded a
charge of $100,000 from discontinued operations, which amount is
included in other (income) expense.
QUARTERLY RESULTS
16
For the three months ended June 30, 1997, the Company reported
total income of $11.5 million as compared to $11.3 million in the
similar period in 1996, an increase of $200,000. The increase in
total income, which represents gross margin from business
activities, was offset by a net increase of $400,000 in selling,
general and administrative expenses, including $1.6 million in
infomercial advertising, and an increase of $2.8 million in other
expenses and distribution center closing costs, of which $2.4
million are non-recurring in nature.
During the second quarter of 1997, DeGeorge recorded 292 loan closings
as compared to 479 loan closings in the similar period in 1996. The
decrease in loan closings is directly attributable to reduced order
activity in the first quarter that occurred as a result of revisions
to the field sales compensation structure and recruitment processes
that were implemented in the latter part of 1996. Since initiating
these changes, which contributed to a turnover of previous sales
representatives, DeGeorge has attracted a higher calibre force of
sales professionals. The number of field sales representatives
increased to 187 at June 30, 1997 from 132 at December 31, 1996, of
which 50% produced orders in June 1997. Gross orders for the second
quarter of 1997 was within 177 orders of the total for the second
quarter of 1996 (781 orders in 1997 versus 958 orders in 1996). At
June 30, 1997, the inventory of active orders was 504 as compared to
1,041 at June 30, 1996. However, leads generated in the second
quarter of 1997 were up 31.3% over the same period in 1996,
continuing the strong pace set in the first quarter of 1997
(up 33.4%).
LIQUIDITY AND CAPITAL RESOURCES
At June 30, 1997, cash and cash equivalents were $1.8 million as
compared to $3.7 million at December 31, 1996.
Since April 1995, the Company has been transferring its construction
loans to a mortgage financing company pursuant to the Construction
Loan Purchase and Servicing Agreement (the "Construction Loan
Agreement"), under which the Company may, at its discretion and
subject to certain criteria, transfer all of its construction loans.
On June 1, 1997, certain provisions of the Construction Loan
Agreement were amended (the "June 1997 Amendment"), including a
reduction in the holdback deposit requirement from 12% to 8% and a
change in the benchmark for computing the cost of funds, from prime
plus 1 1/2% to three month LIBOR plus 3% (10% and 8.81%, respectively,
at June 30, 1997), effectively reducing the cost of funds 119 basis
points as of June 30, 1997. The June 1997 Amendment also extended
the term of the Construction Loan Agreement to June 1, 1999.
Effective January 1, 1997, the Company adopted Statement of Financial
Accounting Standards No. 125, "Accounting for Transfers and Servicing
of Financial Assets and Extinguishments of Liabilities" ("FAS 125").
Under FAS 125, the Company began accounting for the transfer of its
notes receivables under the Construction Loan Agreement as a pledge of
collateral in a borrowing arrangement for all transactions occurring
after December 31, 1996. Prior to January 1, 1997, the Company had
treated the transfer of its receivables as sales. Although there is
no difference in substance or form for sales of notes receivable that
occurred prior to January 1, 1997 to those that transferred after
December 31, 1996, the transactions that occurred prior to 1997 retain
their sale characteristics since FAS 125 proscribes retroactive
application to transactions occurring before January 1, 1997. Thus,
transactions occurring prior to 1997 are not included in
construction loans underwritten or collateralized notes receivable
while all transactions that occurred after December 1996 are
reflected as such in the balance sheet as of June 30, 1997.
17
Under the Construction Loan Agreement, loans are transferred at face
value, net of discounting. The Construction Loan Agreement also
provides for a deposit account, owned by the Company, for retention of
a portion of the proceeds from the transfer of construction loans as
security for credit losses. The balance of deposits at June 30, 1997
and December 31, 1996 was $13.8 million and $22.4 million,
respectively. The significant decrease in the balance of deposits is
attributable to the one-third reduction in reserve requirements as
provided for in the June 1997 Amendment, which resulted in the return
of $7.5 million of deposits to the Company in June 1997. Deposits are
reflected in the financial statements net of provision for estimated
credit losses ($3.0 million and $3.6 million at June 30, 1997 and
December 31, 1996, respectively) on construction loans transferred.
During the second quarter of 1997, the Company transferred $23.2
million of construction loans pursuant to the Construction Loan
Agreement. Net proceeds to the Company for the second quarter were
$21.6 million, after discounting of $1.9 million and net return of
deposits of $300,000 (retainage on sales of $2.6 million less returns
of $2.9 million relative to loan payoffs). For the six months ended
June 30, 1997, the Company transferred $47.7 million, net face value
($49.4 million gross transfers less $1.7 of repurchased accounts), of
construction loans pursuant to the Construction Loan Agreement. Net
proceeds to the Company for the six month period were $44.8 million,
after discounting of $4.0 million and net return of deposits of $1.1
million (retainage on sales of $5.8 million less returns of $6.9
million relative to loan payoffs).
As of June 30, 1997, the Company was servicing $166.7 million, face
value, of previously transferred construction loans. Of this amount,
$117.3 million were transferred prior to January 1, 1997 as sales of
notes receivable. The balance of $49.4 million represent financing
transactions occurring after December 31, 1996.
18
PART II. OTHER INFORMATION
ITEM 5. OTHER INFORMATION:
None
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits:
10.39 Second Amendment to Construction Loan Purchase and Servicing
Agreement dated as of June 1, 1997.
(b) Reports on Form 8-K:
On July 25, 1997 the Company filed a Form 8-K disclosing the
resignation of Price Waterhouse LLP ("Price") as auditor for
the Company, effective July 18, 1997. In connection with
Price's audit for the two most recent fiscal years, and the
subsequent interim periods preceding the resignation of
Price, there were no reportable disagreements on any matter
of accounting principles or practices, financial statement
disclosure or auditing scope or procedure which
disagreement, if not resolved to the satisfaction of Price,
would have caused Price to make a reference to the subject
matter of the disagreement in connection with its report.
19
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.
DEGEORGE FINANCIAL CORPORATION
(Registrant)
Dated: August 19, 1997
By: /s/ SALVATORE A. BUCCI
------------------------------
Salvatore A. Bucci
Senior Vice President and
Chief Financial Officer
20
EXHIBIT INDEX
EXHIBIT NO. DESCRIPTION OF EXHIBIT SEQUENTIAL PAGE
- ----------- ---------------------- ---------------
10.39 Second Amendment to Construction Loan 22
Purchase and Servicing Agreement
21