1 EXHIBIT 13.1 MANAGEMENT'S DISCUSSION AND ANALYSIS OF CROWN GROUP, INC. FINANCIAL CONDITION AND RESULTS OF OPERATIONS The following discussion should be read in conjunction with the Company's consolidated financial statements appearing elsewhere in this annual report. OVERVIEW Crown Group, Inc. ("Crown"), and collectively with its subsidiaries (the "Company"), is a publicly traded buy-out firm which presently owns (i) 65% of Paaco Automotive Group, Inc. and Premium Auto Acceptance Corporation (collectively, "Paaco"), a vertically integrated used car sales and finance company, (ii) 100% of Precision IBC, Inc. ("Precision"), a firm specializing in the sale and rental of intermediate bulk containers, (iii) 80% of Concorde Acceptance Corporation ("Concorde"), a sub-prime mortgage lender, (iv) 49% of Casino Magic Neuquen S.A. ("CMN"), a casino operator in the Province of Neuquen, Argentina, and (v) 80% of Home Stay Lodges I, Ltd., a partnership focusing on the development and operation of extended-stay lodging facilities. In addition, from time to time the Company purchases and sells small ownership interests in securities of privately held and publicly traded firms. The Company is presently focusing on (i) the development and expansion of its existing businesses, and (ii) the potential acquisition or development of other unrelated businesses. Since its inception in 1983 through June 1993 the Company was engaged in various facets of the cable and related programming businesses. During 1992 the Company sold the majority of its programming business and began exploring new business opportunities. In June 1993 the Company made the decision to enter the gaming business, and as a result, proceeded to sell the balance of its cable assets. From June 1993, with the acquisition of 100% of St. Charles Gaming Company, Inc. ("SCGC"), until November 1996, the Company's primary business focus was that of owning, operating and developing casino gaming properties. SCGC owns and operates a riverboat gaming casino located in Calcasieu Parish, Louisiana which had been in the development stage until opening in July 1995. The Company sold a 50% interest in SCGC in June 1995 and the remaining 50% interest in May 1996, in each case resulting in a substantial gain. In November 1996 the Company decided to expand its business interests beyond casino gaming and began pursuing business opportunities in other fields. As a result the Company has either acquired or formed a number of businesses in a variety of industries. RECENT ACQUISITIONS CMN - In June 1997 the Company acquired a 49% interest in CMN for a purchase price of $7 million cash. CMN operates casinos in the cities of Neuquen and San Martin de los Andes in the Province of Neuquen, Argentina under an exclusive concession contract. CONCORDE - In June 1997 the Company, along with certain newly hired management personnel, formed Concorde. Concorde is in the business of originating, purchasing, servicing and selling sub-prime mortgage loans which are secured primarily by first and second liens on residential properties. These loans are sold in privately negotiated transactions to institutional investors and other third parties. PAACO - In February 1998 the Company acquired 53% of the common stock of Paaco for a purchase price of approximately $9.1 million cash. Approximately $4.9 million of Paaco common stock was purchased directly from Paaco, and the remaining $4.2 million was purchased from Paaco management personnel who prior to this transaction were the sole shareholders of Paaco. Effective May 1, 1998 the Company purchased an additional 12% interest in Paaco from the management shareholders. The purchase price of approximately $1.5 million was paid by issuing 375,000 shares of the Company's common stock. Paaco is a vertically integrated used car sales and finance company which operates seven used car dealerships in the Dallas-Ft. Worth metropolitan area. Paaco sells, underwrites and finances used cars and trucks with a focus on the Hispanic market. PRECISION - In February 1998 the Company acquired 80% of the common stock of Precision IBC, Incorporated ("Original Precision") for a purchase price of approximately $2.4 million cash. In March 1998 the Company acquired 80% of the common stock of M&S Tank Rentals, Inc. ("M&S") for a purchase price of $1.65 million cash. Original Precision and M&S were subsequently merged together into a newly formed corporation, Precision IBC, Inc. ("Precision"). Effective May 1, 1998 the Company purchased the remaining 20% of Precision. The purchase price of approximately $1.1 million was paid by issuing 288,027 shares of the Company's common stock. Precision is in the business of renting, selling, testing and servicing principally stainless steel intermediate bulk containers. 2 RESULTS OF OPERATIONS SCGC was a consolidated subsidiary of the Company through June 8, 1995. From June 9, 1995 (the date the first 50% interest in SCGC was sold) through May 3, 1996 (the date the remaining 50% interest in SCGC was sold) the Company accounted for its 50% interest in SCGC using the equity method. The Company's investment in 49% of CMN is accounted for on the equity method. The operating results of Paaco and Precision have been included in the Company's consolidated results of operations from their respective dates of acquisition (February 1998). As a result of the above transactions, operating results of the Company for the years ended April 30, 1998, 1997 and 1996 are not entirely comparable. Below is a presentation of the operating results for the four principal business segments of the Company for the year ended April 30, 1998 (in thousands). The segments include (i) Paaco, which sells and finances used vehicles, (ii) Precision, which rents and sells intermediate bulk containers, (iii) Concorde, which originates and sells sub-prime mortgage loans, and (iv) other, which includes corporate operations, activities of relatively inactive subsidiaries and the Company's equity investment in CMN. For the years ended April 30, 1997 and 1996 the Company operated in a single business segment, and, accordingly, no separate segment disclosures are necessary. Year Ended April 30, 1998 ---------------------------------------------------------------------------------- Paaco Precision Concorde Other Eliminations Consolidated ------------ ----------- --------- -------- -------------- ------------- (in thousands) Revenues: Sales and other $ 14,241 $ 1,351 $ 1,100 $ 1,105 $ 17,797 Interest income 1,519 815 1,472 $ (388) 3,418 -------- -------- -------- -------- -------- -------- Total 15,760 1,351 1,915 2,577 (388) 21,215 -------- -------- -------- -------- -------- -------- Costs and expenses: Cost of sales 8,647 628 9,275 Selling, gen. and admin. 3,363 235 2,042 2,928 8,568 Prov. for credit losses 1,705 4 52 1,761 Interest expense 942 81 586 14 (388) 1,235 Depreciation and amort. 64 122 42 557 785 -------- -------- -------- -------- -------- -------- Total 14,721 1,070 2,722 3,499 (388) 21,624 -------- -------- -------- -------- -------- -------- CMN earnings and other 965 965 -------- -------- -------- -------- -------- -------- Income (loss) before taxes and minority interests $ 1,039 $ 281 $ (807) $ 43 $ -- $ 556 ======== ======== ======== ======== ======== ======== FISCAL YEAR 1998 COMPARED TO FISCAL YEAR 1997 Revenues from sales, rental income, gain on sale of mortgage loans and interest, fees and rentals from CMN pertain to the businesses of Paaco, Precision, Concorde and CMN, which were acquired or formed during fiscal 1998. Interest income for fiscal 1998 increased $1,887,365 compared to fiscal 1997. The increase resulted from (i) the acquisition of Paaco during the fourth quarter of fiscal 1998 ($1,519,249), and (ii) interest earned on Concorde's mortgage loans and excess cash ($814,735), partially offset by a decrease in Crown's interest income as a result of Crown using its cash to make acquisitions and investments. Other income in fiscal 1998 consists of a gain on the sale of certain equipment ($373,999), and service repair, rental and other income principally pertaining to Paaco. Other income in fiscal 1997 pertains to a fee earned by the Company in assisting another company complete an acquisition. Cost of sales pertains to Paaco and Precision's operations. Provision for credit losses pertains principally to Paaco's operations. Selling, general and administrative expenses for fiscal 1998 increased $5,771,341 compared to fiscal 1997. The increase resulted principally from (i) the acquisitions of Paaco and Precision during the fourth quarter of fiscal 1998 ($3,597,834), and (ii) the formation and development of Concorde's mortgage based lending business ($2,041,651). Interest expense for fiscal 1998 increased $1,166,601 compared to fiscal 1997. The increase resulted from interest associated with the debt of Paaco, Precision and Concorde. Depreciation and amortization for fiscal 1998 increased $616,626 compared to fiscal 1997. The increase resulted from (i) amortizing certain agreements and other assets obtained in the acquisition of 49% of CMN ($284,735), (ii) amortizing goodwill that was created in the acquisitions of Paaco and Precision ($137,430), and (iii) depreciating the assets of Paaco and Precision ($156,218). 3 The benefit for income taxes for fiscal 1998 was $131,279 on pretax income of $555,680. This equates to an effective tax rate of 35.4% after removing from pretax income the equity in earnings of CMN ($926,598), which earnings are presented on an after tax basis. The benefit for income taxes for fiscal 1997 was $1,940,000 on pretax income of $6,919,885. The fiscal 1997 benefit differed from the amount determined by applying the 34% federal statutory rate as a result of a difference in the book and tax basis of SCGC stock sold during the period. Minority interests for fiscal 1998 ($338,864) pertain to the portions of Paaco (47%) and Precision (20%) not owned by the Company during the period. Net income for fiscal 1998 decreased $8,511,790 compared to fiscal 1997. The decrease was principally the result of fiscal 1997 including a $14,934,543 pretax gain on the sale of its remaining 50% interest in SCGC, which was partially offset by a loss on the sale of securities received in the sale of SCGC ($5,254,858) and a write-down of land held for sale ($1,019,709). FISCAL YEAR 1997 COMPARED TO FISCAL YEAR 1996 General and administrative expenses for fiscal 1997 decreased $245,801 compared to fiscal 1996. The decrease was primarily attributable to a reduction in compensation costs, partially offset by increases in consulting and transportation expenses. Gaming development and abandonment costs for fiscal 1997 decreased $144,012 compared to fiscal 1996 as a result of the Company's decision to begin pursuing business opportunities in fields other than casino gaming. Interest expense for fiscal 1997 decreased $939,955 compared to fiscal 1996. The decrease was principally the result of the Company no longer consolidating the operating results of SCGC from and after June 9, 1995 as SCGC was formerly responsible for substantially all of the Company's consolidated interest expense. Interest income for fiscal 1997 decreased $762,272 compared to fiscal 1996. The decrease was principally the result of the prepayment of a $10 million note by Louisiana Riverboat Gaming Partnership in August 1996 and the sale of a second $10 million note in October 1996 both of which had been earning interest at 11.5% per annum. The proceeds from such notes were placed in money market funds which earned interest at approximately 5.3% per annum. Other income in fiscal 1997 pertains to a fee earned by the Company in assisting another company complete an acquisition. Gain on sale of SCGC for fiscal 1997 ($14,934,543) pertains to the Company's sale of its remaining 50% interest in SCGC. During fiscal 1996 the Company sold the first 50% interest in SCGC which resulted in a gain of $21,512,640. This initial sale was made approximately one month prior to SCGC's riverboat casino opening for business in July 1996. The gain on the sale of the second 50% interest in SCGC declined $6,578,097 as compared to the sale of the first 50% interest as a result of SCGC's operating results being less than originally projected. During fiscal 1997 the Company sold certain securities it had received in its sale of SCGC for an aggregate loss of $5,254,858. The equity in loss of SCGC for fiscal 1996 ($2,408,213) pertains to the Company's 50% share of SCGC's operating results from June 9, 1995 (the date the first 50% interest in SCGC was sold) through April 30, 1996. The benefit for income taxes for fiscal 1997 was $1,940,000 on pretax income of $6,919,885. The fiscal 1997 benefit differed from the amount determined by applying the 34% federal statutory rate as a result of a difference in the book and tax basis of SCGC stock sold during the period. The provision for income taxes for fiscal 1996 was $3,500,000 on pretax income of $15,798,617. The fiscal 1996 provision differed from the amount determined by applying the 34% federal statutory rate as a result of a difference in the book and tax basis of SCGC stock sold during the period. Net income for fiscal 1997 decreased $3,438,732 compared to fiscal 1996. The decrease was principally the result of (i) fiscal 1996 including a $21,512,640 pretax gain on the sale of the first 50% interest in SCGC, as compared to fiscal 1997 including a $14,934,543 pretax gain on the sale of the remaining 50% interest in SCGC, and (ii) the other items discussed above. LIQUIDITY AND CAPITAL RESOURCES As of July 31, 1998 the Company's sources of liquidity included approximately (i) $3 million of cash on hand, of which $2 million was held by Crown, (ii) $12 million of marketable equity securities held by Crown, the majority of which is subject to a lock-up agreement with an underwriter which prohibits Crown from selling such securities until December 8, 1998, (iii) $17 million remaining to be drawn on the credit facilities of Paaco, Concorde and Precision, although the majority of such additional draws may only be made in connection with a corresponding increase in the related collateral asset (i.e., finance receivables, mortgage loans held for sale and intermediate bulk containers), and (iv) the potential issuance of additional debt and/or equity, although the Company has no specific commitments or arrangements to issue such additional debt and/or equity. The loan agreements which govern the credit facilities of Crown's subsidiaries limit dividends and other distributions from such subsidiaries to Crown. The total amount of restricted net assets of such subsidiaries as of April 30, 1998 was approximately $15 million. For fiscal 1998 net cash used by operating activities amounted to $12.5 million. The principal use of cash was to originate and acquire mortgage loans. The excess of mortgage loans originated or acquired over mortgage loans sold and principal repayments was $13.3 million. Net cash used by investing activities of $11.1 million included (i) an $8.6 million use of cash in finance receivable originations over principal payments received, (ii) a $15.4 million use of cash in the acquisitions of Paaco, Precision and CMN, and (iii) a $17.7 million source of cash resulting from the sale of certain assets including $15.3 million from the sale of the Company's 18.6 acre tract of land in Las Vegas. Net cash provided by financing activities of $8.9 million principally relates to $14.0 million of cash provided 4 by the asset based revolving credit facilities of Paaco, Concorde and Precision, offset by (i) $3.1 million of cash used to repurchase the Company's common stock, and (ii) $2.1 million of net debt repayments. The Company is presently focusing on the development and expansion of its existing businesses and the potential acquisition or development of other unrelated businesses. The Company's existing credit facilities can support the majority of the expected growth of the Company's existing businesses over the next twelve months. In August 1998 the Company reached a preliminary agreement, subject to certain conditions, to acquire Bengal Chemical, Inc. ("Bengal") for approximately $8.3 million, of which $6 million is to be paid in cash. Bengal specializes in the distribution of pesticide products in the southeastern United States. The Company plans to finance a significant portion of the cash required in this acquisition. Presently management believes that the Company's capital resources are sufficient to satisfy its identified capital needs for the next twelve months. In March 1996 the Company's Board of Directors approved a program, as amended, to repurchase up to 3,000,000 shares of the Company's common stock from time to time in the open market. As of April 30, 1998 the Company had repurchased 2,383,739 shares pursuant to this program. The timing and amount of future share repurchases, if any, will depend on various factors including market conditions, available alternative investments and the Company's financial position. RECENT ACCOUNTING PRONOUNCEMENTS In June 1997 the Financial Accounting Standards Board issued SFAS No. 130, "Reporting Comprehensive Income," which establishes standards for reporting comprehensive income and its components in a full set of general purpose financial statements. SFAS No. 130 is effective for fiscal years beginning after December 15, 1997. Comprehensive income includes net income and certain other items that are excluded from net income but are included as a separate component of stockholders' equity such as unrealized appreciation of securities and foreign currency translation adjustments. If the Company had adopted SFAS No. 130 during fiscal 1998 comprehensive income would have been $2,278,595, or $.23 per share, as a result of including the $1,930,500 of unrealized appreciation of securities in comprehensive income. DATA PROCESSING AND YEAR 2000 Each of Crown and its subsidiaries operate their data processing systems independently. Crown and its subsidiaries are at different stages with respect to their hardware, software and networking systems being year 2000 compliant. Some of the software utilized by the Company is licensed from third parties, and to the extent such software is not presently year 2000 compliant, the Company has been advised by such third party software vendor that their software will be updated in the near future. The Company presently has a limited amount of electronic communication with third parties, and as such, has a lower level of exposure to interruptions in its operations due to these third parties not being year 2000 compliant. The Company has contacted some of the third parties in which it communicates with electronically to assess their compliance with the year 2000. Based upon a preliminary review of its data processing systems, the Company does not anticipate the cost to bring all its systems year 2000 compliant will have a material adverse impact on its financial position or results of operations. SEASONALITY The Company's automobile sales operation is seasonal in nature. In the automobile business, the Company's third fiscal quarter (November through January) is historically the slowest period of time for car and truck sales. Many of the Company's operating expenses such as administrative personnel, rent and insurance are fixed and cannot be reduced during periods of decreased sales. None of the Company's other businesses experience significant seasonal fluctuations. 5 CONSOLIDATED BALANCE SHEETS CROWN GROUP, INC. April 30, 1998 1997 ------------- -------------- Assets: Cash and cash equivalents $ 6,481,706 $ 21,117,960 Marketable equity securities 4,742,180 Accounts and other receivables 2,311,668 345,780 Mortgage loans held for sale, net 14,350,437 Finance receivables, net 36,049,525 Inventory 3,783,290 Prepaid and other assets 572,089 37,674 Property and equipment, net 9,165,703 1,585,177 Investment in CMN and related assets, net 6,606,114 Goodwill, net 9,613,972 Land held for sale 15,150,000 ------------ ------------ $ 93,676,684 $ 38,236,591 ============ ============ Liabilities and stockholders' equity: Accounts payable $ 2,014,698 $ 41,284 Accrued liabilities 1,952,828 422,609 Income taxes payable 142,572 335,000 Revolving credit facilities 41,164,524 Other notes payable 4,870,074 Deferred sales tax 2,090,303 Deferred income taxes 2,961,727 1,725,000 ------------ ------------ Total liabilities 55,196,726 2,523,893 ------------ ------------ Minority interests 3,447,705 Commitments and contingencies Stockholders' equity: Preferred stock, par value $.01 per share, 1,000,000 shares authorized; none issued or outstanding Common stock, par value $.01 per share, 50,000,000 shares authorized; 9,433,963 issued and outstanding (10,394,585 in 1997) 94,340 103,946 Additional paid-in capital 35,547,369 38,496,803 Accumulated deficit (2,539,956) (2,888,051) Unrealized appreciation of securities 1,930,500 ------------ ------------ Total stockholders' equity 35,032,253 35,712,698 ------------ ------------ $ 93,676,684 $ 38,236,591 ============ ============ See accompanying notes to consolidated financial statements. 6 CONSOLIDATED STATEMENTS OF OPERATIONS CROWN GROUP, INC. Years Ended April 30, 1998 1997 1996 ------------- ----------- ------------ Revenues: Sales $ 14,938,617 Rental income 494,374 Gain on sale of mortgage loans 1,087,303 Interest income 3,417,689 $ 1,530,324 $ 2,292,596 Interest, fees and rentals from CMN 680,697 Other 596,709 500,000 ------------ ----------- ------------ 21,215,389 2,030,324 2,292,596 ------------ ----------- ------------ Costs and expenses: Cost of sales 9,275,055 Selling, general and administrative 8,567,614 2,796,273 3,042,074 Provision for credit losses 1,761,469 Interest expense 1,235,358 68,757 1,008,712 Depreciation and amortization 785,069 168,443 130,556 Write-down of land held for sale 1,019,709 Gaming development and abandonment 736,942 880,954 SCGC pre-opening and development 536,110 ------------ ----------- ------------ 21,624,565 4,790,124 5,598,406 ------------ ----------- ------------ Other income (expense): Equity in earnings of CMN 926,598 Gain (loss) on sale of securities 38,258 (5,254,858) Gain on sale of SCGC 14,934,543 21,512,640 Equity in loss of SCGC (2,408,213) ------------ ----------- ------------ 964,856 9,679,685 19,104,427 ------------ ----------- ------------ Income before taxes and minority interest 555,680 6,919,885 15,798,617 Provision (benefit) for income taxes (131,279) (1,940,000) 3,500,000 Minority interests 338,864 ------------ ----------- ------------ Net income $ 348,095 $ 8,859,885 $ 12,298,617 ============ =========== ============ Earnings per share: Basic $ 0.04 $ 0.82 $ 1.05 Diluted $ 0.04 $ 0.80 $ 1.03 Weighted average number of shares outstanding: Basic 9,829,392 10,868,119 11,716,462 Diluted 9,905,819 11,027,077 11,981,757 See accompanying notes to consolidated financial statements. 7 CONSOLIDATED STATEMENTS OF CASH FLOWS CROWN GROUP, INC. Years Ended April 30, 1998 1997 1996 ------------ ------------ ------------ Operating activities: Net income $ 348,095 $ 8,859,885 $ 12,298,617 Adjustments to reconcile net income to net cash used by operating activities: Depreciation and amortization 785,069 168,443 130,556 Amortization of debt issuance costs (discount) (252,765) 389,360 Deferred income taxes (990,592) (2,275,000) 3,500,000 Provision for credit losses 1,761,469 Minority interests 338,864 Write down of assets 1,715,718 51,496 Gain on sale of mortgage loans (1,087,303) Gain on sale of assets (437,171) (Gain) loss on sale of securities (38,258) 5,254,858 Gain on sale of SCGC (14,934,543) (21,512,640) Equity in earnings of CMN (926,598) Equity in loss of SCGC 2,408,213 Changes in assets and liabilities, net of transactions: Accounts and other receivables (625,637) 396,466 (780,747) Mortgage loans originated or acquired (36,757,608) Mortgage loans sold and principal repayments 23,441,905 Inventory 862,753 Prepaids and other assets 107,938 12,092 54,347 Accounts payable, accrued liabilities and deferred sales tax 1,178,323 (145,398) 243,606 Income taxes payable (192,428) (335,000) ------------ ------------ ------------ Net cash used by operating activities (12,483,944) (1,282,479) (3,217,192) ------------ ------------ ------------ Investing activities: Finance receivable originations (13,324,694) Collections of finance receivables 4,723,150 Purchase of assets (4,061,196) (1,076,142) (4,536,401) Sale of land/assets 17,721,787 325,000 441,023 Purchase of securities (5,551,714) (4,023,118) Sale of securities 3,772,792 11,593,260 Sale/collection of notes receivable 1,050,750 19,200,000 Sale of SCGC 1,000,000 Purchase of CMN and related assets (7,000,001) Purchase of Paaco, net of cash acquired (4,378,459) Purchase of Precision, net of cash acquired (4,021,142) ------------ ------------ ------------ Net cash provided (used) by investing activities (11,068,727) 26,019,000 (3,095,378) ------------ ------------ ------------ Financing activities: Issuance of common stock 93,282 23,125 Purchase of common stock (3,052,322) (3,299,845) (298,723) Proceeds from revolving credit facilities, net 13,979,273 Proceeds from (repayments of) other debt, net (2,103,816) (987,569) 936,684 Advances from LRGP 4,627,897 ------------ ------------ ------------ Net cash provided (used) by financing activities 8,916,417 (4,287,414) 5,288,983 ------------ ------------ ------------ Increase (decrease) in cash and cash equivalents (14,636,254) 20,449,107 (1,023,587) Cash and cash equivalents at: Beginning of year 21,117,960 668,853 1,692,440 ------------ ------------ ------------ End of year $ 6,481,706 $ 21,117,960 $ 668,853 ============ ============ ============ See accompanying notes to consolidated financial statements. 8 CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY CROWN GROUP, INC. For the Three Years in the Period Ended April 30, 1998 Additional Unrealized Total Common Stock Paid-In Accumulated Appreciation Stockholders' Shares Amount Capital Deficit of Securities Equity ----------- ---------- ------------ ------------ -------------- ------------- Balance at April 30, 1995 11,678,459 $ 116,785 $ 41,859,407 $(24,046,553) $ 17,929,639 Issuance of common stock 50,000 500 199,500 200,000 Purchase of common stock (90,900) (909) (297,814) (298,723) Stock options exercised 13,000 130 22,995 23,125 Net income 12,298,617 12,298,617 ---------- --------- ------------ ------------ ----------- ------------ Balance at April 30, 1996 11,650,559 116,506 41,784,088 (11,747,936) 30,152,658 Purchase of common stock (1,255,974) (12,560) (3,287,285) (3,299,845) Net income 8,859,885 8,859,885 ---------- --------- ------------ ------------ ----------- ------------ Balance at April 30, 1997 10,394,585 103,946 38,496,803 (2,888,051) 35,712,698 Purchase of common stock (1,102,765) (11,028) (3,041,294) (3,052,322) Stock options exercised 142,143 1,422 91,860 93,282 Unrealized appreciation of securities $ 1,930,500 1,930,500 Net income 348,095 348,095 ---------- --------- ------------ ------------ ----------- ------------ Balance at April 30, 1998 9,433,963 $ 94,340 $ 35,547,369 $ (2,539,956) $ 1,930,500 $ 35,032,253 ========== ========= ============ ============ =========== ============ See accompanying notes to consolidated financial statements. 9 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS CROWN GROUP, INC. A - HISTORY AND DESCRIPTION OF BUSINESS Crown Group, Inc. ("Crown"), and collectively with its subsidiaries (the "Company"), is a publicly traded buy-out firm which presently owns (i) 65% of Paaco Automotive Group, Inc. and Premium Auto Acceptance Corporation (collectively, "Paaco"), a vertically integrated used car sales and finance company, (ii) 100% of Precision IBC, Inc. ("Precision"), a firm specializing in the sale and rental of intermediate bulk containers, (iii) 80% of Concorde Acceptance Corporation ("Concorde"), a sub-prime mortgage lender, (iv) 49% of Casino Magic Neuquen S.A. ("CMN"), a casino operator in the Province of Neuquen, Argentina, and (v) 80% of Home Stay Lodges I, Ltd., a partnership focusing on the development and operation of extended-stay lodging facilities. In addition, from time to time the Company purchases and sells small ownership interests in securities of privately held and publicly traded firms. The Company is presently focusing on (i) the development and expansion of its existing businesses, and (ii) the potential acquisition or development of other unrelated businesses. Since its inception in 1983 through June 1993 the Company was engaged in various facets of the cable and related programming business. During 1992 the Company sold the majority of its programming business and began exploring new business opportunities. In June 1993 the Company made the decision to enter the gaming business, and, as a result, proceeded to sell the balance of its cable assets. From June 1993, with the acquisition of 100% of St. Charles Gaming Company, Inc. ("SCGC"), until November 1996, the Company's primary business focus was that of owning, operating and developing casino gaming properties. SCGC owns and operates a riverboat gaming casino located in Calcasieu Parish, Louisiana which had been in the development stage until opening in July 1995. The Company sold a 50% interest in SCGC in June 1995 and the remaining 50% interest in May 1996, in each case resulting in a substantial gain (see Note D). In November 1996 the Company decided to expand its business interests beyond casino gaming and began pursuing business opportunities in other fields. As a result the Company has either acquired (see Note C) or formed a number of businesses in a variety of industries. Generally, it is the Company's desire to hold majority ownership positions in businesses that have above average potential for growth in earnings. B - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES Principals of Consolidation The consolidated financial statements include the accounts of Crown Group, Inc. and all of its majority-owned subsidiaries. All significant intercompany accounts and transactions have been eliminated. The Company's subsidiaries are included in its consolidated results of operations from the point in time such subsidiary became a majority-owned subsidiary of the Company. The Company has accounted for its investment in 49% of CMN on the equity method. Use of Estimates The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amount of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements, and the reported amounts of revenues and expenses during the period. Actual results could differ from those estimates. Concentration of Risk The Company provides financing in connection with the sale of substantially all of its used vehicles. These sales are made primarily to customers residing in the Dallas-Ft. Worth metropolitan area. Periodically, the Company maintains cash in financial institutions in excess of the amounts insured by the federal government. CMN's revenues principally originate from persons living in and around the City of Neuquen, Argentina. Cash Equivalents The Company considers all highly liquid debt instruments purchased with maturities of three months or less to be cash equivalents. Cash equivalents generally consist of interest bearing money market accounts. 10 Marketable Equity Securities Investments in marketable equity securities are recorded at market value based upon closing stock prices as quoted on national stock exchanges or over-the-counter markets. To the extent the Company considers a particular equity security to be a "trading" security, the difference between the Company's historical cost and such security's market value is included in the accompanying statement of operations. All other equity securities are considered to be "available for sale" securities, and the difference between the Company's historical cost and such security's market value is included as a separate component of stockholders' equity entitled "unrealized appreciation of securities," on a net of tax basis. At April 30, 1998 the Company had trading securities and available for sale securities of $742,180 and $4,000,000, respectively. At April 30, 1998 the Company held 222,222 shares of Inktomi Corporation common stock, which company completed its initial public offering ("IPO") on or about June 9, 1998. The Company's Inktomi shares are subject to an underwriter's lock-up agreement which restricts the Company from selling its Inktomi stock until December 8, 1998. Further, the Company's Inktomi shares are not registered, and thus the Company may not sell such shares in the public markets until the completion of a one year holding period which ends on February 25, 1999. The Company valued its Inktomi shares based upon the IPO price of $18.00 per share. Accordingly, at April 30, 1998 the carrying value of the Company's Inktomi stock was $4,000,000, which reflects a gross unrealized gain of $2,925,000 over the Company's cost of $1,075,000. The Company considers its Inktomi shares to be "available for sale." Mortgage Loans Held for Sale Mortgage loans held for sale are carried at the lower of aggregate cost or market. Market value is determined by current investor yield requirements. A portion of these loans are pledged against the Company's revolving credit facility. The cost of mortgage loans held for sale includes the cost of originating or purchasing the mortgage loans reduced by (i) deferred loan origination fees, and (ii) an allowance for loan losses of $27,000 at April 30, 1998. While management believes the allowance for loan losses included in the financial statements to be adequate, such estimate may be more or less than the amount ultimately charged off. The adequacy of the allowance for loan losses is periodically reviewed by management with any changes reflected in current operations. Finance Receivables and Allowance for Credit Losses The Company originates installment sales contracts from the sale of used vehicles at its dealerships. Finance receivables consist of contractually scheduled payments from installment sales contracts net of unearned finance charges and an allowance for credit losses. Unearned finance charges represent the balance of interest income remaining from the capitalization of the total interest to be earned over the original term of the related installment sales contract. The Company discontinues the accrual of interest income when the receivable becomes greater than sixty days delinquent. The Company maintains an allowance for credit losses at a level it considers sufficient to cover anticipated losses in the collection of its finance receivables. The allowance for credit losses is based upon a periodic analysis of the portfolio, economic conditions and trends, historical credit loss experience, borrowers' ability to repay, and collateral values. While management believes the allowance for credit losses included in the financial statements to be adequate, such estimate may be more or less than the amount ultimately charged off. The allowance for credit losses is periodically reviewed by management with any changes reflected in current operations. Inventory Inventory is valued at the lower of cost or market on a specific identification basis. Inventory includes used vehicles, parts for vehicles and supplies and parts related to the intermediate bulk container ("IBC") business. Repossessed vehicles are recorded at the lower of cost or market, which approximates wholesale value. Vehicle reconditioning costs are capitalized as a component of inventory. The cost of used vehicles and IBC's sold is determined on a specific identification basis. Property and Equipment Property and equipment are stated at cost. Expenditures for additions, renewals and improvements are capitalized. Costs of repairs and maintenance are expensed as incurred. Depreciation is computed using the straight-line method over the following estimated useful lives: Leasehold improvements Life of lease Furniture, fixtures and equipment 3 to 10 years Rental equipment 12 years Buildings 39 years Goodwill Goodwill represents the excess of the Company's cost over the fair value of net identifiable assets acquired in its purchases of Paaco and Precision. Goodwill is amortized on a straight line basis over periods ranging from 15 to 25 years. The Company assesses the recoverability of this intangible asset by determining whether the amortization of the goodwill balance over its remaining life can be recovered through undiscounted future operating cash flows of the acquired operation. At April 30, 1998 accumulated amortization of goodwill amounted to $137,430. 11 Income Taxes Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. Revenue Recognition Interest income on finance receivables is recognized using the interest method. Revenue from the sale of used vehicles is recognized upon delivery, when the sales contract is signed and the down payment has been received. Stock Option Plan The Company accounts for its stock option plan in accordance with the provisions of Accounting Principles Board ("APB") Opinion No. 25, "Accounting for Stock Issued to Employees", and related interpretations. As such, compensation expense is recorded on the date of grant only if the current market price of the underlying stock exceeds the exercise price. Beginning in fiscal 1997, the Company adopted the disclosure provisions of Statement of Financial Accounting Standards ("SFAS") No. 123, "Accounting for Stock-Based Compensation", which requires entities to provide pro forma earnings and earnings per share disclosures for employee stock option grants as if the fair value based method as defined in SFAS No. 123 had been applied (see Note L). Earnings Per Share Basic earnings per share is computed by dividing net income by the average number of common shares outstanding during the period. Diluted earnings per share takes into consideration the potentially dilutive effect of common stock equivalents, such as outstanding stock options and warrants, that if exercised or converted into common stock would then share in the earnings of the Company. Recent Accounting Pronouncements In June 1997 the Financial Accounting Standards Board issued SFAS No. 130, "Reporting Comprehensive Income," which establishes standards for reporting comprehensive income and its components in a full set of general purpose financial statements. SFAS No. 130 is effective for fiscal years beginning after December 15, 1997. Comprehensive income includes net income and certain other items that are excluded from net income but are included as a separate component of stockholders' equity such as unrealized appreciation of securities and foreign currency translation adjustments. If the Company had adopted SFAS No. 130 during fiscal 1998 comprehensive income would have been $2,278,595 or $.23 per share, as a result of including the $1,930,500 of unrealized appreciation of securities in comprehensive income. Reclassifications Certain prior year amounts in the accompanying financial statements have been reclassified to conform to the fiscal 1998 presentation. C - ACQUISITIONS CMN Purchase On June 2, 1997 the Company acquired 49% of the capital stock of CMN, as well as interests in certain other assets and contracts related to CMN, from Casino Magic Corp. ("Casino Magic") for a purchase price of $7 million cash. CMN owns and operates casinos in the cities of Neuquen and San Martin de los Andes in the Province of Neuquen, Argentina under an exclusive concession contract that expires in 2007, but can be extended by CMN for an additional five years under certain circumstances. The interests in certain other assets and contracts included (i) a demand promissory note in the amount of $4,226,743 issued by CMN, (ii) a 16.4% interest in a certain management agreement relating to CMN, and (iii) a 49% interest in (a) slot machines and a related lease agreement and (b) a certain royalty agreement relating to CMN. Pursuant to the various CMN agreements, the Company receives its respective share of fees and rental payments due under such agreements. At April 30, 1998 accumulated amortization and depreciation of the Company's investment in various CMN agreements and slot machines, respectively, amounted to $284,735. In October 1997 each of the Company and Casino Magic converted approximately $2.5 million of principal due on certain notes receivable from CMN into shares of CMN capital stock such that each party retained the same ownership percentage of CMN as previously held. At April 30, 1998 CMN had assets, liabilities and stockholders' equity of approximately $12.6 million, $3.6 million, and $9.0 million, respectively. For the twelve months ended April 30, 1998 CMN's summarized unaudited results of operations were as follows (in thousands): Revenues $ 18,255 Costs and expenses 13,355 Interest, fees and rentals to shareholders 1,910 Provision for income taxes 978 ----------- Net income $ 2,012 =========== 12 Paaco Purchase Effective February 1, 1998 the Company acquired 53% of the common stock of Paaco for a purchase price of approximately $9.1 million cash. Approximately $4.9 million of Paaco common stock was purchased directly from Paaco, and the remaining $4.2 million was purchased from Paaco management personnel who prior to this transaction were the sole shareholders of Paaco (the "Paaco Management Shareholders"). Effective May 1, 1998 the Company acquired an additional 12% interest in Paaco directly from the Paaco Management Shareholders. With this purchase the Company now owns 65% of Paaco. The purchase price of approximately $1.5 million was paid by issuing 375,000 shares of the Company's common stock (see Note R). In connection with the Paaco transactions, the Company and the Paaco Management Shareholders entered into a Shareholders' Agreement (the "Paaco Shareholders' Agreement") which provides, among other things, that in the event either the Company or any Paaco Management Shareholder desires to sell their interest in Paaco such shareholder must first offer to sell such interest to Paaco and the other shareholders in accordance with the provisions of the Paaco Shareholders' Agreement. Paaco is a vertically integrated used car sales and finance company which operates seven used car dealerships in the Dallas-Ft. Worth metropolitan area. Paaco sells, underwrites and finances used cars and trucks with a focus on the Hispanic market. For the years ended December 31, 1997, 1996 and 1995, Paaco's revenues were approximately $48.3 million, $28.9 million and $20.1 million, respectively. Precision Purchase On February 3, 1998 the Company acquired 80% of the common stock of Precision IBC, Incorporated ("Original Precision") for a purchase price of approximately $2.4 million cash. On March 5, 1998 the Company acquired 80% of the common stock of M&S Tank Rentals, Inc. ("M&S") for a purchase price of $1.65 million cash. Original Precision and M&S were subsequently merged together into a newly formed corporation, Precision IBC, Inc. ("Precision"). Effective May 1, 1998 the Company acquired the remaining 20% interest in Precision it did not previously own by issuing 288,027 shares of the Company's common stock. All references to Precision include the former entities of Original Precision and M&S. Precision is in the business of renting, selling, testing and servicing principally stainless steel IBC's to customers primarily in the petroleum and chemical industries. For the years ended December 31, 1997, 1996 and 1995 Precision's unaudited revenues were approximately $4.1 million, $2.8 million and $.7 million, respectively. Each of the above acquisitions have been accounted for using the purchase method of accounting. Goodwill resulting from the transactions is being amortized on a straight-line basis over periods ranging from 15 to 25 years. The activities of CMN, Paaco and Precision have been included in the Company's consolidated results of operations since their respective dates of acquisition. In each of fiscal 1997 and 1996 the Company elected not to complete the proposed acquisition of a casino gaming property. As a result of these decisions the Company recorded charges of $696,009 and $664,991 in fiscal 1997 and 1996, respectively. Such amounts are included in "gaming development and abandonment" in the accompanying Consolidated Statements of Operations. Pro Forma Financial Information The following unaudited pro forma condensed consolidated results of operations of the Company for the years ended April 30, 1998 and 1997 were prepared as if the CMN, Paaco and Precision acquisitions had occurred on May 1, 1997 and May 1, 1996, respectively (in thousands, except per share amounts). The adjustments to the historical financial statements principally consist of (i) recognizing the Company's pro-rata share of CMN earnings and contractual fees, (ii) recording interest income on the note receivable from CMN, (iii) eliminating interest income on the cash used in the acquisitions, (iv) amortizing the CMN related agreements and equipment, (v) amortizing goodwill resulting from the acquisitions, (vi) adjusting depreciation expense and interest income resulting from purchase accounting entries, and (vii) adjusting income tax expense to reflect the elimination of an S-corporation in the case of Precision and to take into account the above described adjustments. Years Ended April 30, 1998 1997 ---- ---- Revenue $ 63,514 $ 38,127 Net income 120 10,340 Earnings per share $ .01 $ .90 The unaudited pro forma results of operations are not necessarily indicative of future results or the results that would have occurred had the acquisitions taken place on the dates indicated. 13 D - SALE OF SCGC On June 9, 1995 the Company sold a 50% interest in SCGC to Louisiana Riverboat Gaming Partnership ("LRGP"), a joint venture then owned 50% by Casino America, Inc. ("Casino America") and 50% by Louisiana Downs, Inc. The purchase price consisted of (i) a five-year $20 million non-recourse note with interest payable monthly at 11.5% per annum (the "LRGP Note"), (ii) $1 million cash, and (iii) a non-detachable five-year warrant to purchase 416,667 shares of Casino America common stock at $12 per share. In connection with this transaction, in June 1995, the Company recorded a gain before income taxes of approximately $21.5 million. On May 3, 1996 the Company sold its remaining 50% interest in SCGC to Casino America for (i) 1,850,000 shares of Casino America common stock, which the Company valued at $6.50 per share, (ii) the exchange of the $20 million LRGP Note for LRGP Note A ("Note A") and LRGP Note B ("Note B"), each in the principal amount of $10 million and bearing interest at 11.5% per annum, and (iii) an additional non-detachable five-year warrant to purchase up to another 416,667 shares of Casino America common stock at an exercise price of $12 per share. In connection with this transaction, in May 1996, the Company recorded a gain before income taxes of approximately $14.9 million. In August 1996 LRGP paid off Note A in full and in October 1996 the Company sold Note B at a discount of $800,000. In November 1996 the Company sold the 1,850,000 shares of Casino America common stock it had received in the sale of its remaining 50% interest in SCGC for net proceeds of $7,363,003, resulting in a loss before income taxes of $4,661,997. The Company has included 100% of SCGC's operating results in its consolidated results of operations through June 8, 1995. From and after June 9, 1995 (the date of sale of the first 50% interest in SCGC), the Company has accounted for its investment in SCGC on the equity method, and accordingly has included its proportionate share of SCGC's operating results in its consolidated results of operations. The Company's gain before income taxes on the sale of SCGC is calculated as follows (in thousands): Sale of Sale of First 50% Second 50% (June 1995) (May 1996) ------------ ----------- Consideration received in sale $ 21,000 $ 12,025 The Company's negative basis in stock sold 889 3,297 Transaction and other costs (376) (388) -------- -------- Gain before income taxes on sale of SCGC $ 21,513 $ 14,934 ======== ======== Upon closing of the sale of its remaining 50% interest in SCGC on May 3, 1996, the Company's investment in SCGC was eliminated. Other than a guarantee of certain leases, for which the Company has been indemnified by LRGP, the Company is not liable for any obligations of SCGC. For the year ended April 30, 1996 SCGC had revenues and a net loss of $57.3 million and $6.3 million, respectively. During such year the Company included approximately $3.4 million of net costs and expenses, or approximately $.28 per share, attributable to SCGC in its consolidated results of operations. 14 E - FINANCE RECEIVABLES The Company originates installment sales contracts from the sale of used vehicles at its dealerships. These installment sales contracts typically include interest rates ranging from 18-26% per annum and provide for payments over periods ranging from 24 to 36 months. A summary of finance receivables at April 30, 1998 is as follows: Finance receivables $ 51,417,981 Unearned finance charges (9,930,356) Allowance for credit losses (4,727,679) Valuation discount (710,421) ------------ $ 36,049,525 ============ In accordance with APB Opinion No. 16, as of the acquisition date the Company valued Paaco's finance receivables at market value and determined a valuation discount of $963,186 was appropriate. This discount is being amortized over the life of the finance receivable portfolio that existed on the purchase date using the interest method. A summary of the finance receivables allowance for credit losses for the period from February 1, 1998 (acquisition date) to April 30, 1998 is as follows: Balance at February 1, 1998 $ 4,248,643 Provision for credit losses 1,704,623 Net charge offs (1,225,587) ----------- Balance at April 30, 1998 $ 4,727,679 =========== In addition to the finance receivables allowance for credit losses the Company also has an allowance for credit losses on mortgage loans held for sale and trade accounts receivable aggregating $55,069 as of April 30, 1998. F - PROPERTY AND EQUIPMENT A summary of property and equipment as of April 30, 1998 and 1997 is as follows: April 30, 1998 1997 ----------- ------------ Land and buildings $ 2,332,750 Rental equipment 4,749,652 Furniture, fixtures and equipment 1,904,536 $ 1,811,581 Leasehold improvements 920,583 Less accumulated depreciation and amortization (741,818) (226,404) ----------- ------------ $ 9,165,703 $ 1,585,177 =========== ============ For the years ended April 30, 1998, 1997 and 1996 depreciation expense amounted to $362,904, $168,443 and $130,556, respectively. G - LAND HELD FOR SALE In April 1997 the Company entered into an agreement to sell its 18.6 acre tract of land in Las Vegas, Nevada for $15.25 million cash. As a result of this agreement, the Company wrote down the value of such land to $15.15 million, which represents the contract selling price of the land less the estimated transaction costs. In September 1997 the sale was consummated. 15 H - DEBT A summary of debt at April 30, 1998 is as follows: Revolving Credit Facilities - ---------------------------------------------------------------------------------------------------------------- Facility Interest Primary Balance at Borrower Lender Amount Rate Maturity Collateral April 30, 1998 - ------------ ------------------ ------------ -------------- ------------ --------------- -------------- Paaco Finova $35 million Prime + 3.00% Apr 2000 Finance rec. $ 26,049,875 Concorde Bank One $20 million Libor + 2.25% Dec 1998 Mortgage loans 11,096,224 Precision Wells Fargo $5 million Prime June 2000 IBC's and rec. 3,518,425 Paaco Comerica $500,000 Prime + 2.00% Demand Vehicle inv. 500,000 ------------ $ 41,164,524 ============ Other Notes Payable - ---------------------------------------------------------------------------------------------------------------- Principal Interest Primary Balance at Borrower Lender Payments Rate Maturity Collateral April 30, 1998 - ------------ ------------------ ------------ -------------- ------------ --------------- -------------- Paaco Heller Financial $2,197 month Prime + 2.25% Dec 2015 Real estate $ 630,556 Paaco Various None Various 1998 to 1999 None 4,239,518 ------------ $ 4,870,074 ============ Interest is payable monthly on all of the Company's debt. The loan agreements relating to certain of the above described debt contain various reporting and performance covenants including (i) maintenance of certain financial ratios and tests, (ii) limitations on borrowings from other sources, (iii) restrictions on certain operating activities, and (iv) restrictions on the payment of dividends. The amount of restricted net assets of the Company's subsidiaries as of April 30, 1998 was approximately $15 million. The Company was in compliance with the loan agreements as of April 30, 1998. A summary of future minimum principal payments required under the aforementioned debt as of April 30, 1998 is as follows: Years Ended April 30, Amount -------------- -------------- 1999 $ 15,208,144 2000 26,508,515 2001 3,707,093 2002 38,723 2003 18,842 Thereafter 553,281 ------------ $ 46,034,598 ============ 16 I - INCOME TAXES The Company files a consolidated federal income tax return with its subsidiaries, with the exception of Paaco which files a separate tax return. The provision (benefit) for income taxes for the fiscal years ended April 30, 1998, 1997 and 1996 was as follows: Years Ended April 30, 1998 1997 1996 ----------- ----------- ----------- Provision (benefit) for income taxes Current $(1,121,871) $ 335,000 Deferred 990,592 (2,275,000) $ 3,500,000 ----------- ----------- ----------- $ (131,279) $(1,940,000) $ 3,500,000 =========== =========== =========== The provision (benefit) for income taxes is different from the amount computed by applying the statutory federal income tax rate to income (loss) before income taxes for the following reasons: Years Ended April 30, 1998 1997 1996 ----------- ----------- ----------- Tax provision at 34% statutory rate $ 188,931 $ 2,352,761 $ 5,371,530 Equity in earnings of CMN (315,043) Equity in loss of SCGC 818,792 Basis difference in SCGC stock (4,254,558) (3,459,015) Goodwill amortization 46,726 Other, net (51,893) (38,203) 768,693 ----------- ----------- ----------- $ (131,279) $(1,940,000) $ 3,500,000 =========== =========== =========== Deferred income taxes reflect the net tax effects of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes. Significant components of the Company's deferred tax assets and liabilities as of April 30, 1998 and 1997 were as follows: April 30, 1998 1997 ------------ ------------ Deferred tax liabilities: Unrealized gain on securities $ 994,500 Allowance for loan losses 1,634,165 Tax over book depreciation 884,132 Land held for sale $ 1,445,553 Other 443,034 395,332 ------------ ------------ Total 3,955,831 1,840,885 ------------ ------------ Deferred tax assets: Finance receivable valuation discount 241,543 Reserves 239,290 Net operating loss 464,016 Other 49,255 115,885 ------------ ------------ Total 994,104 115,885 ------------ ------------ Net deferred tax liability $ 2,961,727 $ 1,725,000 ============ ============ In fiscal 1997 the Company utilized approximately $1.4 million of net operating loss carryforwards in determining its federal income tax provision. At April 30, 1998 Paaco had a net operating loss carryforward of $1,364,753 available to offset future taxable income. The net operating loss carryforward expires in 2012. 17 J - CAPITAL STOCK In March 1996 the Company's Board of Directors approved a program, as amended, to repurchase up to 3,000,000 shares of the Company's common stock from time to time in the open market. At April 30, 1998 the Company had repurchased 2,383,739 shares pursuant to this program. The timing and amount of future share repurchases, if any, will depend on various factors including market conditions, available alternative investments and the Company's financial position. The Company is authorized to issue up to one million shares of $.01 par value preferred stock in one or more series having such respective terms, rights and preferences as are designated by the Board of Directors. No preferred stock has been issued. K - EARNINGS PER SHARE A summary of the reconciliation from basic earnings per share to diluted earnings per share for the years ended April 30, 1998, 1997 and 1996 is as follows: Years Ended April 30, 1998 1997 1996 ----------- ----------- ----------- Net income $ 348,095 $ 8,859,885 $12,298,617 =========== =========== =========== Average shares outstanding-basic 9,829,392 10,868,119 11,716,462 Dilutive options 76,427 158,958 195,148 Dilutive warrants 70,147 ----------- ----------- ----------- Average shares outstanding-diluted 9,905,819 11,027,077 11,981,757 =========== =========== =========== Earnings per share: Basic $ 0.04 $ 0.82 $ 1.05 Diluted $ 0.04 $ 0.80 $ 1.03 Antidilutive securities not included: Options 516,068 547,000 382,224 =========== =========== =========== Warrants 899,612 1,184,246 675,832 =========== =========== =========== L - STOCK OPTIONS AND WARRANTS Options Since inception, the shareholders of the Company have approved three stock option plans including the 1986 Incentive Stock Option Plan ("1986 Plan"), the 1991 Non-Qualified Stock Option Plan ("1991 Plan") and the 1997 Stock Option Plan ("1997 Plan"). While previously granted options remain effective, the provisions of the 1986 and 1991 Plans permitting additional option grants have expired. The 1997 Plan sets aside 1,000,000 shares of the Company's common stock to be granted to employees, directors and certain advisors of the Company at a price not less than the fair market value of the stock on the date of grant. At April 30, 1998 and 1997 there were 915,000 and zero shares of common stock available for grant under the Company's stock option plans, respectively. Options granted under the Company's stock option plans expire in the years 1998 through 2007. 18 The following is an aggregate summary of the activity in the Company's stock option plans since April 30, 1995: Number Exercise Price Proceeds of Shares per Share on Exercise ----------- ------------------ ------------- Outstanding at April 30, 1995 797,643 $0.41 to $7.38 $ 2,359,219 Exercised (18,000) $1.41 to $3.31 (53,906) Canceled (25,000) $7.31 (182,813) ----------- ----------- Outstanding at April 30, 1996 754,643 $0.41 to $7.38 2,122,500 Granted 60,000 $2.81 168,750 ----------- ----------- Outstanding at April 30, 1997 814,643 $0.41 to $7.38 2,291,250 Granted 85,000 $2.44 207,188 Exercised (142,143) $0.66 (93,282) ----------- ----------- Outstanding at April 30, 1998 757,500 $0.41 to $7.38 $ 2,405,156 =========== =========== A summary of stock options outstanding as of April 30, 1998 is as follows: Weighted Average Range of Remaining Weighted Exercise Number Contractual Life Average Prices of Shares (in years) Exercise Price - -------------------- ------------ ----------------- ----------------- $0.41 to $1.55 112,500 3.87 $ 1.34 $2.44 to $4.03 610,000 7.25 3.27 $7.31 to $7.38 35,000 5.94 7.33 ----------- $0.41 to $7.38 757,500 6.68 $ 3.18 =========== All of the above options were exercisable at April 30, 1998 with the exception of options to purchase 75,000 shares at prices ranging from $3.31 to $3.88 which become exercisable in 1999 and expire in 2005. The Company applies APB Opinion No. 25 in accounting for the issuance of stock options and, accordingly, no compensation cost has been recognized in the consolidated financial statements. Had the Company determined compensation cost on the date of grant based upon the fair value of its stock options under SFAS No. 123, the Company's pro forma income and earnings per share would have been as follows using the Black-Scholes pricing model with the assumptions detailed below: Years Ended April 30, 1998 1997 1996 -------------- -------------- -------------- Net income $ 262,320 $ 8,800,827 $ 12,298,617 Earnings per share: Basic $ 0.03 $ 0.81 $ 1.05 Diluted $ 0.03 $ 0.80 $ 1.03 Assumptions: Dividend yield 0.0% 0.0% 0.0% Risk-free interest rate 6.5% 6.5% 6.5% Expected volatility 52.5% 52.5% 52.5% Expected life 5 years 5 years 5 years 19 Warrants The Company issued common stock purchase warrants to a variety of parties in connection with financing activities, the development of SCGC's riverboat gaming project and certain other matters. The warrants issued were valued based upon a composite of commonly accepted warrant valuation models. The following is an aggregate summary of warrants outstanding as of April 30, 1998: Number of Underlying Exercise Price Proceeds Shares per Share on Exercise - ---------------- -------------- -------------- 899,612 $3.00 to $12.00 $4,053,021 All of the warrants are presently exercisable. The warrants expire in 1999, contain certain anti-dilution provisions and provide the holders with certain registration rights relative to the underlying shares. M - FAIR VALUE OF FINANCIAL INSTRUMENTS The table below summarizes information about the fair value of financial instruments included in the Company's financial statements at April 30, 1998 and 1997: April 30, 1998 April 30, 1997 -------------------------------- -------------------------------- Carrying Fair Carrying Fair Value Value Value Value --------------- -------------- --------------- -------------- Cash and cash equivalents $ 6,481,706 $ 6,481,706 $ 21,117,960 $ 21,117,960 Marketable equity securities 4,742,180 4,742,180 Mortgage loans held for sale 14,350,437 15,067,959 Finance receivables 36,049,525 36,049,525 Revolving credit facilities 41,164,524 41,164,524 Other notes payable 4,870,074 4,870,074 Because no market exists for certain of the Company's financial instruments, fair value estimates are based on judgments and estimates regarding yield expectations of investors, credit risk, normal cost of administration of mortgage loans and finance receivables and other risk characteristics, including interest rate and prepayment risk. These estimates are subjective in nature and involve uncertainties and matters of judgment and therefore cannot be determined with precision. Changes in assumptions could significantly affect these estimates. The methodology and assumptions utilized to estimate the fair value of the Company's financial instruments are as follows: Financial Instrument Valuation Methodology -------------------- --------------------- Cash and cash equivalents The carrying amount is considered to be a reasonable estimate of fair value. Marketable equity securities The fair value was based on stock prices as quoted on stock exchanges or over-the-counter markets (see Note B). Mortgage loans held for sale The fair value was estimated based on recent sales. Finance receivables The fair value approximates carrying value based upon yields of similar instruments and considering the relatively short maturity of the portfolio. Revolving credit facilities The fair value approximates carrying value due to the short-term nature of the borrowings and the variable interest rates charged on the borrowings. Other notes payable The fair value approximates carrying value as the interest rates charged on such debt approximates market. 20 N - LEASES The Company has certain operating leases for equipment and its office facilities. As of April 30, 1998 the aggregate rentals due under such leases were as follows: Years Ended April 30, Amount --------------- --------------- 1999 $ 1,193,125 2000 857,439 2001 621,050 2002 81,832 2003 26,555 Rent expense for all operating leases was approximately $467,000, $136,000, and $115,000, during fiscal 1998, 1997 and 1996, respectively. O - RELATED PARTY TRANSACTIONS In February 1998 the Company paid an outside director $90,834 as a fee in connection with the Company's purchase of Paaco (see Note C). During fiscal 1998, in exchange for a fee, Paaco sold approximately $608,000 of 90-day service contracts to its customers on behalf of Medallia de Oro LLC ("Medallia"), a company owned by the minority shareholders of Paaco. In addition, Paaco sends the majority of its vehicle trade-ins to an auction company that is partially owned by its minority shareholders. From time to time the minority shareholders of Paaco, and certain of their family members, have loaned money to Paaco at interest rates ranging from 10 to 15%. At April 30, 1998 the aggregate amount of such loans totaled $2,317,350. In June 1996 the Company entered into a definitive asset purchase agreement to acquire a riverboat casino in Clinton, Iowa. This casino is principally owned by the adult children of an outside director of the Company. In November 1996 the Company determined to abandon the proposed transaction, and, as a result, forfeited a $500,000 deposit (see Note C). The Company incurred legal fees of approximately $121,000 during fiscal 1996 from a law firm of which a director of the Company was a partner. In July 1995 this director left such law firm and became a full-time executive officer of the Company. P - COMMITMENTS AND CONTINGENCIES Mortgage Loan Sales In connection with the Company's sale of mortgage loans in the ordinary course of business, in certain circumstances such loan sales involve limited recourse to the Company for up to the first twelve months following the sale. Generally, the events which could give rise to these recourse provisions involve the prepayment or foreclosure of a loan, and violations of customary representations and warranties. If the recourse provisions are triggered the Company may be required to refund all or part of the premium received on the sale of such loan, and in some cases the Company may be required to repurchase the loan. Periodically the Company estimates the potential exposure related to such recourse provisions and accrues a percentage of the total potential liability. Severance Agreements The Company has entered into severance agreements with its three executive officers which provide for payments to the executives in the event of their termination after a change in control, as defined, of the Company. The agreements provide, among other things, for a compensation payment equal to 2.99 times the annual compensation paid to the executive, as well as accelerated vesting of any unvested options under the Company's stock option plans, in the event of such executive's termination in connection with a change in control. 21 Paaco Purchase Contingent Consideration In connection with the Company's purchase of an additional 12% interest in Paaco effective May 1, 1998, the Company agreed to pay the sellers as additional consideration an amount equal to 60% of the excess of Paaco's pretax income in excess of $2.5 million for the twelve months ended January 31, 1999. Such additional consideration, if any, is to be paid in Company common stock valued at $4.00 per share. Q - SUPPLEMENTAL CASH FLOW INFORMATION Supplemental cash flow disclosures for the fiscal years ended April 30, 1998, 1997 and 1996 are as follows: Years Ended April 30, 1998 1997 1996 -------------- --------------- --------------- Note received for sale of first 50% interest in SCGC $ 20,000,000 Stock received for sale of second 50% interest in SCGC $ 12,025,000 Interest paid, net of amount capitalized $ 1,356,075 68,757 922,801 Income taxes paid 925,000 Inventory acquired in repossession 1,710,220 Conversion of a portion of CMN note to equity 2,516,493 In connection with the Company's purchase of Paaco and Precision, assumed liabilities were as follows: Paaco Precision ------------ ----------- Fair value of assets acquired $ 48,077,386 $ 8,258,112 Cash paid for capital stock (9,174,212) (4,032,389) Minority interests (2,980,180) (128,461) ------------ ----------- Liabilities assumed $ 35,922,994 $ 4,097,262 ============ =========== R - SUBSEQUENT EVENTS Paaco and Precision Purchases Effective May 1, 1998 the Company purchased the remaining 20% interest in Precision it did not previously own by issuing 288,027 shares of the Company's common stock. Also effective May 1, 1998 the Company purchased an additional 12% interest in Paaco, bringing its ownership interest to 65%, by issuing 375,000 shares of the Company's common stock. Bengal Acquisition In August 1998 the Company reached a preliminary agreement, subject to certain conditions, to acquire 100% of the outstanding common stock Bengal Chemical, Inc. ("Bengal") for approximately $8.3 million. Bengal specializes in the distribution of pesticide products in the southeastern United States. For the year ended December 31, 1997 Bengal had unaudited revenues of approximately $12 million. 22 S - BUSINESS SEGMENTS Operating results and other financial data are presented for the four principal business segments of the Company for the year ended April 30, 1998. These segments are categorized by legal entity, which also corresponds to their line of business and how they are operated. The segments include (i) Paaco, which sells and finances used vehicles, (ii) Precision, which rents and sells intermediate bulk containers, (iii) Concorde, which originates and sells sub-prime mortgage loans, and (iv) other, which includes corporate operations, activities of relatively inactive subsidiaries and the Company's equity investment in CMN. For the years ended April 30, 1997 and 1996 the Company operated in a single business segment, and, accordingly, no separate segment disclosures are necessary. The Company's business segment data for the year ended April 30, 1998 is as follows (in thousands): Year Ended April 30, 1998 -------------------------------------------------------------------------------------- Paaco Precision Concorde Other Eliminations Consolidated -------- --------- -------- -------- ------------ ------------- (in thousands) Revenues: Sales and other $ 14,241 $ 1,351 $ 1,100 $ 1,105 $ 17,797 Interest income 1,519 815 1,472 $ (388) 3,418 -------- ------- -------- -------- --------- -------- Total 15,760 1,351 1,915 2,577 (388) 21,215 -------- ------- -------- -------- --------- -------- Costs and expenses: Interest expense 942 81 586 14 (388) 1,235 Depreciation and amort. 64 122 42 557 785 Other 13,715 867 2,094 2,928 19,604 -------- ------- -------- -------- --------- -------- Total 14,721 1,070 2,722 3,499 (388) 21,624 -------- ------- -------- -------- --------- -------- CMN earnings and other 965 965 -------- ------- -------- -------- --------- -------- Income (loss) before taxes and minority interests $ 1,039 $ 281 $ (807) $ 43 $ -- $ 556 ======== ======= ======== ======== ========= ======== Capital expenditures $ 1,648 $ 1,057 $ 568 $ 788 $ -- $ 4,061 ======== ======= ======== ======== ========= ======== Total assets $ 45,427 $ 9,337 $ 16,211 $ 43,358 $ (20,656) $ 93,677 ======== ======= ======== ======== ========= ======== 23 T - QUARTERLY RESULTS OF OPERATIONS (UNAUDITED) A summary of the Company's quarterly results of operations for the years ended April 30, 1998 and 1997 is as follows (in thousands): Year Ended April 30, 1998 -------------------------------------------------------------- First Second Third Fourth Quarter Quarter Quarter Quarter Total -------- -------- -------- -------- -------- Revenue(a) $ 494 $ 556 $ 1,165 $ 19,000 $ 21,215 Net income (loss) (309) (51) 14 694 348 Diluted earnings (loss) per share (0.03) (0.01) -- 0.07 0.04 Year Ended April 30, 1997 --------------------------------------------------------------- First Second Third Fourth Quarter Quarter Quarter Quarter Total -------- -------- -------- -------- -------- Revenue $ 601 $ 854 $ 298 $ 277 $ 2,030 Net income (loss)(b) 13,621 (468) (3,531) (762) 8,860 Diluted earnings (loss) per share(b) 1.16 (0.04) (0.34) (0.07) 0.80 (a) - During the fourth quarter in the year ended April 30, 1998 revenues increased significantly as a result of the Company's acquisitions of Paaco and Precision. (b) - During the first quarter in the year ended April 30, 1997 the Company recognized a $14.9 million gain on the sale of its remaining 50% interest in SCGC. During the third quarter of the year ended April 30, 1997 the Company recognized a loss of $4.7 million from the sale of 1,850,000 shares of Casino America common stock it had received in the sale of its remaining 50% interest in SCGC. 24 REPORT OF INDEPENDENT ACCOUNTANTS CROWN GROUP, INC. Stockholders and Board of Directors Crown Group, Inc. In our opinion, the accompanying consolidated balance sheets and the related consolidated statements of operations, stockholders' equity and cash flows present fairly, in all material respects, the financial position of Crown Group, Inc. and its subsidiaries at April 30, 1998 and 1997, and the results of their operations and their cash flows for each of the three years in the period ended April 30, 1998, in conformity with generally accepted accounting principles. These financial statements are the responsibility of the Company's management; our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits of these statements in accordance with generally accepted auditing standards which 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, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for the opinion expressed above. Dallas, Texas PricewaterhouseCoopers LLP August 1, 1998 25 COMMON STOCK INFORMATION, DIVIDENDS AND CROWN GROUP, INC. RELATED STOCKHOLDER MATTERS The Company's common stock is authorized for quotation on the National Association of Securities Dealers Automated Quotation System ("NASDAQ") Small Cap Market under the NASDAQ symbol CNGR. The following table sets forth, by fiscal quarter, the high and low sale prices reported by NASDAQ for the Company's common stock for the periods indicated. Fiscal 1998 Fiscal 1997 High Low High Low ------ ------ ------ ------ First quarter $ 2.56 $ 2.00 $ 3.63 $ 1.69 Second quarter 4.00 2.38 3.06 2.00 Third quarter 3.56 3.00 3.25 2.00 Fourth quarter 4.31 3.00 2.94 2.00 As of July 31, 1998 there were approximately 1,590 stockholders of record. This number excludes individual stockholders holding stock under nominee security position listings. Since its inception the Company has paid no dividends on its common stock. The Company currently intends to follow a policy of retaining earnings to finance future growth. Payment of dividends in the future will be determined by the Company's Board of Directors and will depend upon, among other things, the Company's future earnings, operations, capital requirements and surplus, general financial condition, and contractual restrictions that may exist, and such other factors as the Board of Directors may deem relevant. SELECTED FINANCIAL DATA The financial data set forth below was derived from the audited consolidated financial statements of the Company and should be read in conjunction with the consolidated financial statements and related notes thereto, and Management's Discussion and Analysis of Financial Condition and Results of Operations contained elsewhere herein. (In thousands, except per share amounts.) Years Ended April 30, 1998 1997 1996 1995 1994 -------- -------- -------- -------- -------- Revenues from: Continuing operations $ 21,215 $ 2,030 $ 2,293 $ 177 $ 197 Discontinued opearations 604 Net income (loss) from: Continuing operations $ 348 $ 8,860 $ 12,298 $(20,325) $ (2,052) Discontinued operations (177) -------- -------- -------- -------- -------- $ 348 $ 8,860 $ 12,298 $(20,325) $ (2,229) ======== ======== ======== ======== ======== Earnings (loss) per share (diluted): Continuing operations $ 0.04 $ 0.80 $ 1.03 $ (2.01) $ (0.34) Discontinued operations (0.03) -------- -------- -------- -------- -------- $ 0.04 $ 0.80 $ 1.03 $ (2.01) $ (0.37) ======== ======== ======== ======== ======== Total assets $ 93,677 $ 38,237 $ 39,329 $ 54,507 $ 30,974 Total debt 46,035 987 31,660 Stockholders' equity 35,032 35,713 30,153 17,930 23,837 Shares outstanding 9,434 10,395 11,650 11,678 8,999