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 MARCH 31, 1998
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
DEGEORGE FINANCIAL CORPORATION
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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 ____
Shares of Common Stock outstanding as of May 15, 1998: 10,810,193
DEGEORGE FINANCIAL CORPORATION
INDEX TO FORM 10-Q
PAGE NO.
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS:
Consolidated Balance Sheets as of March 31, 1998 3
and December 31, 1997
Consolidated Statements of Operations for the three 4
months ended March 31, 1998 and 1997
Consolidated Statements of Cash Flows for the three 5
months ended March 31, 1998 and 1997
Notes to Consolidated Financial Statements 6-12
ITEM 2. Management's Discussion and Analysis of Financial 13-17
Condition and Results of Operations
PART II. OTHER INFORMATION
ITEM 5. OTHER INFORMATION 18
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K 18
2
DEGEORGE FINANCIAL CORPORATION
CONSOLIDATED BALANCE SHEETS
($ IN THOUSANDS)
(UNAUDITED)
MARCH 31, DECEMBER 31,
1998 1997
----------- ------------
ASSETS
Cash and cash equivalents $ 2,271 $ 1,179
Notes receivable, net 137,864 124,181
Mortgage loans held for sale 1,189 451
Receivables from related parties 573 661
Construction projects in process and inventory 4,969 4,774
Land held for sale 184 184
Prepaid expenses and other assets 4,452 3,777
Holdback reserve deposit, net 10,803 10,686
Senior Bond collateral fund 2,870 2,829
Real estate owned 3,964 3,280
Property, plant and equipment, less accumulated depreciation
of $3,343 and $3,024 for 1998 and 1997, respectively 14,558 13,146
Assets of discontinued operations 1,072 1,060
Intangible assets, less accumulated amortization of
$2,184 and $2,071 for 1998 and 1997, respectively 1,441 1,554
----------- ------------
Total assets $ 186,210 $ 167,762
----------- ------------
----------- ------------
LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT)
Accounts payable $ 7,469 $ 11,569
Accrued construction costs and unearned
income on sold notes receivable 3,304 4,358
Accrued expenses 9,045 7,236
Deferred income 5,007 4,623
Customer deposits 209 255
Collateralized borrowings 129,752 103,430
12% Senior notes 43,857 43,819
Notes payable 3,637 3,757
Capital lease obligations 126 --
----------- ------------
Total liabilities 202,406 179,047
----------- ------------
Commitments and contingencies (Note 8)
Stockholders' equity (deficit):
Common Stock; par value $.10, 25,000,000 shares
authorized, 10,810,193 shares issued and outstanding 1,081 1,081
Paid in capital 47,384 47,384
Accumulated deficit (64,661) (59,750)
----------- ------------
Total stockholders' equity (deficit) (16,196) (11,285)
----------- ------------
Total liabilities and stockholders' equity (deficit) $ 186,210 $ 167,762
----------- ------------
----------- ------------
See accompanying notes to consolidated financial statements
3
DEGEORGE FINANCIAL CORPORATION
CONSOLIDATED STATEMENTS OF OPERATIONS
FOR THE THREE MONTHS ENDING MARCH 31, 1998 AND 1997
($ IN THOUSANDS, EXCEPT PER SHARE DATA)
(UNAUDITED)
1998 1997
----------- ---------
Financial services income $ 3,920 $ 1,278
----------- ---------
Contract services:
Contract revenue 10,640 13,525
Materials and handling charges (5,440) (9,337)
----------- ---------
Contract services income 5,200 4,188
----------- ---------
Construction services:
Construction revenue 2,395 2,460
Cost of construction (2,115) (1,953)
----------- ---------
Construction services income 280 507
----------- ---------
Total income 9,400 5,973
Operating expenses:
Selling 5,407 3,895
General and administrative 5,014 3,865
Provision for credit losses 601 163
Interest expense 2,927 1,805
Other expense (income) 335 288
----------- ---------
(Loss) income from continuing operations
before income taxes (4,884) (4,043)
Income tax (provision) benefit (6) --
----------- ---------
(Loss) income from continuing operations (4,890) (4,043)
Discontinued operations-Patwil Homes, Inc.
(Loss) income from operations (21) (54)
----------- ---------
Net (loss) income $ (4,911) $ (4,097)
----------- ---------
----------- ---------
Basic and diluted (loss) earnings per common
share:
(Loss) income from continuing operations $ (0.45) $ (0.37)
(Loss) income from discontinued operations -- (0.01)
----------- ---------
Net (loss) income $ (0.45) $ (0.38)
----------- ---------
----------- ---------
See accompanying notes to consolidated financial statements
4
DEGEORGE FINANCIAL CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE THREE MONTHS ENDING MARCH 31, 1998 AND 1997
($ IN THOUSADS)
(UNAUDITED)
1998 1997
-------------- --------------
CASH FLOWS FROM OPERATING ACTIVITIES
Net (loss) income $ (4,911) $ (4,097)
---------- ----------
Adjustments to reconcile net (loss) income to
net cash (used in) provided by operating activities:
Depreciation and amortization 459 4,329
Accretion of discount on collateralized borrowings 2,242 261
Provision for credit losses 601 755
Provision for sales promotions and incentives 1,012 372
Loss (gain) on sale of property, plant and equipment (125) --
Loss (gain) from discontinued operations 21 53
Loss (gain) on sale of real estate owned 260 (83)
Gain on sale of loans (185) (105)
Loans originated for sale (14,361) (5,988)
Proceeds from sales of loans 13,808 6,093
Decrease (increase) in other operating assets (665) (253)
(Decrease) increase in other operating liabilities (3,008) 2,139
---------- ----------
Total adjustments 59 7,573
---------- ----------
Net cash provided by (used in) operating activities of:
Continuing operations (4,852) 3,476
Discontinued operations (33) 477
---------- ----------
Net cash provided by (used in) operating activities (4,885) 3,953
---------- ----------
CASH FLOWS FROM INVESTING ACTIVITIES
Proceeds from sales of property, plant and equipment 206 --
Purchase of property, plant and equipment (1,663) (487)
Proceeds from sales of real estate owned 945 538
Net increase in notes receivable (14,413) (26,968)
Notes receivable repurchased (3,192) (1,671)
---------- ----------
Net cash (used in) provided by investing activities (18,117) (28,588)
---------- ----------
CASH FLOWS FROM FINANCING ACTIVITIES
Proceeds from collateralized borrowings,
net of discounting 36,308 23,648
Repayments of collateralized borrowings (12,082) --
Principal payments on notes payable - other (120) (44)
Borrowings on notes payable - other -- 673
Principal payments on capital leases (12) (115)
---------- ----------
Net cash provided by (used in) financing activities 24,094 24,162
---------- ----------
Net change in cash and cash equivalents 1,092 (473)
Cash and cash equivalents - beginning of the period 1,179 3,737
---------- ----------
Cash and cash equivalents - end of the period $ 2,271 $ 3,264
---------- ----------
---------- ----------
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 March 31,
1998 and December 31, 1997, the results of operations for the three months
ended March 31, 1998 and 1997 and cash flows for the three months ended March
31, 1998 and 1997 of the Company. The results of operations for the three
months ended March 31, 1998 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 1997 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, DeGeorge Capital Corp. ("DeGeorge Capital"), DeGeorge Homes of
Florida, Inc. ("DeGeorge/Florida") and DeGeorge Homes of New England, Inc.
("DeGeorge/New England"). DeGeorge Capital, formerly Plymouth Capital
Company, Inc., changed its name effective April 1, 1998. The combined
assets, liabilities, earnings and equity of DeGeorge, DeGeorge 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, DeGeorge Capital, DeGeorge/Florida and DeGeorge/New
England are not deemed to be material to investors. During the three months
ended March 31, 1998, the Company continued the phase out of operations for its
wholly owned subsidiary, Patwil Homes, Inc. ("Patwil Homes"). See "Note 9 -
Discontinued Operations".
The Company is currently dependent upon cash flow from the financing of
construction loans for its working capital needs. 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 interest rate on its borrowings, from prime plus 1 1/2% to
the three month London Interbank Offered Rate ("LIBOR") plus 3% (10% and
8.71%, respectively, at March 31, 1998), effectively reducing the interest
rate on its borrowings 129 basis points at March 31, 1998. The June 1997
Amendment also extended the term of the Construction Loan Agreement to June
1, 1999. As of August 1, 1997, the Construction Loan Agreement was further
amended to provide for transfer of construction loans for turnkey activities
and an earlier transfer of core business construction loans involving
customer land acquisition advances.
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. Prior to
January 1, 1997, the Company accounted for the transfers of its receivables
as sales. Although there is no difference in substance or form from sales of
notes receivable that occurred prior to January 1, 1997 to those that were
transferred after December 31, 1996, the
6
DEGEORGE FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
(UNAUDITED)
transactions that occurred prior to 1997 retain their sale characteristics in
the financial statements since FAS 125 prohibits retroactive application to
transactions occurring before January 1, 1997. Thus, loans transferred prior
to 1997 are not recognized as assets (or as pledged collateral) on the
balance sheets of the Company, while loans transferred in 1997 and 1998 are
so recognized.
Consistent with the adoption of FAS 125, financial services income
includes interest accrued on construction loans transferred pursuant to the
Construction Loan Agreement after December 31, 1996 without offset for
related interest expense. The cost of the related collateralized borrowings
on notes receivable transferred after 1996 is included in interest expense.
For loans underwritten prior to 1997, servicing income continues to be
recognized net of servicing expense in financial services income.
DeGeorge's closure of its distribution centers in April 1997
fundamentally changed its method of operations. Contract services income
represents margin earned by DeGeorge from services rendered to customers,
including technical support services, budgeting services and materials
purchasing services. Concurrent with the closing of its distribution centers,
DeGeorge determined that recording contract services 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 more
closely matched DeGeorge's new business operations. Accordingly, upon the
closing of the construction loan, which is the confirmed point of sale for
DeGeorge, 60% of the related contract service income is recognized with the
balance of unearned contract services income recognized ratably over the
following ten month period.
For contracts fulfilled prior to April 1997, contract revenue and
materials charges were recognized based on the ratio of individual shipments
of materials to total shipments of materials. Contract revenue is reflected
net of sales discounts and allowances, which typically consist of a free
interest period or merchandise.
Construction services income reflects the results of operations for
turnkey homebuilding operations as well as sales to American Indian tribal
groups, community service and non-profit organizations. DeGeorge has adopted
the completed contract method of accounting for recognizing construction
revenue from turnkey operations. Under this method, billings and costs are
accumulated during the period of construction, but no profits are recorded
before the completion of the work. Provisions for estimated losses on
uncompleted contracts are made when determined. Administrative costs are not
allocated to construction projects.
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 1997 Annual Report on Form 10-K.
Certain reclassifications have been made to the financial statements for
the three months ended March 31, 1997 to conform to the presentation for the
three months ended March 31, 1998. These reclassifications had no effect on net
loss.
7
DEGEORGE FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
(UNAUDITED)
NOTE 2 -- NOTES RECEIVABLE:
Notes receivable at March 31, 1998 and December 31, 1997 are as follows
(in thousands):
MARCH 31, DECEMBER 31,
1998 1997
---------- -------------
Contractual value of notes receivable $198,453 $166,662
Less: unfunded contractual obligations (54,008) (37,034)
-------- --------
Less: 144,445 129,628
Allowance for sales promotions and incentives (839) (691)
Allowance for estimated credit losses (4,282) (3,571)
Deferred loan origination fees, net (1,460) (1,185)
-------- --------
Notes receivable, net $137,864 $124,181
-------- --------
-------- --------
At March 31, 1998 and December 31, 1997, $135.0 million and $107.8
million, respectively, of the contractual value of notes receivable have been
pledged as collateral under the Construction Loan Agreement. Loans
transferred under the Construction Loan Agreement prior to January 1, 1997,
the balance of which was $39.9 million and $61.1 million at March 31, 1998
and December 31, 1997, respectively, retained their sale characteristics and
are not included in notes receivable.
NOTE 3 -- TRANSFER AND SERVICING OF NOTES RECEIVABLE:
Under the Construction Loan Agreement, loans are transferred at face
value, net of cost of funds 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. Deposits are reflected in the financial statements net of
allowance for estimated credit losses representing the estimated impairment
of the deposit in connection with the recourse provisions of the Construction
Loan Agreement on construction loans transferred. The Company received
interest income (reflected in financial services income) on deposit funds of
$169,000 and $288,000 for the three months ended March 31, 1998 and 1997,
respectively.
Funds retained under the holdback provision of the Construction Loan
Agreement are presented as holdback reserve deposit on the balance sheet, net of
estimated credit losses anticipated on construction loans sold, as follows (in
thousands):
MARCH 31, DECEMBER 31,
1998 1997
---------- ------------
Holdback $12,212 $12,447
Allowance for estimated credit losses (1,409) (1,761)
------- -------
Holdback reserve deposit, net $10,803 $10,686
------- -------
------- -------
As earlier described, transfers of loans under the Construction Loan
Agreement subsequent to 1996 are considered financing arrangements and not
loan sales. At March 31, 1998 and December 31, 1997, the balance of these
collateralized borrowings is $129.8 million and $103.4 million, respectively,
which is net of discount of $5.2 and $4.4 million, respectively. For the
three months ended March 31, 1998 and 1997, $2.2 million and $261,000,
respectively, of discount accretion is included in interest expense.
8
DEGEORGE FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
(UNAUDITED)
Loans transferred prior to January 1, 1997 were treated as sales of
notes receivable. At the time of their sale, the fair value of mortgage
servicing rights was calculated based upon estimated service fees that the
Company would expect to receive over the life of the loans sold, less
incremental costs associated with servicing the loans. For the three months
ended March 31, 1998 and 1997, service fee expense, which includes
amortization of mortgage servicing rights, was $1.6 million and $3.9 million,
respectively. Service fee expense is reflected in the financial statements
as an offset to service fee income in financial services income.
NOTE 4 -- CONSTRUCTION PROJECTS IN PROCESS AND INVENTORY:
Construction projects in process and inventory at March 31, 1998 and
December 31, 1997, is as follows (in thousands):
MARCH 31, DECEMBER 31,
1998 1997
-------- ------------
Construction projects in progress and model homes $4,928 $4,733
Raw materials inventory 41 41
------ ------
Construction projects in process and inventory $4,969 $4,774
------ ------
------ ------
NOTE 5 -- INCOME TAXES:
Income tax provision (benefit) for the three months ended March 31, 1998
and 1997 differs from the amount of income tax determined by applying the
applicable U.S. statutory federal tax rate of 34% to pre-tax (loss) income as
a result of the following differences (in thousands):
THREE MONTHS ENDED
MARCH 31,
------------------------
1998 1997
---------- ----------
Statutory U.S. tax rate $(1,599) $(1,387)
State taxes, net of federal income tax benefit (277) (245)
Change in valuation allowance 1,882 1,632
------- -------
Income tax (benefit) provision $ 6 $ --
------- -------
------- -------
The significant components of deferred income taxes at March 31, 1998 and
December 31, 1997 are as follows (in thousands):
MARCH 31, DECEMBER 31,
1998 1997
------------- -------------
Deferred tax assets:
Credit and refinancing allowances $ 1,901 $ 2,179
Goodwill 1,604 1,648
Net operating loss carryforward 19,587 17,399
Other, net (267) (283)
--------- ---------
Total gross deferred tax assets 22,825 20,943
Less: valuation allowance (22,825) (20,943)
--------- ---------
Deferred income taxes $ -- $ --
--------- ---------
--------- ---------
9
DEGEORGE FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
(UNAUDITED)
At March 31, 1998 and December 31, 1997, the Company has net operating
loss carryforwards of $49.0 million and $43.5 million, respectively, which
will fully expire by the year 2019.
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):
THREE MONTHS ENDED
MARCH 31,
--------------------
1998 1997
--------- ---------
Decrease (increase) in:
Deferred loan origination fees $ 275 $ 71
Receivable from related parties 88 (23)
Construction projects in process and inventory (195) 307
Prepaid expenses and other assets (675) 1,126
Holdback reserve deposit (117) 601
Mortgage servicing rights - (2,314)
Senior Bond collateral fund (41) (21)
-------- --------
Total decrease (increase) in other operating assets $ (665) $ (253)
-------- --------
-------- --------
Increase (decrease) in:
Accounts payable and accrued expenses $ (2,291) $ 4,785
Accrued construction costs and unearned
income on sold notes receivable (1,054) (2,671)
Customer deposits (47) 25
Deferred income 384 --
-------- --------
Total increase (decrease) in other
operating liabilities $ (3,008) $ 2,139
-------- --------
-------- --------
Supplemental disclosures of cash flow information:
Interest paid $ 3,137 $ 2,389
Income taxes paid (refunded), net $ 44 $ 29
Supplemental schedule of non-cash investing and
financing activities:
Transfer of notes receivable to real estate owned $ 2,227 $ 806
Notes receivable originated from sales of
real estate owned $ -- $ 147
Capital leases incurred for acquisition
of equipment $ 138 $ --
NOTE 7 -- SUMMARIZED FINANCIAL INFORMATION:
Summarized financial information of DeGeorge as of March 31, 1998 and
December 31, 1997 and for the three months ended March 31, 1998 is as
follows (in thousands):
MARCH 31, DECEMBER 31,
1998 1997
---------- ------------
Total assets $193,178 $174,382
Total liabilities $201,568 $178,137
10
DEGEORGE FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
(UNAUDITED)
Total assets include intercompany receivables of $24.1 million and $24.0
million, respectively, at March 31, 1998 and December 31, 1997.
THREE MONTHS ENDED
MARCH 31,
-------------------------
1998 1997
---------- ---------
Total income $ 9,161 $ 6,074
Net (loss) income $ (4,720) $ (3,925)
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 1997 Annual Report on Form 10-K.
NOTE 9 -- DISCONTINUED OPERATIONS:
Summarized below are the assets of discontinued operations (in
thousands):
MARCH 31, DECEMBER 31,
1998 1997
--------- -----------
Cash $ 86 $ 57
Notes receivable 56 52
Inventory 70 80
Prepaid expenses and other assets 73 71
Costs of uncompleted contracts in excess of
related billings 341 354
Assets held for sale, net 446 446
------ ------
Assets of discontinued operations $1,072 $1,060
------ ------
------ ------
Condensed income (loss) from discontinued operations for the three months
ended March 31, 1998 and 1997 are as follows (in thousands):
THREE MONTHS ENDED
MARCH 31,
--------------------------
1998 1997
----------- -----------
Net revenues $ -- $ 171
Cost of sales -- (150)
Selling, general and administrative expenses (21) (74)
------ --------
Discontinued operations - (loss) income $ (21) $ (53)
------ --------
------ --------
NOTE 10 -- SIGNIFICANT TRANSACTIONS:
On January 30, 1998, the Company signed a definitive agreement to be
acquired through a merger by a company controlled by Mr. Peter R. DeGeorge,
Chairman and Chief Executive Officer of the Company, and certain current and
former directors, officers and related parties. Under the merger agreement,
each of the outstanding shares of common stock of the Company, other than shares
owned by members of the buy-out group, will be converted into the right to
receive $1.50 in cash.
11
DEGEORGE FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
(UNAUDITED)
The merger agreement and the consideration to be received by holders of
shares of common stock, other than members of the buy-out group, were approved
by the Company's Board of Directors following the unanimous recommendation of a
Special Committee of independent directors on January 29, 1998. The merger is
subject to obtaining all necessary corporate and regulatory approvals, but is
not subject to financing.
NOTE 11 -- SUBSEQUENT EVENTS:
Effective April 1, 1998, Plymouth Capital Company, Inc. changed its name
to DeGeorge Capital Corp.
On April 29, 1998, the Company filed a preliminary Proxy Statement with
the Securities and Exchange Commission in connection with a special meeting
of the Company's stockholders to consider the approval and adoption of the
Agreement and Plan of Merger dated as of January 29, 1998. The Company
expects to complete merger by the second fiscal quarter of 1998.
12
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
OVERVIEW
The following discussion makes various comparisons relevant to the
results of operations of the Company for the three months ended March 31,
1998 and 1997 with regard to continuing and discontinued operations.
Discontinued operations relate to the phase out of operations for the
Company's wholly owned subsidiary, Patwil Homes, which ceased new business
activities in late 1995 and has since been executing a plan of liquidation.
Except where noted, all references herein are to continuing operations.
CHANGES IN BUSINESS OPERATIONS, INCOME RECOGNITION AND PRESENTATION OF
OPERATING RESULTS
In April 1997, DeGeorge closed its distribution centers, which
fundamentally changed its operations. Concurrently with the closing of its
distribution centers, DeGeorge determined that recording contract services
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 more closely matched DeGeorge's business operations.
Accordingly, upon the closing of the construction loan, which is the
confirmed point of sale for DeGeorge, 60% of the related contract service
income is recognized with the balance of unearned contract services income
recognized ratably over the following ten month period. For contracts
fulfilled prior to April 1997, contract revenue and materials charges were
recognized based on the ratio of individual shipments of materials to total
shipments of materials.
Effective January 1, 1997, the Company adopted FAS 125, under which the
Company began 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 (see
"Liquidity and Capital Resources" below). Prior to January 1, 1997, the
Company had treated the transfer of its receivables as sales. Thus,
transactions occurring prior to 1997 are not reflected as assets (or as
pledged collateral) on the balance sheets of the Company for the dates
presented while transactions occurring after 1996 are so reflected. For
periods subsequent to the adoption of FAS 125, financial services income
reflects interest charged to customers on construction loans transferred
pursuant to the Construction Loan Agreement after December 31, 1996 without
offset for related interest expense. The cost of funds on post-1996 notes
receivable transferred is included in interest expense. For loans
underwritten prior to 1997, servicing income continues to be reflected net of
servicing expense in financial services income. Interest income on deposits,
previously reflected in other (income) expense, has been reclassified to
financial services income for all periods presented. Other than recasting
the presentation of results of operations to reflect current business
operations, no restatement of results of operations for prior periods has
been made.
RESULTS OF OPERATIONS
NET INCOME (LOSS)
The Company reported a net loss of $4.9 million for the quarter ended
March 31, 1998, or $0.45 per share, as compared to a net loss of $4.1
million, or $0.38 per share, for the similar period in 1997. Per share
amounts are based on 10.8 million weighted average shares outstanding for
each period. Basic and diluted per share amounts are equal for both periods
because the effect of common stock equivalents was anti-dilutive.
FINANCIAL SERVICES INCOME
Financial services income is comprised principally of interest charged
to customers on construction loans, net loan servicing income, loan
origination fees and customer insurance placement
13
fees. Financial services income increased to $3.9 million in 1998 from $1.3
million in 1997, an increase of $2.6 million. The key component of this
increase ($2.3 million) relates to the change in presentation of interest
earnings from customers under construction loans that were transferred after
December 31, 1996, as earlier described. Other components of this increase
include $500,000 of fees earned on mortgage origination activities and
$200,000 of interest income on accounts retained in the Company's portfolio
of notes receivable. Increases in financial services income were offset by a
reduction of $300,000 in service fees collected on accounts sold pursuant to
the Construction Loan Agreement prior to January 1, 1997 and $100,000 of
earnings on reduced reserves held pursuant to the Construction Loan Agreement
(see "Liquidity and Capital Resources" below).
CONTRACT SERVICES INCOME
Contract services income, as described above, represents the income
realized on DeGeorge's core business support activities. Contract services
income was $5.2 million for first quarter of 1998 as compared to $4.2 million
for the similar period in 1997, an increase of $1.0 million, or 24.2%. The
increase in contract services income is attributable to the rise in loan
closings achieved during the first quarter, which totaled 270 in 1998 as
compared to 200 in 1997, an increase of 70, or 35.0%. Loan closings
increased in the first quarter of 1998 primarily due to the increase in
backlog (i.e., the inventory of active loan applications in process) at
December 31, 1997.
Loan applications received during the first quarter of 1998 increased
49.8%, to 903 from 603 in the first quarter of 1997. At March 31, 1998,
DeGeorge had 653 loan applications in active processing as compared to 480 at
March 31, 1997, an increase of 173, or 36.0%. Backlog includes 294
preliminary credit-approved loan applications at March 31, 1998 for which
customers had also identified their building site as compared to 284 similar
loan applications at March 31, 1997, an increase of 3.5%. Backlog also
includes 359 and 196 loan applications at March 31, 1998 and 1997,
respectively, which were in early stages of processing, an increase of 83.2%.
Materials and handling charges relating to contract services reflect the
cost of materials that DeGeorge provides to customers and arranges to have
delivered to customers' construction sites, and for periods prior to the
second quarter of 1997, also includes distribution center warehousing and
truck fleet costs. For the quarters ended March 31, 1998 and 1997 materials
and handling charges as a percentage of contract revenue were 51.1% and
69.0%, respectively.
For marketing purposes, DeGeorge may offer sales promotions to customers
at the time of sale, typically consisting of free interest for the first
several months or merchandise (such as appliances). Contract revenue is
reported net of promotions.
CONSTRUCTION SERVICES INCOME
Construction services income aggregates the results of operations for
the turnkey homebuilding activities of DeGeorge/Florida and DeGeorge/New
England as well as sales to American Indian and non-profit groups.
Construction services income decreased to $300,000 in the quarter ending
March 31, 1998 as compared to $500,000 in the comparable period in 1997, a
decrease of $200,000. The decrease in construction services income is
primarily attributable to reduced construction activity and associated margin
on community service sales.
SELLING EXPENSES
Selling expenses increased by $1.5 million during the first quarter of
1998, to $5.4 million from $3.9 million in 1997. The increase in selling
expenses for the first quarter of 1998 is primarily attributable to
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$800,000 of staffing and other costs relating to branch sales offices
established in the latter part of 1997, $600,000 of compensation paid to
sales representatives in connection with direct marketing operations that
were in the earliest stage of development in the first quarter of 1997 and
$300,000 of increased wages relating to additional sales management staff
required to direct the expanding activities of the field sales force. The
first quarter increases were offset by $200,000 of reduced recruitment costs
and related savings achieved through the elimination of reimbursed expenses
to sales representatives.
At March 31, 1998 and 1997, DeGeorge had 329 and 173 field sales
representatives, respectively. In addition, the Company had 53 and 9
telemarketing representatives in its direct marketing operations at March 31,
1998 and 1997, respectively.
GENERAL AND ADMINISTRATIVE EXPENSES
General and administrative expenses were $5.0 million for the quarter
ended March 31, 1998 as compared to $3.9 million for the similar period in
1997. The $1.1 million increase in first quarter general and administrative
expenses is principally attributable to $600,000 of staffing, depreciation
and facilities charges associated with expanded operations at the Company's
headquarters that replace services previously provided at DeGeorge's
distribution centers, which were closed in the second quarter of 1997. Other
components of the first quarter increase include $200,000 in costs relating
to increased staffing for improvements in processing and information
technology; $100,000 in professional fees, partially attributable to the
pending merger proposal, $100,000 in property and franchise taxes and
$100,000 in travel relating to the development of branch offices.
PROVISION FOR CREDIT LOSSES
During the quarter ended March 31, 1998, the Company recorded a
provision for credit losses of $600,000 as compared to $200,000 for the
similar period in 1997. The provision for credit losses reflects the
replenishment to the allowance for credit losses based on management's
estimate of the potential impairment of notes receivable after taking into
account specific charges to the allowance during the period.
INTEREST EXPENSE
Interest expense for the quarter ended March 31, 1998 increased by $1.1
million, to $2.9 million from $1.8 million in 1997, all of which is directly
attributable to the change in the method of accounting for the transfer of
notes receivable under the Construction Loan Agreement pursuant to the
Company's adoption of FAS 125 on a prospective basis, effective January 1,
1997 (see "Changes in Business Operations, Income Recognition and
Presentation of Operating Results" above). Other principal components of
interest expense include $1.3 million of interest paid on $44.5 million of
outstanding 12% Senior Notes due 2001 of DeGeorge and $100,000 of related
amortization of debt issuance costs.
OTHER (INCOME) EXPENSE
Other expense for each of the three month periods ending March 31, 1998 and 1997
was $300,000. This amount is principally comprised of maintenance and writedown
costs of $400,000 and $200,000 in connection with the servicing of real estate
owned during the respective quarters in 1998 and 1997. During the quarter ended
March 31, 1998, other expense was offset by a net gain of $100,000 on the sale
of fixed assets and real estate owned. Non-recurring customer accommodations of
$100,000 were recorded for the quarter ended March 31, 1997.
15
INCOME TAXES
The Company 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,
1997, the Company had accumulated a gross deferred tax asset of $20.9
million, against which the Company recorded a full valuation allowance.
During the first quarter of 1998, the net loss for tax purposes and changes
in temporary differences caused an increase in the gross deferred tax asset
to $22.8 million, against which a full valuation allowance has also been
recorded.
For federal income tax purposes, the Company had net operating loss
carryovers of $49.0 million at March 31, 1998, which will fully expire by the
year 2019.
LIQUIDITY AND CAPITAL RESOURCES
At December 31, 1997, cash and cash equivalents were $1.2 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
Agreement, under which the Company may, at its discretion and subject to
certain criteria, transfer all of its construction loans. The June 1997
Amendment provided for a reduction in the holdback deposit requirement from
12% to 8% (resulting in the return of $7.5 million of deposits to the Company
in June 1997) and a change in the benchmark for computing the interest rate
on its borrowings, from prime plus 1 1/2% to the three month London Interbank
Offered Rate ("LIBOR") plus 3% (10% and 8.71%, respectively, at March 31,
1998), effectively reducing the interest rate on the Company's borrowings 129
basis points at March 31, 1998. The June 1997 Amendment also extended the
term of the Construction Loan Agreement to June 1, 1999. As of August 1,
1997, the Construction Loan Agreement was further amended to provide for
transfer of construction loans for turnkey activities and an earlier transfer
of core business construction loans involving customer land acquisition
advances.
Under the Construction Loan Agreement, loans are transferred at face
value, net of cost of funds 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 March 31, 1998 and December 31,
1997 was $12.2 million and $12.4 million, respectively. Deposits are
presented in the financial statements net of allowance for estimated credit
losses ($1.4 million and $1.7 million at March 31, 1998 and December 31,
1997, respectively) on construction loans transferred.
During the three months ended March 31, 1998, the Company transferred
$36.2 million, net face value ($39.4 million gross transfers less $3.2
million of repurchased accounts), of construction loans pursuant to the
Construction Loan Agreement. Net proceeds to the Company for the first
quarter of 1998 were $33.3 million, after discounting of $3.1 million and net
return of deposits of $200,000.
As of March 31, 1998, the Company was servicing $39.9 million, face
value, of previously transferred construction loans. Collateralized
borrowings at March 31, 1998 of $135.0 million represent financing
transactions occurring after December 31, 1996, which are reported in the
financial statements net of prepaid interest of $5.2 million, or $129.8
million. As of December 31, 1997, the Company was servicing $61.1 million,
face value, of previously transferred construction loans.
The Company is currently dependent upon cash flow from the financing of
construction loans under the Construction Loan Agreement for its working
capital needs. At March 31, 1998, the Company
16
was committed to fund expenditures relating to contractual obligations with
customers of $57.3 million. In addition, debt service requirements relating
to the 12% Senior Notes and notes payable are expected to be $4.6 million for
the balance of fiscal 1998. The Company's available balance of notes
receivable at March 31, 1998 exceeded the Company's cash flow needs at that
date and the Company believes that a majority of its notes receivable will be
eligible for financing under the terms of the Construction Loan Agreement.
The Company also believes it will generate sufficient new notes receivable
for financing under the Construction Loan Agreement to meet its anticipated
cash needs. On most business days, the Company receives payoff funds from
customers in its capacity as servicer. Under terms of the Construction Loan
Agreement as in effect during the first quarter of 1998, the Company had an
obligation to immediately remit such funds to the mortgage financing company,
though in practice, the Company transferred such funds to the mortgage
financing company on a lag basis, usually in connection with a further
transfer of construction loans. This lag in payments was a technical
violation of the Construction Loan Agreement. Such agreement was amended on
March 31, 1998 to require that such payoff funds be remitted to the mortgage
financing company within 15 days of receipt. While the Company gains a
"float" on such funds, which the Company uses to finance its operations, the
Company is still required to pay interest on such funds through the date of
remittance.
The Company has invested $4.3 million in its corporate facility, which is
subject to a mortgage, the balance of which was $600,000 at March 31, 1998. In
June 1997, the Company began construction of a second facility adjacent to its
corporate offices. The cost of completion for the second facility, including
furniture and fixtures, is expected to be $5.3 million of which $2.7 million had
been disbursed as of March 31, 1998. The Company believes that the mortgaging
of these and other real estate holdings would provide a significant source of
working capital. Additional sources of cash available to the Company include
the sale of certain other assets and the further disposition of remaining assets
of discontinued operations. The Company believes that the proceeds from these
asset sales would be reflective of their carrying value.
17
PART II. OTHER INFORMATION
ITEM 5. OTHER INFORMATION:
None
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits: none
(b) Reports on Form 8-K:
There have been no reports on Form 8-K since the filing of
the Company's 1997 Annual Report on Form 10-K.
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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: May 15, 1998
By: /s/ SALVATORE A. BUCCI
----------------------------
Salvatore A. Bucci
Senior Vice President and
Chief Financial Officer
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