SECURITIES AND EXCHANGE COMMISSION
WASHINGTON D.C. 20549
------------------------
FORM 10-Q
(MARK ONE)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the Quarterly Period Ended September 30, 1999
[ ] 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 000-21193
------------------------
SUNTERRA CORPORATION
----------------------------------------------------
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
MARYLAND 95-4582157
- ------------------------ -------------------
(STATE OF INCORPORATION) (I.R.S. EMPLOYER
IDENTIFICATION NO.)
1781 PARK CENTER DRIVE
ORLANDO, FLORIDA 32835
---------------------------------------------------------
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES INCLUDING ZIP CODE)
(407) 532-1000
--------------------------------------------------
(REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE)
Sunterra.com
----------------------------
(REGISTRANT'S WEBSITE ADDRESS)
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.
[X] Yes [ ] No
Number of shares of common stock outstanding of the issuer's Common Stock,
par value $0.01 per share as of November 12, 1999: 35,971,534.
1
<PAGE>
SUNTERRA CORPORATION
INDEX
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
Consolidated Statements of Income for the three and nine
months ended September 30, 1999 and September 30, 1998 .... 3
Consolidated Balance Sheets as of September 30, 1999 and
December 31, 1998.......................................... 4
Consolidated Statements of Cash Flows for the nine months
ended September 30, 1999 and September 30, 1998............ 5
Notes to the Consolidated Financial Statements................ 6
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations..................................... 9
Item 3. Quantitative and Qualitative Disclosures about Market Risk.... 16
PART II. OTHER INFORMATION
Item 6. Exhibits and Reports on Form 8-K............................... 17
Signatures.............................................................. 17
2
<PAGE>
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
SUNTERRA CORPORATION
CONSOLIDATED STATEMENTS OF INCOME
Three and Nine Months Ended September 30, 1999 and 1998
(Amounts in thousands except per share data, unaudited)
<TABLE>
<CAPTION>
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
------------------------ ------------------------
1999 1998 1999 1998
---- ---- ---- ----
<S> <C> <C> <C> <C>
Revenues:
Vacation Interests sales .......................... $ 125,122 $103,292 $ 326,550 $260,834
Interest income ................................... 15,438 14,208 39,832 38,979
Gain on sales of mortgages receivable ............. 2,501 1,032 5,441 1,032
Other income ...................................... 10,084 8,520 30,109 22,207
--------- -------- --------- --------
Total revenues ............................. 153,145 127,052 401,932 323,052
--------- -------- --------- --------
Costs and Operating Expenses:
Vacation Interests cost of sales .................. 31,820 24,291 81,725 61,928
Advertising, sales and marketing .................. 57,734 45,472 149,887 117,849
Loan portfolio:
Provision for doubtful accounts ................. 2,144 3,252 7,122 9,412
Other expenses .................................. 1,944 727 4,030 2,930
General and administrative ........................ 16,462 13,182 48,353 37,247
Depreciation and amortization ..................... 4,259 3,258 10,888 7,914
--------- -------- --------- --------
Total costs and operating expenses ......... 114,363 90,182 302,005 237,280
--------- -------- --------- --------
Income from operations ............................ 38,782 36,870 99,927 85,772
Interest expense, net of capitalized
interest of $3,567, $2,203, $8,588 and $5,711 for
the three months ended September 30, 1999 and
1998 and the nine months ended September 30, 1999
and 1998, respectively .......................... 10,831 13,310 35,131 34,238
Equity (gain) loss on investment in joint ventures (744) 38 (2,388) 7
Minority interest in loss(income) of consolidated
limited partnership ............................. 3 -- (58) --
--------- -------- --------- --------
Income before provision for income taxes
and extraordinary item ........................ 28,692 23,522 67,242 51,527
Provision for income taxes ........................ 11,189 9,173 26,224 20,095
--------- -------- --------- --------
Income before extraordinary item .................. 17,503 14,349 41,018 31,432
Extraordinary item, net of taxes .................. -- -- -- 129
--------- -------- --------- --------
Net income ...................................... $ 17,503 $ 14,349 $ 41,018 $ 31,303
--------- -------- --------- --------
Earnings per share:
Basic: ........................................ $ 0.49 $ 0.40 $ 1.14 $ 0.87
Diluted: ...................................... $ 0.46 $ 0.38 $ 1.09 $ 0.84
Weighted average number of common
shares outstanding ........................ 35,932 35,888 35,920 35,888
Weighted average number of common and
potentially dilutive common shares
outstanding ............................... 41,055 40,793 40,958 41,357
The accompanying notes are an integral part of these consolidated financial statements.
</TABLE>
3
<PAGE>
SUNTERRA CORPORATION
CONSOLIDATED BALANCE SHEETS
(Amounts in thousands except share and per share data)
<TABLE>
<CAPTION>
SEPTEMBER 30, DECEMBER 31,
1999 1998
----------- ----------
ASSETS (unaudited)
<S> <C> <C>
Cash and cash equivalents ..................................... $ 10,958 $ 28,250
Cash in escrow and restricted cash ............................ 35,478 25,951
Mortgages receivable, net of an allowance of $22,240 and
$22,869 at September 30, 1999 and December 31,
1998, respectively ........................................ 325,157 335,982
Retained interests ............................................ 46,904 12,518
Receivables and other assets .................................. 90,634 86,087
Investment in joint ventures .................................. 23,231 17,876
Real estate and development costs ............................. 355,727 336,620
Property and equipment, net ................................... 116,338 81,125
Intangible assets, net ........................................ 95,387 96,723
---------- ----------
Total assets ........................................... $1,099,814 $1,021,132
========== ==========
LIABILITIES AND STOCKHOLDERS' EQUITY
Accounts payable .............................................. $ 30,743 $ 21,864
Accrued liabilities ........................................... 83,926 80,242
Income taxes payable .......................................... 7,452 9,240
Deferred taxes ................................................ 47,124 30,984
Notes payable ................................................. 635,503 627,089
---------- ----------
Total liabilities ...................................... 804,748 769,419
---------- ----------
Stockholders' equity:
Preferred stock (25,000,000 shares authorized; none
issued or outstanding) ...................................... -- --
Common stock ($0.01 par value, 50,000,000 shares
authorized; 35,946,534 and 35,902,671 outstanding at
September 30, 1999 and December 31, 1998, respectively) ..... 359 359
Additional paid-in capital .................................... 163,687 163,290
Retained earnings ............................................. 127,599 86,581
Accumulated other comprehensive income ........................ 3,421 1,483
---------- ----------
Total stockholders' equity ............................. 295,066 251,713
---------- ----------
Total liabilities and stockholders' equity ............. $1,099,814 $1,021,132
========== ==========
The accompanying notes are an integral part of these consolidated financial statements.
</TABLE>
4
<PAGE>
SUNTERRA CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Amounts in thousands, unaudited)
<TABLE>
<CAPTION>
NINE MONTHS ENDED
SEPTEMBER 30,
--------------------------
1999 1998
--------- ---------
<S> <C> <C>
Operating activities:
Net income ................................................ $ 41,018 $ 31,303
Adjustments to reconcile net income to net cash provided by
(used in) operating activities:
Depreciation and amortization ........................... 10,888 7,914
Provision for doubtful accounts ......................... 7,122 9,412
Amortization of capitalized financing costs ............. 3,292 2,113
Equity (gain) loss on investment in joint ventures ...... (2,388) 7
Minority interest in income of consolidated limited
partnership ........................................... (58) --
Gain on sales of mortgages receivable ................... (5,441) (1,032)
Proceeds from sales of mortgages receivable ............. 125,098 99,700
Changes in operating assets and liabilities:
Cash in escrow and restricted cash ...................... (8,981) (17,949)
Mortgages receivable .................................... (136,323) (88,522)
Retained Interests ...................................... (4,121) --
Real estate and development costs ....................... (23,857) (64,218)
Receivables and other assets ............................ (8,021) (25,185)
Accounts payable and accrued liabilities ................ 12,557 (978)
Income taxes payable .................................... (1,788) 13,461
Deferred taxes .......................................... 16,140 4,833
--------- ---------
Net cash provided by (used in) operating activities ....... 25,137 (29,141)
--------- ---------
Investing activities:
Cash paid for acquisition of subsidiaries ............... -- (88,115)
Property and equipment .................................. (38,499) (32,688)
Intangible assets ....................................... (8,964) (21,805)
Investment in joint ventures ............................ (2,967) (828)
--------- ---------
Net cash used in investing activities ................... (50,430) (143,436)
--------- ---------
Financing activities:
Proceeds from notes payable ............................. 32,616 103,987
Payments on notes payable ............................... (38,522) (99,782)
Proceeds from publicly issued debentures ................ -- 140,000
Proceeds from Senior Bank Credit Facility, net of
debt issuance costs ................................. 89,460 187,768
Payments on Senior Bank Credit Facility ................. (75,140) (140,568)
Other ................................................... 397 321
--------- ---------
Net cash provided by financing activities ................. 8,811 191,726
--------- ---------
Net (decrease) increase in cash and cash equivalents ...... (16,482) 19,149
Effect of exchange rates on cash and cash equivalents ..... (810) 544
Cash and cash equivalents, beginning of period ............ 28,250 38,487
--------- ---------
Cash and cash equivalents, end of period .................. $ 10,958 $ 58,180
========= =========
Supplemental disclosure of cash flow information:
Cash paid for interest .................................... $ 34,237 $ 31,671
Cash paid for taxes, net of tax refunds ................... $ 10,903 $ 2,662
The accompanying notes are an integral part of these consolidated financial statements.
</TABLE>
5
<PAGE>
SUNTERRA CORPORATION
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
Note 1 -- Background
The operations of Sunterra Corporation (formerly Signature Resorts, Inc.)
and its wholly-owned subsidiaries (the "Company") consist of (i) marketing and
selling vacation ownership interests at its resort locations and off-site sales
centers, which entitle the buyer to use a fully-furnished accommodation,
generally for a one-week period each year ("Vacation Intervals"), and vacation
points which may be redeemed for occupancy rights at participating resort
locations ("Vacation Points," and together with Vacation Intervals, "Vacation
Interests"), (ii) acquiring, developing and operating vacation ownership
resorts, (iii) providing consumer financing to individual purchasers for the
purchase of Vacation Interests and (iv) providing rental management and
maintenance services for which it receives fees paid by the resorts' homeowners'
associations.
The Company offers points-based vacation ownership systems in North America
through Club Sunterra, through which members may vacation at any resort in the
Club Sunterra network by utilizing their annual allotment of points ("Sun
Options") as a vacation currency, and through the Vacation Time Share Program
(the "VTS Program"). The Company also offers points-based vacation ownership
systems in Europe through the Grand Vacation Club ("GVC") and in Japan through
Sunterra Japan Vacation Club ("SJVC"). By the end of 1999, the Company
anticipates that it will complete the transition of virtually all Vacation
Interests sales to points-based products.
In the opinion of management, all adjustments considered necessary for a
fair presentation have been included and are of a normal recurring nature.
Operating results for the nine months ended September 30, 1999 are not
necessarily indicative of the results that may be expected for the year ending
December 31, 1999. Certain reclassifications were made to the 1998 accompanying
consolidated financial statements to conform to the 1999 presentation.
Note 2 -- Earnings Per Share
Basic earnings per share was calculated by dividing net income by the
weighted average number of common shares outstanding during the period. Diluted
earnings per share was calculated by dividing net income available to common
stockholders after assumed conversion of dilutive securities by the sum of the
weighted average number of common shares outstanding plus all additional common
shares that would have been outstanding if potentially dilutive common shares
had been issued. The following table reconciles the number of shares utilized in
the earnings per share calculations for the three and nine months ended
September 30, 1999 and 1998:
<TABLE>
<CAPTION>
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
1999 1998 1999 1998
-------- -------- ------- -------
(Amounts in thousands)
<S> <C> <C> <C> <C>
Net income ................................. $17,503 $14,349 $41,018 $31,303
Interest on convertible notes, net of
taxes (a) ................................ 1,210 1,210 3,630 3,630
------- ------- ------- -------
Net income available to common
stockholders after assumed conversion of
dilutive securities(a) ................... $18,713 $15,559 $44,648 $34,933
======= ======= ======= =======
Weighted average number of common shares
used in basic EPS ......................... 35,932 35,888 35,920 35,888
Effect of dilutive convertible notes(a) .... 4,537 4,537 4,537 4,537
Effect of dilutive stock options ........... 586 368 501 932
------- ------- ------- -------
Weighted average number of common shares and
dilutive potential common shares
used in diluted EPS(a) .................... 41,055 40,793 40,958 41,357
======= ======= ======= =======
</TABLE>
(a) The Convertible Subordinated Notes may be converted into shares of common
stock at a conversion price of $30.417 per share at any time prior to
maturity.
6
<PAGE>
Note 3 - Gain on Sale of Mortgages Receivable
In the third quarter of 1999, the Company recognized a pretax gain of $2.5
million, net of expenses, on the sale of $71.8 million of mortgages receivable,
comprised of (1) $64.8 million of mortgages receivable which were sold into the
Company's $100.0 million Mortgages Receivable Conduit Facility ("Conduit
Facility") and (2) $7.0 million of mortgages receivable which were sold to a
finance company.
Under the terms of the Conduit Facility, the Company sells mortgages
receivable through a wholly-owned special purpose entity at 95% of face value,
without recourse to Sunterra. The Company then retains 100% of the excess spread
over the commercial paper rate plus 0.60%. The $64.8 million of mortgages
receivable which were sold into the Conduit Facility had a 9 year weighted
average remaining life and a weighted average interest rate of 15%.
During the third quarter of 1999, the Company also sold to a finance
company $7.0 million of gross mortgages receivable for $6.8 million in cash in
three separate transactions. The Company sold these receivables at 97% of par
value with a 50% participation in the remaining interest spread. These
receivables had a 7 year weighted average remaining life and a weighted average
interest rate of 15%.
In the second quarter of 1999, the Company recognized a pretax gain of $1.3
million, net of expenses, on the sale of $44.4 million of mortgages receivable,
comprised of (1) $17.4 million of mortgages receivable which were sold into the
Conduit Facility; (2) $16.2 million of mortgages receivable which were part of
the 1999-A Securitization (defined below); and (3) $10.8 million of mortgages
receivable which were sold to a finance company.
In May 1999 the Company completed the sale through a Securitization of $100
million principal amount of its Vacation Ownership Receivables-Backed Notes
1999-A (the "1999-A Securitization"). These fixed rate Notes were issued at 94%
of the $106.8 million outstanding mortgages receivable principal balances and
bear interest at a weighted average rate of 6.66%. The 1999-A Securitization
generated approximately $97 million in cash (after funding a reserve account and
paying transaction expenses), which Sunterra used to repay a portion of amounts
outstanding on the $100 million Conduit Facility and $117.5 million Senior Bank
Credit Facility. Of the $106.8 million mortgages receivable included in the
1999-A Securitization, all but $16.2 million had previously been sold into the
Company's Conduit Facility during the fourth quarter of 1998 or the first
quarter of 1999. The receivables had an 8 year weighted average remaining life
and a weighted average interest rate of 15%.
During the second quarter of 1999, the Company also sold to a finance
company $10.8 million of gross mortgages receivable for $10.3 million in cash in
two separate transactions. The Company sold these receivables at 97% of par
value with a 50% participation in the remaining interest spread. These
receivables had an 8 year weighted average remaining life and a weighted average
interest rate of 15%.
During the first quarter of 1999, the Company recognized a pretax gain of
$1.6 million, net of expenses, on the sale of $25.9 million of mortgages
receivable into the $100 million Conduit Facility. These receivables had a 9
year weighted average remaining life and a weighted average interest rate of
15%.
As a result of the 1999-A Securitization and the sales of mortgages
receivable into the Conduit Facility and the sales of mortgages receivable to a
finance company, the Company generated retained interests of $30.5 million.
Retained interests are valued by the Company assuming a 10% average gross
default rate (before recoveries), a 15% average prepayment rate, and an 18%
discount rate, as deemed appropriate by the Company depending on the size, terms
and conditions of each separate sales transaction. The retained interests are
classified as held for sale based on management's intent and the existence of
prepayment options.
7
<PAGE>
Note 4 - Comprehensive Income
Comprehensive income includes all changes in equity (net assets) during a
period from non-owner sources. The reconciliation of net income to comprehensive
net income is as follows:
<TABLE>
<CAPTION>
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
--------------------- -----------------------
1999 1998 1999 1998
------- ------- ------- -------
(amounts in thousands)
<S> <C> <C> <C> <C>
Net income ............................... $17,503 $14,349 $ 41,018 $31,303
Unrealized gain on available for
sale securities .......................... 1,791 -- 2,748 --
Foreign currency translation adjustments . 3,571 737 (810) 544
------- ------- -------- -------
Total comprehensive income $22,865 $15,086 $ 42,956 $31,847
======= ======= ======== =======
</TABLE>
Note 5 - Segment and Geographic Information
The Company operates in one industry segment, which includes the marketing,
sales, financing and management of vacation ownership resorts, and two
geographic segments. The Company's areas of operation outside the United States
include Mexico, Canada, Netherlands Antilles, United Kingdom, Japan, Italy,
Spain, Portugal, Austria and France. The Company's management evaluates
performance of each segment based on profit or loss from operations before
income taxes not including extraordinary items and cumulative effect of change
in accounting principles. The accounting policies of the segments are the same
as those described in the summary of significant accounting policies (see Note 2
of the Company's Annual Report on Form 10-K for the year ended December 31,
1998). The Company's customers are not concentrated in any specific geographic
region and no single customer accounts for a significant amount of the Company's
sales.
Information about the Company's operations in different geographic
locations is shown below:
<TABLE>
<CAPTION>
UNITED STATES FOREIGN ELIMINATION TOTAL
------------- --------- ----------- ----------
(amounts in thousands)
<S> <C> <C> <C> <C>
Three months ended September 30, 1999
Total revenues ................... $ 115,199 $ 37,946 $ 153,145
Income before provision for income
taxes ............................ 20,045 8,647 28,692
Three months ended September 30, 1998
Total revenues ................... $ 95,355 $ 31,697 $ 127,052
Income before provision for income
taxes ............................ 17,788 5,734 23,522
Nine months ended September 30, 1999
Total revenues ................... $ 301,539 $100,393 $ 401,932
Income before provision for income
taxes............................. 48,124 19,118 67,242
Identifiable assets .............. 1,018,552 173,232 (91,970) 1,099,814
Nine months ended September 30, 1998
Total revenues ................... $ 238,970 $ 84,082 $ 323,052
Income before provision for income
taxes ............................ 38,032 13,495 51,527
Identifiable assets .............. 984,792 122,613 (66,607) 1,040,798
</TABLE>
8
<PAGE>
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
Comparison of the Three Months Ended September 30, 1999 to the Three Months
Ended September 30, 1998
Total revenues for the three months ended September 30, 1999 were $153.2
million compared with $127.1 million in the three months ended September 30,
1998, an increase of $26.1 million, or 20.5%. Vacation Interests sales increased
21.1% in the third quarter of 1999, to $125.1 million from $103.3 million in the
third quarter of 1998. The increase in Vacation Interests sales reflects an
increased number of purchases of Vacation Interests at the Company's resorts. As
a result of Hurricane Floyd, current quarter Vacation Interests sales and rental
revenues were lower than expected.
Included in Vacation Interests sales in the third quarter of 1999 are
approximately $40.9 million of Vacation Points sales from Club Sunterra, the
Company's new points-based vacation ownership system that was implemented at
certain North American resorts and off-site sales locations beginning the fourth
quarter of 1998.
Interest income, which includes accretion related to retained interests,
increased to $15.4 million in the third quarter of 1999 from $14.2 million in
the third quarter of 1998. The average mortgage receivable note carries a 14.5%
interest rate and is fully amortized over a weighted average period of nine
years.
During the third quarter of 1999, the Company recorded a $2.5 million
pre-tax gain on the sales of $71.8 million mortgages receivable. These sales
were part of the Company's program of monetizing mortgages receivable through
the use of off-balance sheet conduits, securitizations and other vehicles. The
Company recorded a $1.0 million pretax gain on the sale of mortgages receivable
during the third quarter of 1998.
Other income, which includes resort management and rental fees, increased
18.8% during the third quarter of 1999 to $10.1 million from $8.5 million in the
third quarter of 1998, reflecting: increases in management income in Europe,
primarily as a result of a larger base of managed resorts, and higher rental
income. Other income was 6.6% of total revenues for the third quarter of 1999,
compared with 6.7% in the third quarter of 1998.
As a percentage of Vacation Interests sales, Vacation Interests cost of
sales increased to 25.4% for the third quarter of 1999 from 23.5% for the third
quarter of 1998 due to the mix of inventory sold. Vacation Interests cost of
sales increased 30.9% to $31.8 million in the third quarter of 1999 from $24.3
million in the third quarter of 1998.
As a percentage of Vacation Interests sales, advertising, sales and
marketing expenses increased to 46.1% during the third quarter of 1999 from
44.0% during the third quarter of 1998, reflecting slightly higher costs at the
resorts, due in part to Hurricane Floyd. Advertising, sales and marketing
expenses increased 26.8% to $57.7 million during the third quarter of 1999 from
$45.5 million in the third quarter of 1998.
The provision for doubtful accounts decreased to $2.1 million in the third
quarter of 1999 from $3.3 million in the third quarter of 1998, due to the
$142.1 million of mortgages receivable that were originated and sold in the
first nine months of 1999.
The allowance for doubtful accounts as a percentage of gross mortgages
receivable increased to 6.4% at September 30, 1999, up from 6.3% at September
30, 1998. Consumer loans serviced by the Company in excess of 60 days past due,
including defaulted loans and loans in the deed-in-lieu process at September 30,
1999, were 6.4%, as a percentage of gross mortgages receivable, a decrease from
6.9% at September 30, 1998. Net of inventory recoveries, these same percentages
decrease to 4.4% and 4.7%, respectively.
As a percentage of total revenues, general and administrative expenses
increased slightly to 10.7% in the third quarter of 1999 from 10.4% in the third
quarter of 1998. General and administrative expenses increased 25.0% to $16.5
million during the third quarter of 1999 from $13.2 million during the third
quarter of 1998. The increase in general and
9
<PAGE>
administrative expenses was due primarily to the larger scale of operations,
investments made in the Company's infrastructure relating to the transition to
Club Sunterra, additions of middle and senior management and Y2K expenses.
Depreciation and amortization increased $1.0 million, or 30.3%, to $4.3
million in the third quarter of 1999 from $3.3 million in the third quarter of
1998. As a percentage of revenues, depreciation and amortization was 2.8% for
the third quarter of 1999, an increase from 2.6% for the third quarter of 1998.
The increase in depreciation and amortization was driven by a larger base of
depreciable assets from the prior year period, including hardware and software
costs and other infrastructure additions.
Interest expense, net of capitalized interest, decreased $2.5 million, to
$10.8 million for the third quarter of 1999 from $13.3 million for the third
quarter of 1998. The decrease was due primarily to higher capitalized interest
and lower average borrowings outstanding for the quarter ended September 30,
1999 compared to the prior year period.
Income before provision for income taxes increased 22.1% to $28.7 million
in the third quarter of 1999 from $23.5 million in the third quarter of 1998.
The Company's income tax rate was 39% for both the three month periods
ending September 30, 1999 and 1998, resulting in net income of $17.5 million for
the three months ended September 30, 1999, a 22.4% increase over $14.3 million
for the three months ended September 30, 1998.
Comparison of the Nine Months Ended September 30, 1999 to the Nine Months Ended
September 30, 1998
Total revenues for the nine months ended September 30, 1999 were $401.9
million compared with $323.1 million in the nine months ended September 30,
1998, an increase of $78.8 million, or 24.4%. Vacation Interests sales increased
25.2% in the first nine months of 1999, to $326.6 million from $260.8 million in
the first nine months of 1998. The increase in Vacation Interests sales reflects
an increased number of purchases of Vacation Interests at the Company's resorts
and the recording of Vacation Interests sales resulting from the HTD
Acquisition, which was consummated in July 1998 and Sunterra Japan, which began
sales operations in December 1998.
Included in Vacation Interests sales in 1999 are approximately $88.3
million of Vacation Points sales from Club Sunterra, the Company's new
points-based vacation ownership system that was implemented at certain North
American resorts and off-site sales locations beginning the fourth quarter of
1998.
Interest income, which includes accretion related to retained interests,
increased 2.1% to $39.8 million in the first nine months of 1999 from $39.0
million in the first nine months of 1998. The average mortgage receivable note
carries a 14.5% interest rate and is fully amortized over a weighted average
period of nine years.
During the first nine months of 1999, the Company recorded a $5.4 million
pre-tax gain on the sale of $142.1 million mortgages receivable. These sales
were part of the Company's program of monetizing mortgages receivable through
the use of off-balance sheet conduits, securitizations and other vehicles. The
Company recorded a $1.0 million pre-tax gain on sale of mortgages receivable for
the nine months ended September 30, 1998.
Other income, which includes resort management and rental fees, increased
35.6% during the first nine months of 1999 to $30.1 million from $22.2 million
in the first nine months of 1998, reflecting: increases in management income in
both Europe and the U.S., primarily as a result of a larger base of managed
resorts; higher rental income; and an increase in commissions from the UK
financial institution that directly finances our consumers' purchase of vacation
interests in Europe. Other income was 7.5% of total revenues for the first nine
months of 1999, compared with 6.9% in the first nine months of 1998.
As a percentage of Vacation Interests sales, Vacation Interests cost of
sales increased to 25.0% for the first nine months of 1999 from 23.7% for the
first nine months of 1998 due to the mix of inventory sold. Vacation Interests
cost of sales increased 32.0% to $81.7 million in the first nine months of 1999
from $61.9 million in the first nine months 1998.
10
<PAGE>
As a percentage of Vacation Interests sales, advertising, sales and
marketing expenses increased slightly to 45.9% during the first nine months of
1999 from 45.2% during the first nine months of 1998. Advertising, sales and
marketing expenses increased 27.2% to $149.9 million during the first nine
months of 1999 from $117.8 million in the first nine months of 1998.
The provision for doubtful accounts decreased to $7.1 million for the first
nine months of 1999, compared to $9.4 million for the first nine months of 1998,
due to the $142.1 million of mortgages receivable that were originated and sold
in the first nine months of 1999.
The allowance for doubtful accounts as a percentage of gross mortgages
receivable increased to 6.4% at September 30, 1999, up from 6.3% at September
30, 1998. Consumer loans serviced by the Company in excess of 60 days past due,
including defaulted loans and loans in the deed-in-lieu process at September 30,
1999, were 6.4%, as a percentage of gross mortgages receivable, a decrease from
6.9% at September 30, 1998. Net of inventory recoveries, these same percentages
decrease to 4.4% and 4.7%, respectively.
As a percentage of total revenues, general and administrative expenses
increased to 12.0% in the first nine months of 1999 from 11.5% in the first nine
months of 1998. General and administrative expenses increased 30.1% to $48.4
million during the first nine months of 1999 from $37.2 million during the first
nine months of 1998. The increase in general and administrative expenses was due
primarily to the larger scale of operations, investments made in the Company's
infrastructure relating to the transition to Club Sunterra, additions of middle
and senior management, acquisition of additional resorts, and Y2K expenses.
Depreciation and amortization increased $3.0 million, or 38.0%, to $10.9
million in the first nine months of 1999 from $7.9 million in the first nine
months of 1998. As a percentage of revenues, depreciation and amortization
increased to 2.7% for the first nine months of 1999 from 2.4% during the first
nine months of 1998. The increase in depreciation and amortization was driven by
the amortization of goodwill associated with the Company's Sunterra Pacific,
Global and HTD Acquisitions as well as additional depreciation expense
reflecting a larger base of depreciable assets from the prior year period.
Interest expense, net of capitalized interest, increased $0.9 million, to
$35.1 million for the first nine months of 1999 from $34.2 million for the first
nine months of 1998. The increase was due primarily to increases in debt from
public securities offerings and from the Company's privately placed, on-balance
sheet asset-backed securitization issued in June 1998, offset by higher
capitalized interest.
Income before provision for income taxes and extraordinary item increased
30.5% to $67.2 million in the first nine months of 1999 from $51.5 million in
the first nine months of 1998.
The Company's income tax rate was 39% for both the nine month periods ended
September 30, 1999 and 1998, resulting in net income of $41.0 million for the
nine months ended September 30, 1999, a 31.0% increase over $31.3 million for
the nine months ended September 30, 1998.
Year 2000
Background
The Company uses software that will be affected by the date change in the
year 2000 and recognizes that the arrival of the year 2000 poses challenges that
will require modifications of portions of its software to enable it to function
properly. As the year 2000 approaches, date sensitive systems may recognize the
year 2000 as 1900, or not at all. This may cause systems to process critical
financial and operational information incorrectly. This is generally referred to
as the Year 2000 issue. If this situation occurs, the potential exists for
computer system failures or miscalculations by computer programs, which could
disrupt operations.
APPROACH
The Company has named a Year 2000 project manager, reporting to the
Company's Vice President and Chief Information Officer, to coordinate the
Company's response to the Year 2000
11
<PAGE>
issue. The Company has established a Year 2000 program office at its
headquarters in Orlando, Florida, to handle all customer requests for
compliance, survey, and other general information related to its Year 2000
programs. The Company has initiated a Year 2000 project (the "Project") designed
to identify and assess the risks associated with its information systems,
products, operations and infrastructure, suppliers and customers that are not
Year 2000 compliant, and to develop, implement, and test remediation and
contingency plans to mitigate these risks throughout the Company's offices and
resort locations.
STATUS
As part of an enterprise-wide process, the Company has begun integrating
resorts to a common platform. The Company is replacing a substantial portion of
its existing information systems with a fully integrated, enterprise information
system. The vendor of the financial portion of this system has not warranted it
to be Year 2000 compliant. Testing completed to date indicates the application
will continue to function correctly on and after January 1, 2000.
During the third quarter, the Company completed remediation of the seven
mission critical applications previously identified as non-compliant. Six
successfully passed regression testing and the seventh is currently undergoing
final Y2K regression testing and is expected to be completed before November 30,
1999. The application under analysis at the end of the second quarter was found
to be compliant.
The mission critical facility inventory, such as air conditioners and
health and safety items, have been identified for the resorts. The Company
completed re-certification of manufacturers' Year 2000 disclosure statements for
97% of these items. The Company expects to retire, replace or upgrade the
remaining 3% before November 30, 1999.
It is the Company's goal to have the Project completed for mission critical
systems by December 30, 1999. Based upon the analysis conducted to date, the
Company believes the mission critical systems at the Company's offices and
resort locations will be compliant by December 30, 1999.
The Company is in the process of standardizing its platform with regard to
its hardware and desktop technology. The Company has upgraded or purchased
replacements for approximately 8% of its PCs that were identified with potential
of encountering Y2K-related failures.
The Year 2000 project encompasses the following phases:
PHASE 1 -- PLANNING AND AWARENESS
The Company has defined Year 2000 compliance and developed a project plan
and budget to provide organizational awareness of Year 2000 compliance,
globally. The Year 2000 Office provides monthly progress reports to the
Company's senior management and ongoing communication throughout and across all
business units. This phase is complete.
PHASE 2 - INVENTORY
In the Inventory Phase, the Company established a Year 2000 repository,
which contains mission critical automated systems or inventory elements and
electronic partners and interfaces. The Company has assessed known business and
technical risks associated with identified systems and inventory elements
assessed to date. The Company completed the capture and assessment of additional
mission critical facility inventory in the third quarter. This phase is
complete.
PHASE 3 -- DETAILED ASSESSMENT
The Company believes the facility items identified to date as non-compliant
are minimal to the overall business operations and customer satisfaction. The
assessment process of whether or not to repair, replace or retire the specific
affected systems was completed in the
12
<PAGE>
third quarter. The Company completed the assessment of their electronic
partnerships with external vendors. This phase is complete.
PHASE 4 - RESOLUTION
In this phase, the Company will continue to implement resolution decisions
and define system level go/no go decision criteria. The Company completed the
resolution phase of its non-compliant applications. Repairs, upgrades or
replacements of non-compliant facility equipment is expected to be complete by
November 30, 1999.
PHASE 5 - TEST PLANNING
The Company has established a Year 2000 Purchasing Policy and Change
Management process to reduce non-compliant solutions from reaching production
operations. Test planning has been completed for known mission critical
applications. As part of the testing methodology for internal applications, the
Company tests for critical dates such as, but not limited to, December 31, 1999,
January 1, 2000, January 3, 2000, and February 29, 2000. In addition, scripts
are executed in a test environment, which reflects the years 1999, 2000 and
2004.
The Company has formulated its company wide contingency plans to mitigate
any potential business disruptions. Individual business units are currently
reviewing additional requirements as applicable to their areas. The selection of
action will depend on the criticality of the inventory element or system and
available solution alternatives. The anticipated completion date of the plan is
November 30, 1999.
PHASE 6 -- TEST EXECUTION
The Year 2000 office established a formal mirror test environment to test
for compliance and if necessary, conduct regression testing. Included in this
phase is the involvement of end users in test execution and user signoff for
each compliant application. The Company completed electronic testing with its
third party vendors and electronic partners. One application is currently
undergoing regression testing. Anticipated completion date for this phase is
November 30, 1999.
PHASE 7 - DEPLOYMENT
This phase involves deploying systems into the production environment,
staging appropriate bridges and data conversion for deployment, verifying that
contingency plans are in place, coordination with third parties and electronic
partners and executing final system validation. Six of the seven remediated
systems have been deployed through the standard change control process. The
remaining application is expected to undergo deployment by November 30, 1999.
PHASE 8 -- FOLLOW-UP
In the Follow-up Phase, the Company intends to regulate continued Year 2000
compliance throughout its worldwide operations and develop procedures to
minimize the impact of compliance efforts on its business operations.
COSTS
The Company expects that the expenditures relating to Year 2000 issues will
be funded from operating cash flows and will not exceed the established budget
of $2.75 million. To date, the Company has incurred approximately $1.4 million
in costs associated with Year 2000 issues. The preliminary estimate of costs
includes administrative expenses, testing, and hardware/software/facility
replacement costs. The Company will capitalize and depreciate the cost of any
replacement equipment and software over the expected useful life of the assets.
The Company is expensing as incurred all costs related to software modification,
as well as all costs associated with the Company's administration of the
Project. Costs of remediation and/or replacement related to equipment and
systems owned by the various homeowners' associations for which the Company is
the manager will be borne by those homeowners' associations.
13
<PAGE>
RISKS
The Company utilizes computer systems in many aspects of its business and
is continuing to evaluate Year 2000-related risks and to design and implement
corrective actions. The risks associated with the Year 2000 problem are complex
and can be difficult to identify and to address. Even if the Company, in a
timely manner, completes all of its assessments, identifies and tests plans it
believes to be adequate, and develops contingency plans believed to be adequate,
some problems may not be identified or corrected in time to prevent material
adverse consequences to the Company.
The Project is currently in the Testing, Resolution and Deployment phases.
The Company believes that its greatest potential risks for Year 2000 issues are
associated with its information systems and systems embedded in its operations
and infrastructure. The Company has completed its assessments and determined
resolutions for non-compliant systems. However, the Company has not completed
deployment and final contingency planning. The Company is not yet in a position
to state the total cost of remediation of all Year 2000 issues. As the Year 2000
project continues, the Company may discover additional Year 2000 problems, may
not be able to develop, implement, or test remediation or contingency plans, or
may find that the costs of these activities exceed current expectations and
become material. While the worst case scenario entails the loss of one or more
of its mission critical applications, the Company has backup systems that do not
require computer applications.
In many cases, the Company is relying on assurances from vendors and
service providers that their systems will be Year 2000 compliant. The Company is
exposed to the risk that one or more of its vendors or service providers could
experience Year 2000 problems that impact the ability of such vendor or service
provider to provide goods and services. To date, the Company is not aware of any
vendor or service provider Year 2000 issue that the Company believes would have
a material adverse impact on the Company's operations. The Company requested Y2K
disclosures from its mission critical vendors of which 70% provided Y2K
readiness statements. The Company is pursuing Y2K disclosures of the remaining
30%, however, the Company has no means of insuring that those vendors or service
providers will respond or be Year 2000 ready. Although the Company is not aware
of any vendor or service provider that is not ready for the Year 2000, the
inability of vendors or service providers to complete their Year 2000 resolution
processes in a timely manner could materially adversely affect the Company's
business or results of operations.
Widespread disruptions in the national or international economy, including
disruptions affecting the financial markets, or certain industries such as
commercial or investment banks, resulting from Year 2000 issues, could also have
a material adverse impact on the Company. The likelihood and effect of such
disruptions is not determinable at this time.
The foregoing information concerning Year 2000 matters is as of September
30, 1999.
Readers are cautioned that forward-looking statements contained in this
Year 2000 discussion should be read in conjunction with the Company's
disclosures regarding forward-looking statements contained in the final
paragraph of Management's Discussion and Analysis of Financial Condition and
Results of Operations.
LIQUIDITY AND CAPITAL RESOURCES
The Company generates cash from (i) cash sales and cash down payments from
sales of Vacation Interests,(ii)sales of the Company's mortgages receivable
through its Conduit Facility, asset-backed securitizations or whole loan sales ,
(iii) hypothecation of its mortgages receivable through its Senior Bank Credit
Facility or other lines of credit, (iv) principal payments and customer
prepayments of principal from its mortgages receivable portfolio, (v) interest
from its mortgages receivable portfolio, (vi)rental of unsold Vacation
Interests, and (vii) receipt of management, reservations and points-based
vacation club fees.
14
<PAGE>
For the nine months ended September 30, 1999, cash provided by operations
was $25.1 million, compared to cash used in operations of $29.1 million for the
nine months ended September 30, 1998. Excluding investment in real estate and
development costs of $105.6 million and $126.1 million, respectively, cash
provided by operations was $130.7 million for the nine months ended September
30, 1999, compared to cash provided by operations of $97.0 million for the nine
months ended September 30, 1998.
During the third quarter of 1999, the Company continued its program of
monetizing mortgages receivable through the use of off-balance sheet conduits,
securitizations, and other vehicles. The Company sold $108.1 million of
mortgages receivable through the Conduit Facility in the first nine months of
1999. During the three year term of the Conduit Facility, the Company intends to
sell mortgages receivable through a wholly-owned special purpose entity at 95%
of face value. The Company then retains 100% of the excess spread over the
commercial paper rate plus 0.60%. These sales will be without recourse to the
Company for defaults experienced by the mortgages receivable portfolios. The
Company also sold $17.8 million of gross mortgages receivable for $17.0 million
in cash in five separate transactions. The Company sold these receivables at 97%
of par value with a 50% participation in the remaining interest spread.
In May 1999, the Company completed the securitization of $100 million
principal amount of its Vacation Ownership Receivables-Backed Notes 1999-A (the
"1999-A Securitization"). These fixed rate Notes were issued at 94% of the
$106.8 million outstanding mortgages receivable principal balances, bear
interest at a weighted average rate of 6.66%, and are without recourse to
Sunterra. Included in the 1999-A Securitization were $90.6 million mortgages
receivable which had been previously sold into the Company's off-balance sheet
Conduit Facility during the fourth quarter of 1998 or the first quarter of 1999.
The securitization generated approximately $97 million in cash (after funding a
reserve account and paying transaction expenses), which Sunterra used to repay
amounts outstanding on the $100 million Conduit Facility and the $117.5 million
Senior Bank Credit Facility.
In September 1999, the Company closed a $15 million facility to finance its
pre-sale notes and certain of its mortgages receivable (the "Pre-Sale/Unseasoned
Line"). Additionally, in September 1999, the Company closed a $50 million
facility to finance certain of its inventory (the "Inventory Line"). There were
no borrowings under the Inventory Line in the third quarter of 1999.
As of September 30, 1999 the Company had approximately $96.2 million
available on its Senior Bank Credit Facility, $20.4 million on its Conduit
Facility, $7.8 million available on its Pre-Sale/Unseasoned Line and $50 million
available on its Inventory Line. The Company also had available approximately
$221.4 million of unencumbered mortgages receivable.
During the first nine months of 1999, the Company spent $38.5 million for
property and equipment, primarily for the development of computer systems for
property and Club Sunterra management systems; and $105.6 million for expansion
and development activities at the Company's resort locations. The Company funded
these activities through (i) an increase of $32.6 million in notes payable, (ii)
borrowings on the Senior Bank Credit Facility and the Pre-Sale/Unseasoned Line,
(iii) the sale of $142.1 million of mortgages receivable. The Company expects to
incur approximately $31.3 million over the remainder of 1999 on real estate and
development projects. However, the Company has not made any binding commitments
for such planned construction beyond the projects on which it has currently
initiated development.
The Company believes that, with respect to its current operations, the
Senior Bank Credit Facility, the Conduit Facility and other lines of credit,
together with cash on hand and cash generated from operations, future
borrowings, or the sale or securitization of receivables, will be sufficient to
meet the Company's working capital and capital expenditure needs for the next
twelve months. However, depending upon conditions in the capital and other
financial markets, the Company's growth, development and expansion plans, and
other factors, the Company may from time to time consider the issuance of other
debt or equity securities, the proceeds of which would be used to finance
acquisitions, refinance debt, finance mortgages receivable or meet other
operational needs. Any debt incurred or issued by the Company may be secured or
unsecured, may bear interest at fixed or variable rates and may be subject to
such terms, as management deems prudent. As of September 30, 1999, the Company
was in compliance with all applicable covenants in its debt agreements.
The indentures for the Company's Senior notes and Senior Subordinated Notes
contain certain covenants that, among other things, limit and/or condition the
ability of the Company
15
<PAGE>
and its related subsidiaries to (i) incur additional indebtedness, (ii) pay
dividends or make other distributions with respect to capital stock of the
Company and its restricted subsidiaries, (iii) create certain liens, (iv) sell
certain assets of the company or its restricted subsidiaries and (v) enter into
certain mergers and consolidations. In addition, certain of the Company's Senior
Indebtedness, contain other and more restrictive covenants that, among other
things, restrict and/or condition the following: the making of investments,
loans, and advances and the paying of dividends and other restricted payments;
the incurrence of additional indebtedness; the granting of liens, other than
certain permitted liens; mergers, consolidations and sales of all or a
substantial part of the company's business or property; the sales of assets; and
the making of capital expenditures.
Certain of the Company's Senior Indebtedness, including the Senior Credit
Facility, also require the Company to maintain certain financial ratios,
including interest coverage, leverage and fixed charge ratios.
The preceding discussion should be read in conjunction with the financial
statements and notes included elsewhere in this Form 10-Q. The preceding
Management's Discussion and Analysis of Financial Condition and Results of
Operations may contain forward looking statements, which include the Company's
growth and expansion plans, financing plans, future prospects and other
forecasts and statements of expectations. Although management believes these
statements are based on reasonable assumptions, actual results may differ
materially from those expressed in any of our forward looking statements due to,
among other things, factors related to the timing and terms of future
acquisitions and the introduction of Club Sunterra, mortgages receivable
financing, integration of acquired operating companies and resort properties,
future acquisitions and other factors identified in the Company's filings with
the Securities and Exchange Commission, including those set forth in Parts I and
II of the Company's Annual Report on Form 10-K for the year ended December 31,
1998 and in the Company's Current Reports on Forms 8-K filed in 1999.
ITEM 3 - QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Foreign Currency Risk
The Company's total revenues denominated in a currency other than U.S.
dollars for the nine months ended September 30, 1999 (primarily revenues derived
from the United Kingdom and Japan) were approximately 21% of total revenues. The
Company's net assets maintained in a functional currency other than U.S. dollars
at September 30, 1999 (primarily assets located in western Europe and Japan)
were approximately 10% of total net assets. The effects of changes in foreign
currency exchange rates has not historically been significant to the Company's
operations or net assets.
Interest Rate Risk
As of September 30, 1999, the Company had fixed interest rate debt of
approximately $556.7 million and floating interest rate debt of approximately
$78.8 million. The floating interest rates are based upon the prevailing LIBOR
rate of the prevailing prime interest rate for the Company's Senior Bank Credit
Facility and endpaper debt, respectively. For floating rate debt, interest rate
changes do not generally affect the market value of debt but do impact future
earnings and cash flows, assuming other factors are held constant. Conversely,
for fixed rate debt, interest rate changes do affect the market value of debt
but do not impact earnings or cash flows. A hypothetical one-percentage change
in the prevailing LIBOR, prime or commercial paper rate would impact after-tax
earnings of the Company by less than $0.5 million per year. A similar change in
the interest rate would impact the total fair value of the Company's fixed rate
debt, excluding the Convertible Notes, by approximately $21.2 million. The
conversion feature to Common Stock makes it impractical to estimate the effect
of a change in interest rates on the Company's Convertible Notes. There is a
high correlation between the fair value of the Convertible Notes and the
Company's Common Stock.
16
<PAGE>
PART II -- OTHER INFORMATION
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
27 Financial Data Schedule.
(b) Reports on Form 8-K
Current Report on Form 8-K, dated August 5, 1999 filed with the
Securities and Exchange Commission on August 11, 1999, announcing the
Company's second quarter 1999 results.
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.
SUNTERRA CORPORATION
BY: /s/ RICHARD GOODMAN
----------------------------
Richard Goodman
Executive Vice President,
And Chief Financial Officer
(Principal Financial Officer)
Dated: November 13, 1999
17
<PAGE>
EXHIBIT INDEX
EXHIBIT NO. DESCRIPTION
- ---------- ------------
27 Financial Data Schedule
<TABLE> <S> <C>
<ARTICLE> 5
<S> <C>
<PERIOD-TYPE> 9-MOS
<FISCAL-YEAR-END> DEC-31-1999
<PERIOD-START> JAN-01-1999
<PERIOD-END> SEP-30-1999
<CASH> 46,436
<SECURITIES> 0
<RECEIVABLES> 347,397
<ALLOWANCES> 22,240
<INVENTORY> 355,727
<CURRENT-ASSETS> 0
<PP&E> 116,338
<DEPRECIATION> 0
<TOTAL-ASSETS> 1,099,814
<CURRENT-LIABILITIES> 0
<BONDS> 478,000
0
0
<COMMON> 359
<OTHER-SE> 294,707
<TOTAL-LIABILITY-AND-EQUITY> 1,099,814
<SALES> 326,550
<TOTAL-REVENUES> 401,932
<CGS> 81,725
<TOTAL-COSTS> 231,612
<OTHER-EXPENSES> 60,825
<LOSS-PROVISION> 7,122
<INTEREST-EXPENSE> 35,131
<INCOME-PRETAX> 67,242
<INCOME-TAX> 26,224
<INCOME-CONTINUING> 41,018
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 41,018
<EPS-BASIC> 1.14
<EPS-DILUTED> 1.09
</TABLE>
