- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
UNITED STATES
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 MARCH 31, 1999
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 NO. 000-21193
---------------
SUNTERRA CORPORATION
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
MARYLAND 95-4582157
(STATE OF INCORPORATION) (I.R.S. EMPLOYER
IDENTIFICATION NUMBER)
1781 PARK CENTER DRIVE
ORLANDO, FLORIDA 32835
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES, INCLUDING ZIP CODE)
TELEPHONE (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 each of the issuer's
Common stock, par value $.01 per share as of May 12, 1999: 35,930,130.
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
<PAGE>
SUNTERRA CORPORATION
INDEX
PAGE
----
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
Consolidated Statements of Income for the three months ended
March 31, 1999 and March 31, 1998 .............................. 3
Consolidated Balance Sheets as of March 31, 1999 and
December 31, 1998 .............................................. 4
Consolidated Statements of Cash Flows for the three months ended
March 31, 1999 and March 31, 1998 .............................. 5
Notes to the Consolidated Financial Statements ................... 6
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations ...................................... 10
Item 3. Quantitative and Qualitative Disclosures about Market Risk ....... 19
PART II. OTHER INFORMATION
Item 6. Exhibits and Reports on Form 8-K ................................. 20
Signatures ................................................................. 21
2
<PAGE>
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
SUNTERRA CORPORATION
CONSOLIDATED STATEMENTS OF INCOME
THREE MONTHS ENDED MARCH 31, 1999 AND 1998
(AMOUNTS IN THOUSANDS EXCEPT SHARE AND PER SHARE DATA, UNAUDITED)
<TABLE>
<CAPTION>
THREE MONTHS ENDED
MARCH 31,
-------------------------------
1999 1998
-------------- --------------
<S> <C> <C>
REVENUES:
Vacation Interests sales .............................................. $ 92,561 $ 71,487
Interest income ....................................................... 11,339 12,075
Gain on sales of mortgages receivable ................................. 1,597 --
Other income .......................................................... 8,788 6,187
------------ ------------
Total revenues ...................................................... 114,285 89,749
------------ ------------
COSTS AND OPERATING EXPENSES:
Vacation Interests cost of sales ...................................... 22,452 17,456
Advertising, sales and marketing ...................................... 42,670 33,727
Loan portfolio:
Provision for doubtful accounts ..................................... 2,290 2,300
Other expenses ...................................................... 897 1,116
General and administrative ............................................ 15,050 12,191
Depreciation and amortization ......................................... 3,413 2,098
------------ ------------
Total costs and operating expenses .................................. 86,772 68,888
------------ ------------
Income from operations ................................................ 27,513 20,861
Interest expense, net of capitalized interest of $2,456 and
$1,653 in 1999 and 1998, respectively ............................... 12,090 9,165
Equity gain on investment in joint ventures ........................... (1,013) (241)
Minority interest in loss of consolidated limited partnership ......... (10) --
------------ ------------
Income before provision for income taxes ............................ 16,446 11,937
Provision for income taxes ............................................ 6,414 4,656
------------ ------------
Net income ........................................................... $ 10,032 $ 7,281
============ ============
EARNINGS PER SHARE:
Basic: ................................................................ $ 0.28 $ 0.20
Diluted: .............................................................. $ 0.27 $ 0.20
Weighted average number of common shares outstanding ................. 35,908,000 $35,875,000
Weighted average number of common and potentially dilutive
common shares outstanding .......................................... 40,986,000 36,665,000
</TABLE>
The accompanying notes are an integral part
of these consolidated financial statements.
3
<PAGE>
SUNTERRA CORPORATION
CONSOLIDATED BALANCE SHEETS
(AMOUNTS IN THOUSANDS EXCEPT SHARE AND PER SHARE DATA)
<TABLE>
<CAPTION>
MARCH 31, DECEMBER 31,
1999 1998
------------- -------------
(UNAUDITED)
<S> <C> <C>
ASSETS
Cash and cash equivalents ......................................... $ 32,240 $ 28,250
Cash in escrow and restricted cash ................................ 43,628 25,951
Mortgages receivable, net of an allowance of $23,518 and $22,869 at
March 31, 1999 and December 31, 1998, respectively .............. 344,524 335,982
Retained interests ................................................ 17,053 12,518
Due from related parties .......................................... 24,097 25,849
Other receivables, net ............................................ 38,060 38,207
Prepaid expenses and other assets ................................. 23,365 22,031
Investment in joint ventures ...................................... 18,933 17,876
Real estate and development costs ................................. 341,012 336,620
Property and equipment, net ....................................... 95,517 81,125
Intangible assets, net ............................................ 96,066 96,723
---------- ----------
Total assets ................................................... $1,074,495 $1,021,132
========== ==========
LIABILITIES AND STOCKHOLDERS' EQUITY
Accounts payable .................................................. $ 22,452 $ 21,864
Accrued liabilities ............................................... 89,684 80,242
Income taxes payable .............................................. 11,154 9,240
Deferred taxes .................................................... 32,364 30,984
Notes payable ..................................................... 658,072 627,089
---------- ----------
Total liabilities .............................................. 813,726 769,419
---------- ----------
Stockholders' equity:
Preferred stock (25,000,000 shares authorized;
none issued or outstanding) ..................................... -- --
---------- ----------
Common stock ($.01 par value,50,000,000 shares authorized;
35,908,671 and 35,902,671 outstanding at March 31, 1999 and
December 31, 1998, respectively) ................................ 359 359
Additional paid-in capital ........................................ 163,346 163,290
Unrealized gain on available for sale securities .................. 1,534 --
Retained earnings ................................................. 96,613 86,581
Accumulated other comprehensive (loss) income ..................... (1,083) 1,483
---------- ----------
Total stockholders' equity ..................................... 260,769 251,713
---------- ----------
Total liabilities and stockholders' equity ..................... $1,074,495 $1,021,132
========== ==========
</TABLE>
The accompanying notes are an integral part
of these consolidated financial statements.
4
<PAGE>
SUNTERRA CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
(AMOUNTS IN THOUSANDS, UNAUDITED)
<TABLE>
<CAPTION>
THREE MONTHS ENDED
MARCH 31,
--------------------------
1999 1998
------------ -----------
<S> <C> <C>
OPERATING ACTIVITIES:
Net income ............................................................... $ 10,032 $ 7,281
Adjustments to reconcile net income to net cash
provided by (used in) operating activities:
Depreciation and amortization ........................................... 3,413 2,098
Provision for doubtful accounts ......................................... 2,290 2,300
Amortization of capitalized financing costs ............................. 1,057 456
Equity gain on investment in joint ventures ............................. (1,013) (241)
Minority interest in loss of consolidated limited partnership ........... (10) --
Gain on sales of mortgages receivable ................................... (1,597) --
Proceeds from sales of mortgages receivable ............................. 21,348 --
Changes in operating assets and liabilities:
Cash in escrow and restricted cash ....................................... (17,677) (2,469)
Mortgages receivable ..................................................... (35,031) (17,866)
Due from/to related parties .............................................. 1,752 (2,315)
Prepaid expenses and other assets ........................................ (1,334) (6,619)
Real estate and development costs ........................................ (9,142) (38,102)
Retained interests ....................................................... (373) --
Other receivables, net ................................................... 2,915 (4,335)
Accounts payable and accrued liabilities ................................. 9,861 (2,807)
Income taxes payable ..................................................... 1,914 4,398
Deferred taxes ........................................................... 1,380 --
--------- ---------
Net cash used in operating activities ..................................... (10,215) (58,221)
--------- ---------
INVESTING ACTIVITIES:
Cash paid for acquisition of subsidiaries ................................ -- (18,850)
Property and equipment ................................................... (12,008) (8,697)
Intangible assets ........................................................ (1,917) (6,068)
Investment in joint ventures ............................................. (44) --
--------- ---------
Net cash used in investing activities .................................... (13,969) (33,615)
--------- ---------
FINANCING ACTIVITIES:
Proceeds from notes payable .............................................. 28,395 1,529
Payments on notes payable ................................................ (13,212) (15,503)
Proceeds from Senior Bank Credit Facility, net of debt issuance costs .... 17,501 96,297
Payments on Senior Bank Credit Facility .................................. (2,000) --
Other .................................................................... 56 181
--------- ---------
Net cash provided by financing activities ................................. 30,740 82,504
--------- ---------
Net increase (decrease) in cash equivalents ............................... 6,556 (9,332)
Effect of exchange rates on cash and cash equivalents ..................... (2,566) (203)
Cash and cash equivalents, beginning of period ............................ 28,250 38,487
--------- ---------
Cash and cash equivalents, end of period .................................. $ 32,240 $ 28,952
========= =========
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Cash paid for interest .................................................... $ 7,113 $ 6,804
Cash paid for taxes, net of tax refunds ................................... $ 2,902 $ 258
</TABLE>
The accompanying notes are an integral part
of these consolidated financial statements.
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 residence, generally
for a one-week period each year in perpetuity ("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 at its resort locations and off-site
sales centers and (iv) providing rental management and maintenance services for
which it receives fees paid by the resorts' homeowners' associations.
In the third quarter of 1998, the Company began introducing Club Sunterra
to its sales centers on a resort-by-resort basis, which is anticipated to be
fully implemented at all wholly-owned Sunterra resorts by the end of 1999. Club
Sunterra is a new points-based vacation ownership system, enabling members to
vacation at any resort in the Club Sunterra network by utilizing their annual
allotment of points ("SunOptions") as a vacation currency. The Company also
offers points-based vacation ownership systems in North America through the
Vacation Time Share Program (the "VTS Program"), in Europe through the Grand
Vacation Club ("GVC") and in Japan through Sunterra Japan Vacation Club
("SJVC").
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 three months ended March 31, 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
6
<PAGE>
SUNTERRA CORPORATION
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
NOTE 2 -- EARNINGS PER SHARE--(CONTINUED)
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 months ended March 31, 1999 and 1998:
<TABLE>
<CAPTION>
THREE MONTHS ENDED
MARCH 31,
----------------------
1999 1998
---------- ---------
(AMOUNTS IN THOUSANDS)
<S> <C> <C>
Net income ............................................... $10,032 $7,281
Interest on convertible bonds, net of taxes(a) ........... 1,210 --
------- ------
Net income available to common stockholders after
assumed conversion of dilutive securities(a) ........... $11,242 $7,281
======= ======
Weighted average number of common shares used
in basic EPS ........................................... 35,908 35,875
Effect of dilutive convertible bonds(a) .................. 4,537 --
Effect of dilutive stock options ......................... 541 790
------- ------
Weighted average number of common shares and dilutive
potential common shares used in diluted EPS(a) ......... 40,986 36,665
======= ======
</TABLE>
- ----------------
(a) The potential effect on net income and on common stock shares related to
the Company's 53/4% Convertible Subordinated Notes due 2007 have not been
included in the calculation of net income or weighted average number of
common shares and dilutive potential common shares outstanding used in
diluted EPS for the three months ended March 31, 1998 because the effect
would be anti-dilutive. 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.
NOTE 3 -- SALES OF MORTGAGES RECEIVABLE
During the first quarter of 1999, the Company sold $25.9 million of
mortgages receivable as part of its $100.0 million Mortgage Receivable Conduit
Facility ("Conduit Facility"). 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. The Company then retains 100% of
the excess spread over the commercial paper rate plus 0.60%.
The Company recognized a gain on the sale of mortgages receivable of $1.6
million, net of expenses, as a result of the $25.9 million sale and a retained
interest held for sale in these mortgages receivable of $3.8 million. The
retained interest was valued by the Company assuming a 6% default rate (net of
recoveries), a 15% prepayment rate, an 18% discount rate, a 2.5% interest rate
on the required reserve account, and a 7.0% annual interest rate on the monthly
balance of the financing. In addition, the receivables had a 9.0
7
<PAGE>
SUNTERRA CORPORATION
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
NOTE 3 -- SALES OF MORTGAGES RECEIVABLE--(CONTINUED)
year weighted average remaining life and a weighted average interest rate of
15.0%. The retained interest is classified as held for sale based on
management's intent and the existence of prepayment options.
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 (amounts in thousands):
<TABLE>
<CAPTION>
THREE MONTHS ENDED
MARCH 31,
----------------------
1999 1998
---------- ---------
<S> <C> <C>
Net income ............................................... $ 10,032 $7,281
Unrealized gain on available for sale securities ......... 1,534 --
Foreign currency translation adjustments ................. (2,566) (203)
-------- ------
Total comprehensive income ............................. $ 9,000 $7,078
======== ======
</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 of the United
States include Mexico, Canada, Netherlands Antilles, United Kingdom, Japan,
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.
8
<PAGE>
SUNTERRA CORPORATION
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
NOTE 5 -- SEGMENT AND GEOGRAPHIC INFORMATION--(CONTINUED)
Information about the Company's operations in different geographic
locations is shown below (amounts in thousands):
<TABLE>
<CAPTION>
UNITED STATES FOREIGN TOTAL
--------------- --------- ------------
<S> <C> <C> <C>
Three months ended March 31, 1999
Total revenues ................................... $ 87,091 $27,194 $ 114,285
Income before provision for income taxes ......... 12,597 3,849 16,446
Identifiable assets .............................. 993,805 80,690 1,074,495
Three months ended March 31, 1998
Total revenues ................................... $ 68,064 $21,685 $ 89,749
Income before provision for income taxes ......... 9,466 2,471 11,937
Identifiable assets .............................. 795,018 64,134 859,152
</TABLE>
NOTE 6 -- SUBSEQUENT EVENT
On May 5, 1999, the Company announced the completion of 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. The securitization generated approximately $97 million in
cash (after funding a reserve account and paying transaction expenses), which
Sunterra used to immediately repay amounts outstanding on the Company's $100
million Conduit Facility and $117.5 million Senior Bank Credit Facility.
Immediately following the securitization, total availability on these two
facilities increased to $179 million.
The Company expects the 1999-A Securitization to result in a gain on the
sale of the mortgages receivable of approximately $0.01 per diluted share in
the second quarter of 1999. This reflects that all but $16 million of the
mortgages receivable in the 1999-A Securitization had been previously sold into
the Company's Conduit Facility during the fourth quarter of 1998 and in the
first quarter of 1999 -- generating gains of $0.08 per share and of $0.02 per
share in the fourth quarter of 1998 and first quarter of 1999, respectively.
9
<PAGE>
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
COMPARISON OF THE THREE MONTHS ENDED MARCH 31, 1999 TO THE
THREE MONTHS ENDED MARCH 31, 1998
Total revenues for the three months ended March 31, 1999 were $114.3
million compared with $89.7 million in the three months ended March 31, 1998,
an increase of $24.6 million, or 27%. Vacation Interests sales increased 29% in
the first quarter of 1999, to $92.6 million from $71.5 million in the first
quarter of 1998. The increase in Vacation Interests sales reflects increased
prices for Vacation Interests at the Company's resorts, increased sales
activities at certain of the Company's resorts, and the recording of Vacation
Interests sales resulting from the HTD Acquisition, which was consummated in
July 1998.
Included in Vacation Interests sales in 1999 are approximately $16.7
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 decreased 6% to $11.3 million in the first quarter of 1999
from $12.1 million in the first quarter of 1998, reflecting the decrease in net
mortgages receivable to $344.5 million at March 31, 1999, from $354.4 million
at March 31, 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 quarter of 1999, the Company recorded a $1.6 million
pre-tax gain on the sale of $25.9 million mortgages receivable into the Conduit
Facility. During the three-year term of the Conduit Facility, the Company will
sell mortgages receivable through a wholly-owned special purpose entity at 95%
of face value without recourse. On these sales, the Company will pay interest
at the commercial paper rate plus 0.60% and retain 100% interest in the excess
spread. The Company did not sell mortgages receivable during the first quarter
of 1998.
Other income, which includes resort management and rental fees, increased
42% during the first quarter of 1999 to $8.8 million from $6.2 million in the
first quarter of 1998, reflecting: substantial 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 the consumers' purchase of
Vacation Interests in Europe. Other income was 7.7% of total revenues for the
first quarter of 1999, compared with 6.9% in the first quarter of 1998.
As a percentage of total revenues, total costs and operating expenses
improved to 76% during the first quarter of 1999 from 77% during the first
quarter of 1998. The overall improvement in margins reflects increased
economies of scale, higher-margin sales to current owner families and improving
operations at acquired companies and locations. Total costs and operating
expenses increased 26% to $86.8 million during the first quarter of 1999 from
$68.9 million during the first quarter of 1998.
10
<PAGE>
As a percentage of Vacation Interests sales, Vacation Interests cost of
sales was 24% for both the first quarter of 1999 and the first quarter of 1998.
Vacation Interests cost of sales increased 29% to $22.5 million in the first
quarter of 1999 from $17.5 million in the first quarter of 1998.
As a percentage of Vacation Interests sales, advertising, sales and
marketing expenses improved to 46% during the first quarter of 1999 from 47%
during the first quarter of 1998, reflecting the continued reduction of
advertising, sales and marketing costs at many of the Company's mature resorts,
offset partially by higher startup costs at the Company's more recently
acquired resorts and resorts implementing Club Sunterra. Advertising, sales and
marketing expenses increased 27% to $42.7 million during the first quarter of
1999 from $33.7 million in the first quarter of 1998.
The provision for doubtful accounts was $2.3 million for both the first
quarter of 1999 and the first quarter of 1998. As a percentage of total
revenues, the provision for doubtful accounts was 2.0% for the first quarter of
1999, compared with 2.6% for the first quarter of 1998. This decrease is due to
the reduction of the Company's long term default risk as a result of the $25.9
million of mortgages receivable that were originated and sold in the first
quarter of 1999.
The allowance for doubtful accounts as a percentage of gross mortgages
receivable remained at 6.4% at March 31, 1999, unchanged from December 31,
1998, and up from 6.3% at March 31, 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 March 31, 1999, were 6.8%, as a percentage of gross
mortgages receivable, slightly lower than 6.9% at March 31, 1998.
Other loan portfolio expenses, which are primarily costs incurred in
servicing the Company's loan portfolio, decreased to $0.9 million in the first
quarter of 1999, from $1.1 million in the first quarter of 1998. As a
percentage of total revenues, other loan portfolio expenses were 0.8% for the
first quarter of 1999, compared to 1.2% for the first quarter of 1998.
As a percentage of total revenues, general and administrative expenses
improved to 13.2% in the first quarter of 1999 from 13.6% in the first quarter
of 1998, reflecting the greater efficiencies resulting from the Company's
larger size. General and administrative expenses increased 23% to $15.0 million
during the first quarter of 1999 from $12.2 million during the first quarter of
1998. The increase in general and administrative expenses was due primarily to
the acquisition of additional resorts, Y2K expenses and the implementation of
Club Sunterra in the first quarter of 1999.
Depreciation and amortization increased $1.3 million, or 63%, to $3.4
million in the first quarter of 1999 from $2.1 million in the first quarter of
1998. As a percentage of revenues, depreciation and amortization increased to
3.0% for the first quarter of 1999 from 2.3% during the first quarter of 1998.
The increase in depreciation and amortization was driven by
11
<PAGE>
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,
including hardware and software costs related to the development of the
Company's Club Sunterra and other infrastructure additions.
Interest expense, net of capitalized interest, increased $2.9 million, to
$12.1 million for the first quarter of 1999 from $9.2 million for the first
quarter of 1998. The increase was due primarily to increases in debt from
public securities offerings and borrowings under the Company's Senior Bank
Credit Facility, and from the Company's privately placed, on-balance sheet
asset-backed securitization issued in June 1998.
Income before provision for income taxes increased 38% to $16.4 million in
the first quarter of 1999 from $11.9 million in the first quarter of 1998.
The Company's income tax rate was 39% for both the three month periods
ending March 31, 1999 and 1998, resulting in net income of $10.0 million for
the three months ended March 31, 1999, a 38% increase over $7.3 million for the
three months ended March 31, 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 director, reporting to the Company's
Vice President and Chief Information Officer, to coordinate the Company's
response to the Year 2000 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.
12
<PAGE>
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, RCC, warrants this system to be Year 2000
compliant. In addition the financial applications employed by the Company have
been warranted by Oracle to be Year 2000 Compliant.
The remaining mission critical applications, 7 in total, have undergone
compliance testing. Four applications are considered to be Year 2000 compliant.
Of the remaining three systems, two are undergoing remediation and the other is
being analyzed.
The mission critical facility inventory, such as air conditioners, health
and safety items, has been identified for resorts. The company believes 97% of
all items are Year 2000 compliant. The remaining 3% are expected be retired,
replaced or upgraded before the end of the third quarter 1999.
It is the Company's goal to have the Project completed for mission
critical systems by the third quarter of 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 the third quarter
of 1999.
The Company is in the process of standardizing its platform with regard to
its hardware and desktop technology and therefore does not anticipate any major
hardware or desktop failures. To ensure Year 2000 compliance, the Company has
implemented an inventory-tracking tool.
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 is assessing known business and
technical risks associated with identified systems and has assigned a business
priority to each system or inventory element assessed to date. The inventory
for known mission critical items has been completed. The Company is continuing
to audit its software applications to determine the status of non-mission
critical desktop applications.
PHASE 3 -- DETAILED ASSESSMENT
The Year 2000 Office is identifying and classifying known Year 2000
problems. The Company believes the facility items identified to date as
non-compliant are minimal to the
13
<PAGE>
overall business operations and customer satisfaction. The assessment process
of whether or not to repair, replace or retire the specific affected systems is
in progress. One system supporting property management is in the process of
detailed assessment. Anticipated completion date is June 30, 1999.
PHASE 4 -- RESOLUTION
The Company implements resolution decisions and defines system level go/no
go decision criteria in this phase. The Company will attempt to obtain and
apply any needed commercial off the shelf (COTS) Year 2000 resolution products
and/or develop and execute required customized solutions for any remaining
non-compliant systems. One system supporting contract processing is currently
being remediated. Anticipated completion date for this phase is September 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. In addition, the Company intends to coordinate with third parties
and electronic partner interfaces, formulate contingency plans, and obtain and
construct mirror test environments and data. This will include developing
comprehensive test plans and scripts to facilitate test execution. 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.
PHASE 6 -- TEST EXECUTION
The Year 2000 office established a formal test environment and has
completed Year 2000 compliance testing of its mission critical applications.
The company tests for compliance and if necessary conducts remediation and
integration testing. Included in this phase is the involvement of end users in
test execution and user signoff for each compliant application. Anticipated
completion date for this phase is June 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. All remediated systems will be
deployed through the standard change control process by September 30, 1999.
14
<PAGE>
PHASE 8 -- FOLLOW-UP
In the Follow-up Phase, the Company intends to regulate continued Year
2000 compliance throughout its worldwide operations and intends to develop
procedures to minimize the impact of compliance efforts on its business
operations.
COSTS
The Company has prepared a preliminary estimate of costs with regard to
making its mission critical systems Year 2000 compliant. The Company has
established that the initial sample of non-compliant items was not
representative of total inventory and has therefore reduced the cost estimate
to $2.75 million. The Company expects that expenditures relating to Year 2000
issues will be funded from operating cash flows. To date the Company has
incurred approximately $0.8 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.
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 Inventory, Assessment and Testing phases
and, with respect to certain information systems and products, in the
Resolution Phase. 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 is in the process of
determining the extent of contingency planning that may be required. The
Company has not yet completed its assessments, developed remediation plans for
all problems, developed contingency plans, or completely implemented or tested
any of its remediation plans; therefore, 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
15
<PAGE>
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 is currently identifying and mailing compliance questionnaires to all
mission critical vendors and anticipates this research to be completed by June
1, 1999. However, the Company has no means of ensuring that its vendors or
service providers will be Year 2000 ready. 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.
The foregoing information concerning Year 2000 matters is as of April 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, (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.
For the three months ended March 31, 1999, cash used in operations was
$10.2 million, compared to cash used in operations of $58.2 million for the
three months ended March 31, 1998. Excluding investment in real estate and
development costs of $31.6 million and $55.6 million respectively, the Company
generated cash flows from operations of $21.4 million for the three months
ended March 31, 1999, compared to cash used in operations of $2.6 million for
the three months ended March 31, 1998. Approximately 81% of the Company's total
revenues in the first three months of 1999 were from Vacation Interests sales
during which period the Company financed approximately 65% of its Vacation
Interests sales, with the 35% balance being cash sales. The Company finances
Vacation Interests sales and holds the related mortgages receivable to generate
profit from such financing activities.
As a result of the Company's significant mortgages receivable financing
activity, operating costs exceed the initial cash proceeds received from sales
of Vacation Interests.
16
<PAGE>
Prior to June 1998, this strategy required the Company to increase its levels
of indebtedness on its Senior Bank Credit Facility or other existing revolving
lines of credit.
During 1998, the Company began selling or securitizing its mortgages
receivable. On December 31, 1998, the Company entered into the Conduit
Facility. 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. On these sales, the Company will pay interest at
the commercial paper rate plus 0.60% and retain 100% of the excess interest
spread. These sales will be without recourse to the Company for defaults
experienced by the mortgages receivable portfolios. The Company sold $25.9
million of mortgages receivable through the Conduit Facility in the first
quarter of 1999.
As of March 31, 1999 the Company had approximately $81.9 million available
on its Senior Bank Credit Facility. The Conduit Facility was fully drawn. The
Company also had available approximately $226.3 million of unencumbered
mortgages receivable. 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. The 1999-A Securitization generated approximately $97
million in cash (after funding a reserve account and paying transaction
expenses), which Sunterra used to immediately repay amounts outstanding under
the $100 million Conduit Facility and the $117.5 million Senior Bank Credit
Facility. Immediately following the 1999-A Securitization, total availability
on these two facilities increased to $179 million.
The Company expects the 1999-A securitization to result in a gain on the
sale of the mortgages receivable of approximately $0.01 per diluted share in
the second quarter of 1999. This reflects that all but $16 million of the
mortgages receivable in the 1999-A Securitization had been previously sold into
the Company's off-balance sheet Conduit Facility either during the fourth
quarter of 1998 or in the first quarter of 1999 -- generating gains of $0.08
per share in fourth quarter of 1998 and of $0.02 per share in the first quarter
of 1999.
During the first quarter of 1999, the Company spent: $12.0 million for
property and equipment, primarily for the development of computer systems for
property and Club Sunterra management systems; and $31.6 million for expansion
and development activities at the Company's resort locations. The Company
funded these activities through (i) an increase of $27.3 million in notes
payable, (ii) borrowings on the Senior Bank Credit Facility and (iii) the sale
of $25.9 million of mortgages receivable through the Conduit Facility. The
Company expects to incur approximately $69 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 and the Conduit Facility, together with cash on
hand and cash generated from
17
<PAGE>
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 March 31, 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 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 Bank
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. Actual results might differ
materially from those expressed in any forward looking statements due to, among
other things, factors related to the timing and terms of the Company's new
product development, mortgages receivable financing, integration of acquired
properties and companies, future acquisitions and those factors identified in
the Company's filings with the Securities and Exchange Commission, including
those set forth in the Company's Annual Report on Form 10-K for the year ended
December 31, 1998.
18
<PAGE>
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 three months ended March 31, 1999 (primarily revenues derived
from the United Kingdom and Japan) were approximately 19% of total revenues.
The Company's net assets maintained in a functional currency other than U.S.
dollars at March 31, 1999 (primarily assets located in western Europe and
Japan) were approximately 7% 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 RISKS
As of March 31, 1999, the Company had fixed interest rate debt of
approximately $565.9 million and floating interest rate debt of approximately
$92.2 million. The floating interest rates are based upon the prevailing LIBOR
rate or the prevailing prime interest rate for the Company's Senior Bank Credit
Facility and endpaper debt, respectively. In addition, the Company sold $25.9
million of mortgages receivable through its Conduit Facility. The gain on sale
recognized by the Company is based upon the prevailing commercial paper rates.
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 $0.6 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 $20 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.
19
<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 February 10, 1999, filed with the
Securities and Exchange Commission on February 18, 1999, announcing the
Company's fourth quarter and 1998 year-end results.
20
<PAGE>
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: May 13, 1999
21
<PAGE>
EXHIBIT INDEX
EXHIBIT DESCRIPTION
- ------- -----------
27 Financial Data Schedule
<TABLE> <S> <C>
<ARTICLE> 5
<S> <C>
<PERIOD-TYPE> 3-MOS
<FISCAL-YEAR-END> DEC-31-1999
<PERIOD-END> MAR-31-1999
<CASH> 75,868
<SECURITIES> 0
<RECEIVABLES> 368,042
<ALLOWANCES> 23,518
<INVENTORY> 341,012
<CURRENT-ASSETS> 0
<PP&E> 95,517
<DEPRECIATION> 0
<TOTAL-ASSETS> 1,074,495
<CURRENT-LIABILITIES> 0
<BONDS> 478,000
0
0
<COMMON> 359
<OTHER-SE> 260,410
<TOTAL-LIABILITY-AND-EQUITY> 1,074,495
<SALES> 92,561
<TOTAL-REVENUES> 114,285
<CGS> 22,452
<TOTAL-COSTS> 65,122
<OTHER-EXPENSES> 18,337
<LOSS-PROVISION> 2,290
<INTEREST-EXPENSE> 12,090
<INCOME-PRETAX> 16,446
<INCOME-TAX> 6,414
<INCOME-CONTINUING> 10,032
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 10,032
<EPS-PRIMARY> 0.28
<EPS-DILUTED> 0.27
</TABLE>
