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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20459
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FORM 10-K
(MARK ONE)
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE FISCAL YEAR ENDED DECEMBER 31, 1998
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM TO
COMMISSION FILE NUMBER 000-21193
SUNTERRA CORPORATION
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
MARYLAND 95-458215-7
(STATE OR OTHER JURISDICTION OF (IRS EMPLOYER
INCORPORATION OR ORGANIZATION) IDENTIFICATION NO.)
1781 PARK CENTER DRIVE
ORLANDO, FLORIDA 32835
"WWW.SUNTERRA.COM"
REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE: (407) 532-1000
SECURITIES REGISTERED PURSUANT TO SECTION 12(B) OF THE ACT:
TITLE OF EACH CLASS NAME OF EACH EXCHANGE ON WHICH REGISTERED
Common Stock, par value $0.01 per share New York Stock Exchange
SECURITIES REGISTERED PURSUANT TO SECTION 12(G) OF THE ACT:
None
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 past 90 days. YES [X] NO [ ].
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of Registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K: YES [ ] NO [X].
The aggregate market value of the voting stock held by non-affiliates of the
Registrant based upon the closing sales price of the Common Stock on March 18,
1999, as reported on the New York Stock Exchange, was approximately $274.2
million. At March 18, 1999 there were 35,912,596 shares of the Registrant's
Common Stock outstanding.
DOCUMENTS INCORPORATED BY REFERENCE:
Certain portions of the Registrant's Definitive Proxy Statement, to be filed
with the Securities and Exchange Commission pursuant to Regulation 14A not later
than 120 days after the close of the Registrant's 1998 fiscal year, are
incorporated by reference in part III of this Form 10-K.
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PART I
Unless the context otherwise indicates, the "Company" refers to Sunterra
Corporation (formerly Signature Resorts, Inc.) and includes its corporate and
partnership predecessors and wholly-owned subsidiaries and affiliates including
AVCOM International, Inc. ("AVCOM") and its subsidiaries, which were acquired in
February 1997 (the "AVCOM Acquisition"); Plantation Resorts Group, Inc. ("PRG")
and its subsidiaries, which were acquired in May 1997 (the "PRG Acquisition");
LSI Group Holdings, plc (doing business as Sunterra Europe, "LSI") and its
subsidiaries, which were acquired in August 1997 (the "LSI Acquisition"); Marc
Hotels & Resorts, Inc. ("Marc"), which was acquired in October 1997 (the "Marc
Acquisition"); Sunterra Pacific, Inc. (formerly known as Vacation International,
Ltd.) and its subsidiaries ("Sunterra Pacific"), which were acquired in November
1997 (the "Sunterra Pacific Acquisition"); Global Development Ltd. and certain
of its subsidiaries (the "Global Group"), which was acquired in December 1997
(the "Global Acquisition"); MMG Holding Corporation and its subsidiaries
("MMG"), which were acquired in February 1998 (the "MMG Acquisition"), and
Harich Tahoe Developments and its subsidiaries ("HTD"), which were acquired in
July 1998 (the "HTD Acquisition").
ITEMS 1 AND 2 BUSINESS AND PROPERTIES
THE COMPANY
Sunterra Corporation is the world's largest vacation ownership company, as
measured by resort locations and owner families. Currently, the Company has 89
resort locations in North America, Europe, the Caribbean and Japan. The
Company's resort locations are in a variety of popular vacation destinations,
including California, Hawaii, Arizona, Florida, South Carolina, Virginia, the
Caribbean, Mexico, France, the United Kingdom, Spain, Japan and the Canary
Islands. Through both internal development and strategic acquisitions, the
Company has expanded the number of its resort locations and its owner family
base from nine resort locations and approximately 25,000 owner families at the
time of its August 1996 initial public offering to 87 resort locations and
approximately 240,000 owner families at December 31, 1998. The Company has
acquired interests in two additional resort locations in 1999.
The Company's operations 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 vacation residence, generally for a
one-week period each year in perpetuity ("Vacation Intervals"), and vacation
points which may be redeemed for occupancy rights for varying lengths of stay 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 resort rental, management and
maintenance services for which it receives fees paid by the resorts' homeowners'
associations.
The Company markets Vacation Interests as Sunterra Resorts and offers
points-based vacation ownership systems in North America through Club Sunterra
and 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"). The Company also markets Vacation Intervals at four Embassy Vacation
Resorts ("EVR"), which operate under an agreement with Promus Hotel Corporation
("Promus") and one Westin Vacation Club ("WVC") resort which is operated and
managed by Starwood Hotels and Resorts Worldwide, Inc. ("Starwood").
The Company provides mortgage financing for approximately 65% of its
Vacation Interests sales. In addition to enhancing sales revenues, financing
customer receivables generates attractive profit margins and cash flows from the
spread between interest rates charged by the Company on its mortgages receivable
and the Company's cost of capital. This financing is typically collateralized by
the underlying Vacation Interests.
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RECENT DEVELOPMENTS
Acquisition of Interests in New Resorts. In January 1999, the Company
acquired one resort in Soriano nel Cirino, Italy (approximately 20 minutes
outside of Rome) and entered into a leasing agreement with respect to eight
units located at one resort in Izu, Japan. These resorts will be included in the
GVC and SJVC points-based vacation ownership systems, respectively.
New Management Changes and Organizational Alignment. In January 1999, the
Company announced a realignment of its business units and the consolidation of
management to its Orlando, Florida headquarters. The Company is now organized
under the following six integrated business units, with the heads of each
business unit reporting directly to L. Steven Miller, Chief Executive Officer
and President: Sales; Owner Services; Finance and Administration; Legal;
Sunterra Europe; and Marketing.
The Sales business unit operates under the direction of James E. Noyes,
Executive Vice President -- Sales. Mr. Noyes manages the development and
operation of a fully integrated global sales system designed to maximize the
demand for the Company's resorts.
The Owner Services business unit operates under the direction of Charles C.
Frey, Senior Vice President -- Owner Services. Mr. Frey manages all service
functions related to owners, guests and visitors, including hospitality
management and call center operations (reservation, travel and membership
services), as well as construction for both newly acquired and existing resorts.
The Finance and Administration business unit operates under the direction
of Richard Goodman, Executive Vice President and Chief Financial Officer. Mr.
Goodman manages all finance, treasury, accounting and investor relations
functions, as well as human resources, information technology, risk management
and acquisition and development.
The Legal business unit operates under the direction of Thomas A. Bell,
Senior Vice President and General Counsel. Mr. Bell manages all legal matters,
including shareholder matters, federal filings, legislative developments and
governmental agency relations.
The Sunterra Europe business unit operates under the direction of Richard
Harrington, Managing Director-Sunterra Europe. Mr. Harrington manages all
European operations.
The Marketing business unit is responsible for the development and
commercialization of the Company's brand, products and markets. The Company is
currently evaluating candidates to head the Marketing business unit.
BUSINESS STRATEGY
The Company's business strategy is designed to (i) implement Club Sunterra
and grow its vacation club membership base, (ii) expand its resort network
through development and acquisition, (iii) increase sales through existing and
future resort locations and off-site sales centers, (iv) improve operating
efficiencies and profitability, and (v) expand rental services and property
management businesses.
Club Sunterra. The Company is currently 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 believes
the flexibility of its Club Sunterra product will expand the market for vacation
ownership, as it is designed to evolve with an owner's life style changes, and
enable the Company to target a wider base of new potential customers.
Through Club Sunterra, the Company believes that it has created a superior
product which provides customers with the variety and flexibility they desire in
their vacation experiences. The Company believes Club Sunterra increases the
value of vacation ownership by offering customers a superior product and myriad
of options for vacation planning. Club Sunterra creates an affinity relationship
with the owner base and provides the platform for cross marketing opportunities
for leisure time products and services.
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In addition, the Club Sunterra membership business generates annual
recurring revenues to the Company, which currently are $139 per member per year.
This fee entitles such member to participate in the Club Sunterra vacation
ownership system, including fee-less exchanges within the Club Sunterra resort
network and an annual membership to a third party exchange company for exchanges
outside of the Club Sunterra resort network.
Expand Resort Network. A larger network of resorts provides the Company's
owners, guests and potential customers more vacation choices. With the
implementation of Club Sunterra, a continually expanding network of resorts
provides the Company's current and future owners more options to customize their
vacations.
In addition, the expanded network of resorts will provide a greater base of
resorts to distribute and sell Vacation Interests, leverage the development of
more sophisticated delivery and support systems, and create a consumer brand.
The Company has achieved its leading position in the industry by developing
and acquiring desirable resorts at attractive prices which the Company believes
will allow it to achieve above average returns. Management believes that its
proven acquisition and development record and public company status give the
Company a competitive advantage in acquiring assets, businesses and operations
in the fragmented vacation ownership industry. The Company's continued
development of its infrastructure, building of its management team, and
implementation of Club Sunterra further enable the Company to successfully
integrate future acquisitions into its operations.
Increase Sales. The Company intends to increase sales of Vacation Interests
through the implementation of its more flexible vacation ownership product, Club
Sunterra. Through Club Sunterra, customers have access to the Company's network
of resorts and the flexibility to choose the season, location, duration and unit
size, based on their annual allotment of SunOptions. Club Sunterra is designed
to profile the entire resort network, enabling purchasers to have a home resort
advantage, yet also the ability to use their SunOptions to experience a vacation
or multiple vacations at any of the resorts in the network. The Company believes
sales opportunities will significantly increase at all resort locations as well
as at off-site centers because the sales and marketing processes are no longer
associated with just one resort. This selling process increases customer contact
which, over time, will increase each customer's affinity with Club Sunterra and
the Sunterra Resorts brand.
The Company also expects to enhance sales through its network of off-site
sales centers and larger distribution channels. There are currently seven and
seventeen off-site sales centers operating in the United States and Europe,
respectively. In addition, the Company's expansion of its resort network will
provide additional distribution outlets for the sale of Vacation Interests.
Improve Operating Efficiencies and Profitability. The Company intends to
improve operating efficiencies and profitability by implementing the Club
Sunterra points-based vacation ownership system and consolidating and
centralizing several key operating functions including mortgages receivable
processing, call center and reservations services, all of which were typically
performed at each resort location. Additionally, by leveraging against a larger
customer base, the Company anticipates that it will be able to lower its cost
associated with delivering services.
Expand Rental Services and Property Management Businesses. The Company
intends to expand its rental services operations and property management
business. To date, the Company believes an efficient rental market does not
currently exist with respect to vacation ownership resorts, other resorts and
condominium accommodations. The Company intends to develop services which are
designed to increase efficiency of a rental market and capitalize on the growing
need of owners to provide the flexibility associated with rental of their
accommodations. The Company intends to pursue these opportunities by utilizing
its traditional sales channels and through its Club Sunterra reservations
systems. Additionally, the Company believes substantial opportunities exist to
increase its property management business, both for owned vacation ownership
resorts and for other vacation ownership resorts as well as hotels, condominiums
and other resorts.
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THE VACATION OWNERSHIP INDUSTRY
The Market. The resort component of the leisure industry primarily is
serviced by two separate alternatives for overnight accommodations: commercial
lodging establishments and vacation ownership resorts. Commercial lodging
consists of hotels and motels in which a room is rented on a nightly, weekly or
monthly basis for the duration of the visit and is supplemented by rentals of
privately-owned condominium units or homes. For many vacationers, particularly
those with families, the space provided to the guest relative to the cost
(without renting multiple rooms) is not economical. Also, room rates and
availability at such establishments are subject to change periodically. In
addition to providing improved lifestyle benefits to owners, vacation ownership
presents an economical alternative to commercial lodging for vacationers.
The vacation ownership industry represents one of the fastest growing
segments of the lodging industry. According to the American Resort Development
Association ("ARDA") and other industry sources, during the 17 year period
ending in 1997, worldwide Vacation Interest sales volume increased from $490
million in 1980 to an estimated $6.0 billion in 1997, a compounded annual growth
rate of 15.9%. Vacation ownership has size and reach, with more than 5,000
vacation ownership resorts in over 80 countries and 4.5 million vacation
ownership families in 174 countries worldwide. The January 1999 issue of
"Vacation Ownership World" indicated that the top 38 companies in the vacation
ownership industry (representing approximately 66% of the market) generated 24%
growth in year-over-year Vacation Interest sales in 1998.
As shown in the following charts, according to ARDA, the worldwide vacation
ownership industry has expanded significantly since 1980 both in Vacation
Interest sales volume and number of Vacation Interest owners.
[Chart [Chart
indicating Interest Sales Volume] indicating Vacation Interest Owners]
Source: ARDA (includes, with respect to 1995, 1996 and 1997 unpublished
estimates provided by ARDA)
The Company believes that overall, the vacation ownership industry offers
many vacationers a superior economic value and a more flexible alternative to
traditional commercial lodging accommodations, and as a result, has historically
achieved high levels of customer satisfaction. A survey of vacation owners
conducted by ARDA in 1997 found that approximately 85% were either satisfied or
very satisfied with their vacation ownership purchase. ARDA also found that
about 76% of purchasers consider their time-of-purchase expectations to have
been matched or exceeded and that approximately 72% of owners eventually
purchase additional vacation ownership time. The average vacation ownership
customer owns 1.7 vacation ownership weeks. Industry research also suggests that
customer satisfaction increases with length of ownership, age, income, multiple
location ownership and accessibility to Vacation Interest exchange networks.
Increased government regulation, higher standards of quality and service,
increased flexibility and the rapid entry of a number of well-organized lodging
and entertainment companies, including Marriott Ownership Resorts ("Marriott"),
The Walt Disney Company ("Disney"), Four Seasons Hotel & Resorts ("Four
Seasons"), Hilton Hotels Corporation ("Hilton"), Hyatt Corporation ("Hyatt"),
Promus Hotel Corporation ("Promus") and Starwood Hotels and Resorts Worldwide,
Inc. ("Starwood"), have enhanced the industry's image and increased consumer
satisfaction.
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Sunterra believes it has significant opportunities to capitalize on
positive industry dynamics including continued worldwide industry growth and
favorable trends in consumer demographics. The large Baby Boomer market segment
is projected to reach its greatest ever concentration in the next ten years,
with an estimated 40 million people turning 50 years old over that period.
Additionally, the Generation X market segment has the highest awareness of and
receptivity to vacation ownership products that has ever been experienced in the
21 to 35 year old category. Demographic trends favor continuing growth in
overall demand for vacation ownership products, as the population of individuals
aged 45 to 60 is expected to increase by more than 50% in the United States
within the next decade. Historically, individuals age 45 to 60 represent a
market with significant discretionary income and have been the vacation
ownership industry's primary target market. In addition, the Company will seek
to capture an increasing share of the overall worldwide leisure travel and hotel
stay markets, providing substantial opportunities to increase market share from
contiguous, yet non-traditional marketing channels.
DESCRIPTION OF THE COMPANY'S RESORT LOCATIONS
Currently, the Company has 89 resort locations, which include 33 resort
locations sold as Vacation Intervals and 56 resort locations sold in
points-based vacation ownership systems. With respect to the Company's resorts,
all of the units are fully-furnished, and include telephones, televisions, VCRs
and stereos, and all but the studio units feature full kitchens. Most of the
units contain a washer and dryer, microwave and outdoor barbecue grill. Many
units also include a private deck.
The Company offers Vacation Interests through the following six principal
products:
Sunterra Resorts -- Club Sunterra. The Company is in the process of
introducing Club Sunterra to each resort location and off-site sales center and
plans to complete the roll-out by the end of 1999. Until Club Sunterra is
introduced to individual resorts, the resorts will continue to sell Vacation
Intervals. Vacation Intervals at the Company's Sunterra Resorts generally sell
for $5,000 to $11,000 for a studio unit, $7,000 to $13,000 for a one-bedroom
unit, $8,000 to $20,000 for a two-bedroom unit, $10,000 to $21,000 for a three-
bedroom unit and $12,000 to $22,000 for a four-bedroom unit.
Sunterra Europe -- Grand Vacation Club. GVC allows members to purchase an
annual allotment of points that can be redeemed for occupancy rights at GVC's
European resorts and at other participating resorts. The Company markets GVC in
the United Kingdom, Spain, Portugal, Italy, France and Austria. Each GVC member
receives a new allotment of points each year throughout the term of its
membership in the club.
Sunterra Pacific -- Vacation Time Share Program. The VTS Program is
marketed to potential buyers in the United States, Canada and Mexico. The VTS
Program is a points-based vacation ownership system much like GVC in that it
allows members to purchase Vacation Points that are redeemed for occupancy
rights at participating VTS Program resorts. Each VTS Program member receives a
new allotment of points each year throughout the term of its membership in the
program.
Sunterra Japan -- SJVC. The Company markets SJVC to potential buyers in
Japan. SJVC is much like GVC in that it allows members to purchase Vacation
Points that are redeemed for occupancy rights at participating Sunterra Japan
resorts.
Embassy Vacation Resorts. Vacation Intervals at the Company's four EVR
resorts generally sell for $13,000 to $26,000. EVR resorts are designed to
provide vacation ownership accommodations that offer the same high quality and
value that is represented by the more than 140 Embassy Suites hotels throughout
North America. The Company is one of two licensees and operators of EVR resorts.
Westin Vacation Club Resort. Vacation Intervals at the Company's one WVC
resort sell for $18,000 to $20,000.
The Company also has six other resort locations, which are not affiliated
with the above-mentioned products.
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As of December 31, 1998, the Company had the following number of resorts,
completed units, potential unit expansion, total potential units and current
inventory of Vacation Intervals or Vacation Points by product offering:
CURRENT
INVENTORY(C)
NUMBER POTENTIAL TOTAL -----------------------
OF COMPLETED UNIT POTENTIAL VACATION VACATION
RESORTS UNITS(A) EXPANSION(B) UNITS INTERVALS POINTS
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Sunterra Resorts.................................. 27 2,300 2,302 4,602 16,091 --
Sunterra Europe -- GVC............................ 24 1,835 231 2,066 -- 470,302
Sunterra Pacific -- VTS Program................... 22 776 -- 776 -- 169,674
Sunterra Japan -- SJVC............................ 3 48 -- 48 -- 180,708
Embassy Vacation Resorts.......................... 4 504 456 960 12,605 --
Westin Vacation Club Resorts...................... 1 48 48 96 1,557 --
Other............................................. 6 66 -- 66 1,310 --
-- ----- ----- ----- ------- -------
Total..................................... 87 5,577 3,037 8,614 31,563 820,684
(a) Completed units represent only those units that have received their
certificate of occupancy as of December 31, 1998. The Company generally is
able to sell 51 Vacation Intervals with respect to each unit at its resorts.
(b) Potential unit expansion includes, as of December 31, 1998, (i) units then
under construction and (ii) units planned to be developed on land then owned
by the Company or under option to be acquired and which were not then under
construction. The Company estimates that it would incur approximately $400
million to develop all of the potential unit expansion. However, except for
the projects currently under construction (the costs of which completing are
expected to be approximately $14.3 million in 1999), the Company has not
committed to develop any other of the potential unit expansion.
(c) Current inventory of Vacation Intervals or Vacation Points represents only
those unsold Vacation Intervals or Vacation Points that have received their
certificate of occupancy as of December 31, 1998.
The following tables set forth the name and location, as of December 31,
1998, of each of the Company's 87 resort locations. Of the resort locations set
forth below, the EVR Poipu Point and Kaanapali Beach, the NorthBay at Lake
Arrowhead, Ridge Point Tahoe and the WVC St. John are held in partnership with
third parties.
RESORT LOCATION
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SUNTERRA RESORTS
Avalon Deerfield Beach, Florida
Bent Creek Golf Village Gatlinburg, Tennessee
Carambola Beach St. Croix, USVI
Coral Sands Miami Beach, Florida
Cypress Pointe Lake Buena Vista, Florida
Flamingo Beach St. Maarten, Netherlands Antilles
Ft. Lauderdale Beach Ft. Lauderdale, Florida
Greensprings Plantation Williamsburg, Virginia
The Highlands at Sugar Banner Elk, North Carolina
Mountain Meadows Pigeon Forge, Tennessee
The Plantation at Fall Creek Branson, Missouri
Polynesian Isles Orlando, Florida
Powhatan Plantation Williamsburg, Virginia
The Ridge on Sedona Golf Sedona, Arizona
Royal Dunes Hilton Head, South Carolina
Royal Palm Beach St. Maarten, Netherlands Antilles
San Luis Bay Avila Beach, California
The Savoy on South Beach Miami Beach, Florida
Scottsdale Villa Mirage Scottsdale, Arizona
Sedona Springs Sedona, Arizona
Sedona Summit Sedona, Arizona
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RESORT LOCATION
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Town Square Gatlinburg, Tennessee
Town Village Gatlinburg, Tennessee
Villas at Poco Diablo Sedona, Arizona
Villas de Santa Fe Santa Fe, New Mexico
Villas of Sedona Sedona, Arizona
Villas on the Lake Montgomery, Texas
SUNTERRA EUROPE -- GRAND VACATION CLUB
The Alpine Club Schladming, Austria
Carlton Court London, England
Club del Carmen Lanzarote, Canary Islands
Club Mougins Cannes, France
Flanesford Priory Country Estate Herefordshire, England
Kenmore Club Perthshire, Scotland
Le Moulin de Connelles Normandy, France
Los Amigos Beach Club Costa del Sol, Spain
Marina Baie des Anges Nice, France
Pine Lake Resort Lancashire, England
Royal Oasis Club at Benal Beach Costa del Sol, Spain
Royal Oasis Club at La Quinta Costa del Sol, Spain
Royal Sunset Beach Club Tenerife, Canary Islands
Royal Tenerife Country Club Tenerife, Canary Islands
Sahara Sunset Club Costa del Sol, Spain
Santa Barbara Golf & Ocean Club Tenerife, Canary Islands
Sunset Bay Club Tenerife, Canary Islands
Sunset Harbour Club Tenerife, Canary Islands
Sunset View Club Tenerife, Canary Islands
Vilar do Golf Algarve, Portugal
White Sands Beach Club Menorca, Balearic Islands
White Sands Country Club Menorca, Balearic Islands
Woodford Bridge Country Club North Devon, England
Wychnor Park Country Club Straffordshire, England
SUNTERRA PACIFIC -- VTS PROGRAM
Clock Tower Whistler, British Columbia
Elkhorn Village(1) Sun Valley, Idaho
Embarcadero(1) Newport, Oregon
Fairway Villa Oahu, Hawaii
Hololani Maui, Hawaii
Kapaa Shore Kauai, Hawaii
Kihei Kai Nani Maui, Hawaii
Kingsbury Stateline, Nevada
Marina Inn(1) Oceanside, California
Oasis Palm Springs, California
Papakea Maui, Hawaii
The Pines at Sunriver Sunriver, Oregon
Point Brown Resort Ocean Shores, Washington
Pono Kai Kauai, Hawaii
Royal Kuhio Oahu, Hawaii
Sea Mountain Big Island, Hawaii
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RESORT LOCATION
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Sea Village Big Island, Hawaii
Tahoe Beach & Ski S. Lake Tahoe, California
Torres Mazatlan Mazatlan, Mexico
Vallarta Torre Puerto Vallarta, Mexico
Valley Isle Maui, Hawaii
The Village at Steamboat Steamboat Springs, Colorado
SUNTERRA JAPAN--SJVC
Kawaguchiko Yamanashi, Japan
Minamibousoh(1)(2) Chiba, Japan
Naeba Niigat, Japan
EMBASSY VACATION RESORTS
Grand Beach(1) Orlando, Florida
Kaanapali Beach Maui, Hawaii
Lake Tahoe(1) S. Lake Tahoe, California
Poipu Point Kauai, Hawaii
WESTIN VACATION CLUB
St. John(1) St. John, USVI
OTHER
Los Clavales(1) Tenerife, Canary Island
Malibu Village(1) Roussilon, France
Northbay at Lake Arrowhead Lake Arrowhead, California
Playa Paraiso Majorca, Spain
Ridge Pointe Tahoe(1) S. Lake Tahoe, California
Tahoe Seasons(1) S. Lake Tahoe, California
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(1) Units owned by the Company at the resort are managed by a third party
management company.
(2) The Company is currently leasing units at this resort.
CUSTOMER FINANCING
The Company offers consumer financing to the purchasers of Vacation
Interests at the Company's resort locations and off-site sales centers who make
a down payment generally equal to at least 10% of the purchase price. This
financing generally bears interest at fixed rates and is collateralized by the
underlying Vacation Interest.
At December 31, 1998, the Company's mortgages receivable portfolio included
approximately 52,000 promissory notes totaling approximately $358.9 million,
with a stated maturity of typically seven to ten years and a weighted average
interest rate of 14.5% per annum. Consumer loans in excess of 60 days past due,
including defaulted loans and loans in the deed-in-lieu process, at December 31,
1998, were 7.4% as a percentage of gross mortgages receivable. As of December
31, 1998, the Company's allowance for doubtful accounts, which is net of
recoveries, was 6.4% as a percentage of gross mortgages receivable. Management
believes that this percentage is an adequate reserve for expected loan losses
because the past due loan amounts do not include amounts recovered from the
underlying Vacation Interests nor do all past due loans become defaulted loans.
The Company has entered into agreements with lenders for the Company's
financing or sale of customer receivables. At December 31, 1998, the Company had
approximately $123.1 million of additional borrowing capacity available, which
could be used for financing mortgages receivables and other general corporate
purposes.
Sunterra Europe currently contracts with a third-party bank to provide
financing to purchasers of Vacation Points in its GVC and is paid an upfront
commission of approximately 14% (which includes a
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1% commission contingent on the Company meeting certain volume thresholds) of
the principal amount of eligible consumer loans on a non-recourse basis.
SALES AND MARKETING
The Company's primary means of selling Vacation Interests is through both
on-site and off-site sales teams. A variety of marketing programs are employed
to generate prospects for these sales efforts, which include targeted mailings,
overnight mini-vacation packages, gift certificates, seminars and various
destination-specific local marketing efforts. Additionally, incentive premiums
are offered to guests and other potential customers to encourage resort tours,
in the form of entertainment tickets, hotel stays, gift certificates or free
meals. The Company's sales process is tailored to each prospective buyer based
upon the marketing program that brought the prospective buyer to the resort for
a sales presentation. Prospective target customers are identified through
various means of profiling, and are intended to include current owners of
Vacation Interests.
ACQUISITION PROCESS
The Company obtains information with respect to resort acquisition
opportunities through interaction by the Company's management team with resort
operators, real estate brokers, lodging companies or financial institutions with
which the Company has established business relationships. From time to time, the
Company is also contacted by lenders and property owners who are aware of the
Company's development, management, operations and sales expertise with respect
to vacation resort properties.
During 1998, the Company acquired in separate transactions MMG, HTD, and an
additional ten resorts located in the United States, Europe, and Japan. The
Company has expertise in all areas of resort development including, but not
limited to, architecture, construction, finance, management, operations and
sales.
Management believes that its proven acquisition and development record and
public company status give the Company a competitive advantage in acquiring
assets, businesses and operations in the fragmented vacation ownership industry
that will prove to increase operating profits and enable Club Sunterra to
expand.
RENTAL OPERATIONS
The Company generates additional revenue by renting the unsold or unused
Vacation Interests at certain of its resorts. The Company rents unoccupied units
both through direct consumer sales, travel agents and/or vacation package
wholesalers. In addition to providing the Company with supplemental revenue, the
Company believes its room-rental operations provide it with a good source of
potential customers for the purchase of Vacation Interests. As part of the
management services provided by the Company to Vacation Interests owners, the
Company receives a fee for services provided to rent an owner's Vacation
Interests in the event the owner is unable to use or exchange the Vacation
Interests. In addition, the Company has purchased traditional resort
condominiums and resort hotels with the intention of converting each such resort
location to a vacation ownership property. Until such time as a unit at each
resort is sold as Vacation Interests, the Company continues (and will continue)
to rent the underlying unit on a nightly basis. Resorts acquired in the future
may be operated in this fashion during the start-up of Vacation Interests sales.
RESORT MANAGEMENT
The Company's resort locations are (i) generally managed by the Company
pursuant to management agreements with homeowner associations with respect to
each of the Company's Sunterra Resorts, (ii) managed by Promus pursuant to
management agreements with the Company with respect to EVR Grand Beach and EVR
Lake Tahoe and (iii) managed by Westin with respect to the WVC resort. At
December 31, 1998, the Company managed 27 Sunterra Resorts, two EVR resorts, 19
Sunterra Pacific resorts and 24 Sunterra Europe resorts. The Company manages
third party units at an additional 18 resorts in Hawaii. The remaining resort
locations are managed by third party management companies. See "-- Description
of the Company's Resort Locations."
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At each of the Company's managed resort locations, the Company enters into
a management agreement to provide for management and maintenance of the resort.
Pursuant to each such management agreement the Company is typically paid a
monthly management fee equal to 10% to 15% of monthly maintenance fees. The
management agreements are typically for a three-year period, automatically
renewable annually unless notice of non-renewal is given by either party.
Pursuant to each management agreement, the Company has primary responsibility
and authority for all activities necessary for the day-to-day operation of the
managed resort locations, including administrative services, procurement of
inventories and supplies and promotion and publicity. With respect to each
managed resort location, the Company generally also obtains comprehensive and
general public liability insurance, all-risk property insurance, business
interruption insurance and such other insurance as is customarily obtained for
similar properties. The Company also provides all managerial and other employees
necessary for the managed resort locations, including those necessary for review
of the operation and maintenance of the resorts, preparation of reports, budgets
and projections, employee training, and the provision of certain in-house legal
services. At EVR Grand Beach and EVR Lake Tahoe, Promus provides these services,
and the Company shares in the profitability of these agreements. Sunterra Europe
manages each resort in GVC pursuant to contracts that typically provide for a
management fee of 15% of monthly maintenance fees to be paid to Sunterra Europe.
VACATION INTERVAL OWNERSHIP
The purchase of a Vacation Interval typically entitles the buyer to use a
fully furnished vacation residence, generally for a one-week period each year,
in perpetuity. Typically, the buyer acquires an ownership interest in the
vacation residence, which is often held as tenant in common or similar legal
arrangement with other buyers of Vacation Interests in the property.
The owners of Vacation Intervals manage the property through a non-profit
homeowners' association, which is governed by a board consisting of
representatives of the developer and owners of Vacation Intervals at the resort.
The board hires a management company, delegating many of the rights and
responsibilities of the homeowners' association, as described above, including
grounds landscaping, security, housekeeping and operating supplies, garbage
collection, utilities, insurance, laundry and repair and maintenance.
Each Vacation Interval owner is required to pay the homeowners' association
a share of all costs of maintaining the property. These charges (generally $300
to $700 per Vacation Interval) can consist of an annual maintenance fee plus
applicable real estate taxes and, where needed, special assessments, assessed on
an as-needed basis. If the owner does not pay such charges, the owner's use
rights may be suspended and the homeowners' association may foreclose on the
owner's Vacation Interval.
POINTS-BASED VACATION OWNERSHIP
In general, under a points-based vacation ownership system, owners (usually
referred to as members) purchase points which act as an annual currency
entitlement for occupancy rights at any of the club's participating resorts. The
Company's Club Sunterra points-based vacation ownership system operates on a
basis very similar to the standard Vacation Interval ownership structure in that
members have a home resort, and have a deeded, fee-simple interest in a
particular unit at that home resort. The advantages of a points-based vacation
ownership system relate to the flexibility given to members with respect to the
usage of their Vacation Points versus the usage of a traditional Vacation
Interval. In traditional Vacation Interval ownership, owners can either use
their Vacation Interval for a one-week stay in a specific unit size in a
specific resort or exchange through an external exchange organization (i.e.,
Resort Condominiums International, LLC ("RCI") or Interval International, Inc.
("II")). Because Vacation Points function as currency under a points-based
vacation ownership system, owners can, subject to availability, choose the
location, season, duration and unit size of their vacation, based on their
annual Vacation Points allocations. Additionally, in a points-based vacation
ownership system, owners can redeem their points for a stay in any one of the
resorts included in the club without having to exchange through an external
exchange company such as RCI or II. Members of Club Sunterra are, however, able
to exchange through RCI for vacation stays at resorts outside of the Club
Sunterra resort network if they desire, as the $139 annual Club Sunterra
membership fee includes annual membership in RCI.
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Each Vacation Points owner is required to pay the homeowners' association a
share of all costs of maintaining the properties in the resort network
(depending on the number of SunOptions owned). These charges consist of an
annual maintenance fee plus applicable real estate taxes and special
assessments, assessed on an as-needed basis. If the owner does not pay such
charges, the owner's use rights may be suspended and the homeowners' association
may foreclose on the owner's Vacation Points.
The Company currently operates four points-based vacation ownership
systems: Club Sunterra (currently six resort locations in the United States),
Sunterra Europe -- GVC (currently 25 resort locations in Europe), Sunterra
Pacific -- VTS Program (currently 22 resort locations in North America) and
Sunterra Japan -- SJVC (currently four resort locations in Japan). Club Sunterra
operates as an umbrella points-based vacation ownership system for its European
and North American operations. In addition to attracting new owners, the Company
will market Club Sunterra to its existing base of owner families.
PARTICIPATION IN VACATION INTEREST EXCHANGE NETWORKS
The Company believes that its Vacation Interests are made more attractive
by the Company's participation in Vacation Interest exchange networks operated
by RCI and II. In a 1998 study sponsored by ARDA, the exchange opportunity was
cited by purchasers of Vacation Interests as one of the most significant factors
in determining whether to purchase a Vacation Interests. Participation in RCI
and II allows the Company's customers to exchange their occupancy right in a
particular year in the unit in which they own a Vacation Interest for an
occupancy right at the same time or a different time in another participating
resort, based upon availability and the payment of a variable exchange fee.
Members may exchange their Vacation Interests for occupancy rights in another
participating resort by listing their Vacation Interests as available with the
exchange organization and by requesting occupancy at another participating
resort, indicating the particular resort or geographic area to which the member
desires to travel, the size of the unit desired and the period during which
occupancy is desired. Both RCI and II assign ratings to each listed Vacation
Interest. These ratings are based upon a number of factors, including the
location and size of the unit, the quality of the resort and the period during
which the Vacation Interest is available, and attempts to satisfy the exchange
request by providing an occupancy right in another vacation interest with a
similar rating. If RCI or II is unable to meet the member's initial request, it
suggests alternative resorts based on availability.
COMPETITION
The Company competes with both branded and non-branded hospitality and
lodging companies, as well as other established vacation ownership companies.
Although major lodging and hospitality companies such as Marriott, Disney,
Hilton, Hyatt, Four Seasons, Inter-Continental Hotels and Resorts
("Inter-Continental"), Carlson Companies, Promus and Starwood have established
or declared an intention to establish vacation ownership operations in the past
decade, the industry remains largely unbranded and highly fragmented. However,
the majority of the approximately 5,000 worldwide vacation ownership resorts are
owned and operated by smaller, regional companies.
In addition, the Company also competes with the buyers of its Vacation
Intervals who subsequently decide to resell those Vacation Intervals. While the
Company believes, based on experience at its resorts, that the market for resale
of Vacation Intervals by buyers is presently limited, such resales are typically
at prices substantially less than the original purchase price. The market price
of Vacation Intervals sold by the Company at a given resort or by its
competitors in the market in which each resort is located could be depressed by
a substantial number of Vacation Intervals offered for resale.
GOVERNMENTAL REGULATION
General. The Company's marketing and sales of vacation interests are
subject to extensive regulations by the federal government and the states and
foreign jurisdictions in which its resort properties are located and in which
vacation interests are marketed and sold. On a federal level, the Federal Trade
Commission has taken the most active regulatory role through the Federal Trade
Commission Act, which prohibits unfair or deceptive acts or competition in
interstate commerce. Other federal legislation to which the Company is or
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may be subject includes the Truth-In-Lending Act and Regulation Z, the Equal
Credit Opportunity Act and Regulation B, the Interstate Land Sales Full
Disclosure Act, Telephone Consumer Protection Act, Telemarketing and Consumer
Fraud and Abuse Prevention Act, Fair Housing Act and the Civil Rights Act of
1964 and 1968. In addition, many states have adopted specific laws and
regulations regarding the sale of vacation interest ownership programs. The laws
of most states, including Florida, South Carolina and Hawaii require the Company
to file with a designated state authority for its approval a detailed offering
statement describing the Company and all material aspects of the project and
sale of vacation interests. The laws of California require the Company to file
numerous documents and supporting information with the California Department of
Real Estate, the agency responsible for the regulation of vacation interests.
When the California Department of Real Estate determines that a project has
complied with California law, it will issue a public report for the project. In
most states, the Company is required to deliver an offering statement or public
report to all prospective purchasers of vacation interests, together with
certain additional information concerning the terms of the purchase. Laws in
most states where the Company sells vacation interests generally grant the
purchaser of a vacation interest the right to cancel a contract of purchase at
any time within a period ranging from 3 to 15 calendar days following the
earlier of the date the contract was signed or the date the purchaser received
the last of the documents required to be provided by the Company. Most states
have other laws that regulate the Company's activities such as real estate
licensure; exchange program registration; sellers of travel licensure;
anti-fraud laws; telemarketing laws; price gift and sweepstakes laws; and labor
laws. The Company believes that it is in material compliance with all federal,
state, local and foreign laws and regulations to which it is currently or may be
subject. However, no assurance can be given that the Company will not incur
significant costs in qualifying under vacation interest ownership regulations in
all jurisdictions in which the Company desires to conduct sales. Any failure to
comply with applicable laws or regulations could have material adverse effect on
the Company.
Certain state and local laws may also impose liability on property
developers with respect to construction defects discovered or repairs made by
future owners of such property. Pursuant to such laws, future owners may recover
from the Company amounts in connection with the repairs made to the developed
property.
In addition, from time to time, potential buyers of Vacation Interests
assert claims with applicable regulatory agencies against Vacation Interest
salespersons for unlawful sales practices. Such claims could have adverse
implications for the Company in negative public relations and potential
litigation and regulatory sanctions. However, the Company does not believe that
such claims will have a material adverse effect on the Company or its business.
A number of state and federal laws, including the Fair Housing Act and the
Americans with Disabilities Act (the "ADA"), impose requirements related to
access and use by disabled persons on a variety of public accommodations and
facilities. These requirements did not become effective until after January 1,
1991. Although the Company believes that its resorts are substantially in
compliance with laws governing the accessibility of its facilities to disabled
persons, a determination that the Company is not in compliance with the ADA
could result in a judicial order requiring compliance, imposition of fines or an
award of damages to private litigants. The Company is likely to incur additional
costs of complying with the ADA; however, such costs are not expected to have a
material adverse effect on the Company's results of operations or financial
condition. Additional legislation may impose further burdens or restrictions on
property owners with respect to access by disabled persons. If a homeowners'
association at a resort was required to make significant improvements as a
result of non-compliance with the ADA, Vacation Interests owners may default on
their mortgages and/or cease making required homeowners' association assessment
payments. The Company is not aware of any non-compliance with the ADA, the Fair
Housing Act or similar laws that management believes would have a material
adverse effect on the Company's business, assets or results of operations.
The Company sells Vacation Interests at its resort locations through
independent sales agents. Such independent sales agents provide services to the
Company under contract and, the Company believes, are not employees of the
Company. Accordingly, the Company does not withhold payroll taxes from the
amounts paid to such independent contractors. In the event the Internal Revenue
Service or any state or local taxing authority were to successfully classify
such independent sales agents as employees of the Company, rather
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than as independent contractors, and hold the Company liable for back payroll
taxes, such reclassification may have a material adverse effect on the Company.
The marketing and sales of the GVC points-based vacation ownership system
and its other operations are subject to national and European regulation and
legislation. Within the European Community (which includes all the countries in
which the Company conducts its operations), the European Timeshare Directive of
1994 regulates vacation ownership activities. The terms of the Directive require
the Company to issue a disclosure statement providing specific information about
its resorts and its vacation ownership operations as well as making mandatory a
10-day rescission period and a prohibition on the taking of advance payments
prior to the expiration of that rescission period. Member States are permitted
to introduce legislation that is more protective of the consumer when
implementing the European Timeshare Directive. In the United Kingdom, where the
majority of the Company's marketing and sales operations take place, the
Directive has been implemented by way of an amendment to the Timeshare Act 1992.
In the United Kingdom, a 14-day rescission period is mandatory. There are other
United Kingdom laws which the Company is or may be subject to including the
Consumer Credit Act 1974, the Unfair Terms in Consumer Contracts Regulations
1995 and the Package Travel, Package Holidays and Package Tours Regulations
1992. The Timeshare Act 1992 does appear to have extra-territorial effect in
that United Kingdom resident purchasers buying timeshare in other European
Economic Area States may rely upon it. All the countries in which the Company
operates have consumer and other laws which regulate its activities in those
countries. The Company is member of the Timeshare Council which is the United
Kingdom's self regulating trade body for vacation ownership companies. As a
member, it is obligated to comply with all laws as well as with certain codes of
conduct (including a code of conduct for the operating of points systems)
promulgated by the Timeshare Council.
Environmental Matters. Under various federal, state, local and foreign
environmental, health, safety and land use laws, ordinances, regulations and
similar requirements (collectively, "Environmental Laws"), a current or previous
owner or operator of real property may be required to investigate and clean up
hazardous or toxic substances or wastes or releases of petroleum products or
wastes at such property, and may be held liable to a governmental entity or to
third parties for associated damages and for investigation and clean-up costs
incurred by such parties in connection with the contamination. Such laws may
impose clean-up responsibility and liability without regard to whether the owner
knew of or caused the presence of the contaminants, and the liability under such
laws has been interpreted to be joint and several unless the harm is divisible
and there is a reasonable basis for allocation of responsibility. The cost of
investigation, remediation or removal of such substances may be substantial, and
the presence of such substances, or the failure to properly remediate the
contamination on such property, may adversely affect the owner's ability to sell
or rent such property or to borrow using such property as collateral. In
addition, persons who arrange for the disposal or treatment of hazardous or
toxic substances at a disposal or treatment facility may also be liable for the
costs of removal or remediation of a release of hazardous or toxic substances or
wastes at such disposal or treatment facility, whether or not such facility is
owned or operated by such person. In addition, some Environmental Laws create a
lien on the contaminated site in favor of the government for damages and costs
it incurs in connection with the contamination. Finally, the owner of a site may
be subject to statutory or common law claims by third parties based on damages
and costs resulting from environmental contamination emanating from a site. In
connection with its ownership and operation of its properties, the Company
potentially may be liable for such costs. In addition, as a result of the
consummation of the Acquisitions, the Company could be held liable for the
pre-existing environmental and other liabilities of the acquired companies, if
any.
Certain Environmental Laws govern the removal, encapsulation or disturbance
of asbestos-containing materials ("ACMs") when such materials are in poor
condition or in the event of construction, remodeling, renovation or demolition
of a building. Such laws may impose liability for release of ACMs and may
provide for third parties to seek recovery from owners and operators of real
properties for personal injury associated with ACMs. In connection with its
ownership and operation of its properties, the Company potentially may be liable
for such costs.
In addition, recent studies have linked radon, a naturally-occurring
substance, to increased risks of lung cancer. While there are currently no state
or federal requirements regarding the monitoring for, presence of, or exposure
to, radon in indoor air, the EPA and the Surgeon General recommend testing
residences for the
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presence of radon in indoor air, and the EPA further recommends that
concentrations of radon in indoor air be limited to less than 4 picocuries per
liter of air (pCI/L) (the "Recommended Action Level"). The presence of radon in
concentrations equal to or greater than the Recommended Action Level in one or
more of the Company's resorts may adversely affect the Company's ability to sell
vacation interests at such resorts and the market value of such resort. In
addition, the Company is required to disclose to potential purchasers and owners
of vacation interests at the Company's resorts that were constructed prior to
1978 any known lead-paint hazards and failure to so notify could impose damages
on the Company.
The Company has conducted Phase I environmental assessments (which
typically involve inspection without soil sampling or groundwater analysis)
performed by independent environmental consultants at each of the resort
locations at which it has sold or owns a material amount of inventory in order
to identify potential environmental concerns. These Phase I assessments have
been carried out in accordance with accepted industry practices, and generally
have included a preliminary investigation of the sites and identification of
publicly known conditions concerning properties in the vicinity of the sites,
physical site inspections, review of aerial photographs and relevant
governmental records where readily available, interviews with knowledgeable
parties, investigation for the presence of above ground and underground storage
tanks presently or formerly at the sites, a visual inspection of potential
lead-based paint and suspect friable ACMs where appropriate, and the preparation
and issuance of written reports.
The Company's assessments of its resorts have not revealed any
environmental liability that the Company believes would have a material adverse
effect on the Company's business, assets or results of operations, nor is the
Company aware of any such material environmental liability. Nevertheless, it is
possible that the Company's assessments do not reveal all environmental
liabilities or that there are material environmental liabilities of which the
Company is unaware. The Company believes that its properties are in compliance
in all material respects with all Environmental Laws regarding hazardous or
toxic substances or wastes. The Company does not believe that continued
compliance with applicable Environmental Laws or regulations will have a
material adverse effect on the Company or its financial condition or results of
operations.
In connection with the acquisition and development of the EVR Lake Tahoe
and the Sunterra Resorts San Luis Bay, several areas of environmental concern
have been identified. The areas of concern at the EVR Lake Tahoe relate to
possible soil and groundwater contamination that has migrated onto the resort
site from an upgradient source; in addition, residual contamination may exist on
the resort site as a result of leaking underground storage tanks that were
removed prior to the Company's acquisition of the resort site. California
regulatory authorities are monitoring the off-site contamination and have
required or are in the process of requiring the responsible parties to undertake
remedial action. The Company has been indemnified by Chevron (USA), Inc. for
certain costs and expenses in connection with the off-site contamination. The
Company does not believe that it will be held liable for this contamination and
does not anticipate incurring material costs in connection therewith; however,
there can be no assurance that the indemnitor will meet its obligations in a
complete and timely manner.
Sunterra Resorts San Luis Bay is located in an area of Avila Beach,
California which has experienced soil and groundwater contamination resulting
from a nearby oil refinery. California regulatory authorities have required the
installation of groundwater monitoring wells on the beach near the resort site
(among other locations). Remediation has commenced and negotiations with the oil
refinery are underway as to possible damages the Company has suffered from the
contamination and remediation activities. It is possible that the Company's
operations could be adversely impacted, including possible temporary
interference with access to the resort site and temporary loss of beach access,
once remediation is underway. The Company does not believe that it is liable for
this contamination and does not anticipate incurring material costs in
connection therewith; however, there can be no assurance that claims will not be
asserted against the Company with respect to this matter.
Other Regulations. Under various state and federal laws governing housing
and places of public accommodation the Company is required to meet certain
requirements related to access and use by disabled persons. Many of these
requirements did not take effect until after January 1, 1991. Although the
Company's management believes that its facilities are substantially in
compliance with present requirements of such laws,
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the Company may incur additional costs of compliance. Additional legislation may
impose further burdens or restriction on owners with respect to access by
disabled persons. The ultimate amount of the cost of compliance with such
legislation is not currently ascertainable, and, while such costs are not
expected to have a material effect on the Company, such costs could be
substantial. Limitations or restrictions on the completion of certain
renovations may limit application of the Company's growth strategy in certain
instances or reduce profit margins on the Company's operations.
EMPLOYEES
As of December 31, 1998, the Company had approximately 6,500 full and part
time employees. The Company believes that its employee relations are good. With
the exception of certain employees located at the St. Maarten, Netherlands
Antilles resorts, none of the Company's employees are represented by a labor
union. The Company sells Vacation Interests at its resorts through approximately
1,400 independent sales agents.
INSURANCE
The Company carries comprehensive liability, fire, hurricane, storm,
earthquake and business interruption insurance with respect to the Company's
resorts locations, with policy specifications, insured limits and deductibles
customarily carried for similar properties which the Company believes are
adequate. In September 1995 and July 1996, the Company's St. Maarten resorts
were damaged by a hurricane. With respect to such September 1995 damage, the
Company has recovered amounts from its insurance carriers sufficient to cover
100% of the property damage losses and is in the process of recovering amounts
for business interruption. In August of 1998, the Company's Caribbean resorts
were damaged by hurricane Georges. The Company is currently in the process of
recovering amounts for hurricane damage and business interruption related to the
hurricane. There are, however, certain types of losses (such as losses arising
from acts of war) that are not generally insured because they are either
uninsurable or not economically insurable. Should an uninsured loss or a loss in
excess of insured limits occur, the Company could lose its capital invested in a
resort, as well as the anticipated future revenues from such resort and would
continue to be obligated on any mortgage indebtedness or other obligations
related to the property. Any such loss could have a material adverse effect on
the Company.
TRADEMARKS
While the Company owns and controls a number of trade secrets, confidential
information, trademarks, trade names, copyrights and other intellectual property
rights, including the "Sunterra" and "Own Your World" service marks which, in
the aggregate, are of material importance to its business, it is believed that
the Company's business, as a whole, is not materially dependent upon any one
intellectual property or related group of such properties. The Company is
licensed to use certain technology and other intellectual property rights owned
and controlled by others, and, similarly, other companies are licensed to use
certain technology and other intellectual property rights owned and controlled
by the Company.
CAUTIONARY STATEMENT FOR PURPOSES OF THE SAFE HARBOR PROVISIONS OF THE PRIVATE
SECURITIES LITIGATION REFORM ACT OF 1995
The Company desires to take advantage of the "safe harbor" provisions of
the Private Securities Litigation Reform Act of 1995. Certain statements in this
Annual Report on Form 10-K for the fiscal year ended December 31, 1998 (the
"10-K") that are not historical fact constitute "forward-looking statements"
within the meaning of the Private Securities Litigation Reform Act of 1995.
Discussions containing such forward-looking statements may be found in the
material set forth under "Business and Properties," as well as within this 10-K
generally. In addition, when used in this 10-K the words "believes,"
"anticipates," "expects," "intends" and similar expressions are intended to
identify forward-looking statements. Such statements are subject to a number of
risks and uncertainties. Actual results could differ materially from those
projected in the forward-looking statements as a result of the risk factors set
forth below and the matters set forth in this 10-K generally. The Company
undertakes no obligation to publicly release the result of any revisions to
these forward-looking statements that may be made to reflect any future events
or circumstances.
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RISK OF INCREASING LEVERAGE; LIQUIDITY
The Company finances approximately 65% of its Vacation Interest sales and
prior to 1998, chose to retain the originated mortgages receivable rather than
sell or securitize them. As a result, the Company was required to increase its
levels of indebtedness to fund its operations. At December 31, 1998, the Company
had approximately $627.1 million of outstanding indebtedness (excluding trading
payables).
During 1998, the Company began selling or securitizing its mortgages
receivable. During the year, the Company (i) completed a $100.3 million
on-balance sheet asset-backed securitization in the second quarter of 1998, (ii)
sold $101.9 million of mortgages receivable in the third quarter of 1998 and
(iii) sold $79.0 million of mortgages receivable into a conduit facility in the
fourth quarter of 1998.
The Company intends to continue to convert its mortgages receivable to cash
through (i) outright mortgages receivable sales, (ii) off-balance sheet
asset-backed securitizations of mortgages receivable or (iii) the origination of
mortgages receivable for, or by, a third party institution, and receipt of an
origination fee, as the Company currently does in its Sunterra Europe
operations. Such transactions are expected to be without recourse to the
Company, thereby reducing the Company's risk of default on the underlying
mortgages receivable.
The Company may further increase levels of indebtedness by utilizing its
$117.5 million senior bank credit facility with Bank of America Corporation, as
administrative lender which was entered into on February 18, 1998 (as amended,
the "Senior Credit Facility") to warehouse mortgages receivable until such
mortgages receivable are sold in an off-balance sheet asset-backed
securitization. In addition, the Company may incur indebtedness for (i) future
acquisitions or (ii) to finance construction of certain resort locations.
As of December 31, 1998, the Company had approximately $98.2 million
available on its Senior Credit Facility and $24.9 million available on its
$100.0 million mortgages receivable conduit facility (the "Conduit Facility").
In addition, the Company is currently negotiating a new conduit facility and an
off-balance sheet asset-backed securitization. Both transactions are expected to
close in the second quarter of 1999.
Markets for the Company's mortgages receivable include the asset-backed
securitization market, the commercial paper market (utilized by the Conduit
Facility) and the commercial bank and finance company markets. A decline in all
of these markets could materially adversely affect the Company's results of
operations, cash flows and capital resources.
The indentures for the Company's $140 million 9 1/4% Senior Notes due 2006
(the "Senior Notes") and the $200 million 9 3/4% Senior Subordinated Notes due
2007 (the "Senior Subordinated Notes") contain certain covenants that, among
other things, limit and/or condition the ability of the Company and its
restricted 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 other indebtedness
that is not subordinated by its terms in right of payment to any indebtedness or
other obligation of the Company ("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 sale 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. There can be no
assurance that these requirements will be met in the future. If they are not,
the holders of the indebtedness under certain of the Company's other Senior
Indebtedness may be entitled to declare such indebtedness immediately due and
payable.
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RISKS ASSOCIATED WITH CUSTOMER FINANCING
The Company offers customer financing to the purchasers of Vacation
Interests at the Company's resort locations and off-site sales centers who make
a down payment generally equal to at least 10% of the purchase price. This
financing generally bears interest at fixed rates and is collateralized by the
underlying Vacation Interests. The Company has entered into agreements with
lenders for the financing and sale of customer receivables.
The Company has historically derived income from its financing activities.
At December 31, 1998, the Company's mortgages receivable portfolio included
approximately 52,000 promissory notes totaling approximately $358.9 million,
with a stated maturity of typically seven to ten years and a weighted average
interest rate of 14.5% per annum. Additionally, at December 31, 1998, the
weighted average maturity of all outstanding consumer loans was approximately
9.5 years and the total borrowings secured by promissory notes were
approximately $142 million, bearing a weighted average interest rate of 7.5%.
However, because the Company's borrowings bear interest at variable rates and
the Company's loans to buyers of Vacation Interests bear interest at fixed rates
(which, as of December 31, 1998, equaled 14.5% per annum on a weighted average
basis), the Company bears the risk of increases in interest rates with respect
to the loans it has from its lenders. The promissory notes are prepayable at any
time without penalty. To the extent interest rates on the Company's borrowings
decrease, the Company faces an increased risk that customers will pre-pay their
loans and reduce the Company's income from financing.
The Company bears the risk of defaults by buyers who financed the purchase
of their Vacation Interests through the Company. The Company does not, however,
bear the risk of defaults with respect to mortgages receivable that it has sold
to third parties. Consumer loans in excess of 60 days past due, including
defaulted loans and loans in the deed-in-lieu process, at December 31, 1998 were
7.4%, as a percentage of gross mortgages receivable. The Company's allowance for
doubtful accounts, which is net of recoveries, was 6.4% as a percentage of gross
mortgages receivable. Management believes that this percentage is an adequate
reserve for expected loan losses because the past due loan amounts do not
include amounts recovered from the underlying Vacation Interests nor do all past
due loans become defaulted loans.
If a buyer of a Vacation Interest defaults on a mortgage receivable, the
Company may foreclose and recover the underlying Vacation Interest. However, the
Company will incur relatively substantial costs in foreclosing on the Vacation
Interest, returning it to inventory and reselling it. Although private mortgage
insurance or its equivalent is available to cover Vacation Interests, the
Company has never purchased such insurance and has no present intention of doing
so. In addition, although the Company in many cases may have recourse against
Vacation Interest purchasers and sales agents for the purchase price paid and
for commissions paid, respectively, no assurance can be given that the Vacation
Interest purchase price or any commissions will be fully or partially recovered
in the event of a buyer default under a mortgage receivable. The Company is
subject to the costs and delays associated with the foreclosure process and no
assurance can be given that the value of the underlying Vacation Interests being
foreclosed upon at the time of resale will exceed the purchase price of the
defaulted loans, taking into consideration the costs of foreclosure and resale
or that the costs of any such foreclosures will not have a material adverse
effect on the Company's results of operations.
RISKS RELATED TO THE DEVELOPMENT AND INTEGRATION OF A POINTS-BASED VACATION
OWNERSHIP SYSTEM
The Company has developed its Club Sunterra points-based vacation exchange
system which will offer points-based exchanges throughout the Company's
worldwide network of resort locations. Although the Company has purchased and
operated points-based vacation ownership systems through the Sunterra Pacifica,
LSI and Global Acquisitions, the Company has not developed a company-wide
points-based vacation ownership system and no assurance can be given as to
management's ability to efficiently develop or operate such a company-wide
system. Although management believes such system will be in place at all
Sunterra resort locations by the end of 1999, there can be no assurance that
such system will be placed into operation by such time. Risks associated with
the operation of the Company's Club Sunterra company-wide points-based vacation
ownership system, include the risks that: the Company cannot effectively develop
or acquire the
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computer software necessary to operate Club Sunterra; the North American
points-based vacation ownership systems cannot be efficiently combined or
operated with the Company's current vacation ownership operations; and the North
American points-based vacation ownership systems may be or become subject to
extensive regulation by federal, state and local jurisdictions, possibly making
such points-based vacation ownership systems uneconomical or unprofitable.
VARIABILITY OF QUARTERLY RESULTS
The Company has historically experienced and expects to continue to
experience seasonal fluctuations in its gross revenues and net income from the
sale of Vacation Interests. This seasonality may cause significant variations in
quarterly operating results. If sales of Vacation Interests are below seasonal
normality during a particular period, the Company's annual operating results
could be materially adversely affected.
Due to the foregoing and other factors, the Company believes that its
quarterly and annual revenues, expenses and operating results could vary
significantly in the future and that period-to-period comparisons should not be
relied upon as indications of future performance. Because of the above factors,
it is possible that the Company's operating results will be below the
expectations of securities market analysts and investors, which could have an
adverse effect on the market value of the Company's Common Stock. Numerous
factors, including announcements of fluctuations in the Company's or its
competitors' operating results and market conditions for hospitality and
vacation ownership industry securities in general, could have a significant
impact on the future price of the Common Stock. In addition, the securities
market in recent years has experienced significant price and volume fluctuations
that often have been unrelated or disproportionate to the operating performance
of companies. These broad fluctuations may adversely affect the market price of
the Common Stock.
RISKS OF DEVELOPMENT, CONSTRUCTION AND ACQUISITION ACTIVITIES; ACCOUNTING
TREATMENT
A principal component of the Company's strategy is to grow through
development and construction of existing resort locations and acquisition of new
resort locations. Risks associated with the Company's development, construction,
acquisition and expansion activities may include the risks that: acquisition
and/or development opportunities may be abandoned; construction costs of a
resort may exceed original estimates, possibly making the resort uneconomical or
unprofitable; sales of Vacation Interests at a newly completed or acquired
resort may not be sufficient to make the resort profitable; financing may not be
available on favorable terms for development, construction or acquisition of, or
the continued sales of Vacation Interests at, a resort; and construction may not
be completed on schedule, resulting in decreased revenues and increased interest
expense. The failure of the Company to successfully complete its development,
construction, redevelopment, conversion, acquisition and expansion activities
may have a material adverse effect on the Company's results of operations.
The AVCOM, PRG and LSI Acquisitions have been accounted for by the Company
by the pooling-of-interests method of accounting. Under this method of
accounting, the recorded assets and liabilities of the Company, AVCOM, PRG and
LSI have been carried forward at their book values to the Company and the
reported income of the Company, AVCOM, PRG and LSI for prior periods has been
combined and restated as income of the Company. Although the Company has
received an opinion from its independent public accountants that the AVCOM, PRG
and LSI Acquisitions will qualify for pooling-of-interests accounting treatment,
opinions of accountants are not binding upon the Commission, and there can be no
assurance that the Commission will not successfully assert a contrary position.
In such case, the purchase method of accounting would be applicable. Under the
purchase method, the book value of AVCOM's, PRG's and LSI's assets would be
increased to their fair values, which could result in higher operating costs and
expenses as the excess of the purchase price over the fair value of AVCOM's,
PRG's and LSI's assets would be amortized and expensed over a period of years,
which would adversely affect the Company's future earnings. The Sunterra
Pacific, Marc, Global, MMG and HTD Acquisitions were each accounted for using
the purchase method of accounting.
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GENERAL ECONOMIC CONDITIONS, CONCENTRATION AND COMPETITION IN VACATION OWNERSHIP
INDUSTRY
Any downturn in economic conditions or any price increases (e.g., airfares)
related to the travel and tourism industry could depress discretionary consumer
spending and have a material adverse effect on the Company's business. Any such
economic conditions, including recession, may also adversely affect the future
availability of attractive financing rates for the Company or its customers and
may materially adversely affect the Company's business. Furthermore, changes in
general economic conditions may adversely affect the Company's ability to
collect its loans to Vacation Interest buyers. Because the Company's operations
are conducted solely within the vacation ownership industry, any adverse changes
affecting the industry (such as an oversupply of vacation ownership units, a
reduction in demand for such units, changes in travel and vacation patterns,
changes in governmental regulations of the industry and increases in
construction costs or taxes, as well as negative publicity for the industry)
could have a material adverse effect on the Company's operations.
The Company is subject to significant competition at each of its resorts
from other entities engaged in the business of resort development, sales and
operation, including Vacation Interest ownership, condominiums, hotels and
motels. Many of the world's most recognized lodging, hospitality and
entertainment companies have begun to develop and sell Vacation Interests in
resort properties. Other major companies that now operate or are developing or
planning to develop vacation ownership resorts include Marriott, Disney, Hilton,
Hyatt, Four Seasons, Inter-Continental, Carlson Companies, Promus and Starwood.
Many of these entities possess significantly greater financial, marketing,
personnel and other resources than those of the Company and may be able to grow
at a more rapid rate or more profitably as a result. The Company also competes
with other established vacation ownership companies.
In addition, the Company competes with the buyers of its Vacation Intervals
who subsequently decide to resell those Vacation Intervals. While the Company
believes, based on experience at its resorts, that the market for resale of
Vacation Intervals by buyers is presently limited, such resales are typically at
prices substantially less than the original purchase price. The market price of
Vacation Intervals sold by the Company at a given resort or by its competitors
in the market in which each resort is located could be depressed by a
substantial number of Vacation Intervals offered for resale. See
"-- Competition."
DEPENDENCE ON VACATION INTERVAL EXCHANGE NETWORKS; RISK OF INABILITY TO QUALIFY
RESORTS
The attractiveness of Vacation Interest ownership is enhanced significantly
by the availability of exchange networks that allow Vacation Interest owners to
exchange in a particular year the occupancy right in their Vacation Interest for
an occupancy right in another participating network resort. According to ARDA,
the ability to exchange Vacation Interests was cited by buyers as a primary
reason for purchasing a Vacation Interest. RCI and II provide broad-based
Vacation Interest exchange services and the Company's resort locations are
currently qualified for participation in either the RCI and II exchange
networks.
If such exchange networks cease to function effectively, or if the
Company's resorts are no longer included in such exchange networks, the
Company's sales of Vacation Interests could be materially adversely affected.
See "-- Participation in Vacation Interest Exchange Networks." However, this
risk is greatly reduced as the Company completes the roll-out of Club Sunterra
and owners have the choice to vacation at any of the Company's 89 resorts
locations.
APPLICABILITY OF FEDERAL SECURITIES LAWS TO THE SALE OF VACATION INTERESTS
It is possible that the Vacation Interests may be deemed to be a security
as defined in Section 2(1) of the Securities Act. If the Vacation Interests were
determined to be a security for such purpose, their sale would require
registration under the Securities Act. The Company has not registered the sale
of the Vacation Interests under the Securities Act and does not intend to do so
in the future. If the sale of the Vacation Interests were found to have violated
the registration provisions of the Securities Act, purchasers of the Vacation
Interests would have the right to rescind their purchases of Vacation Interests.
If a substantial number of purchasers sought rescission and were successful, the
Company's business, results of operations and financial condition could be
materially adversely affected. The Company has been advised by its vacation
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ownership counsel, Schreeder, Wheeler & Flint, LLP, that in the opinion of such
counsel, based on its review of the Company's Vacation Interests programs and
the sales practices utilized in such program, the Vacation Interests do not
constitute a security within the meaning of Section 2(1) of the Securities Act.
REGULATION OF MARKETING AND SALES OF VACATION INTERESTS; OTHER LAWS
As described under "-- Governmental Regulation -- General" above, the
Company's marketing and sales of Vacation Interests and other operations are
subject to extensive regulation by the federal government and the states and
foreign jurisdictions in which its resorts are located and in which Vacation
Interests are marketed and sold. The Company believes that it is in material
compliance with all federal, state, local and foreign laws and regulations to
which it is currently subject. However, no assurance can be given that the cost
of qualifying under vacation ownership regulations in all jurisdictions in which
the Company desires to conduct sales will not be significant or that the Company
is in fact in compliance with all applicable federal, state, local and foreign
laws and regulations. Any failure to comply with applicable laws or regulations
could have a material adverse effect on the Company.
POSSIBLE ENVIRONMENTAL LIABILITIES; UNINSURED LOSSES
As described under "-- Governmental Regulation -- Environmental Matters"
above, under various Environmental Laws, the owner or operator of real property
may be liable for the costs of removal or remediation of certain hazardous or
toxic substances or wastes located on or in, or emanating from, such property,
as well as related costs of investigation and associated damages. The Company is
not aware of environmental liability that would have a material adverse effect
on the Company's business, assets or results of operations, nor has the Company
been notified by any governmental authority or any third party, and is not
otherwise aware, of any material noncompliance, liability or other claim
relating to hazardous or toxic substance or petroleum products in connection
with any of its present or former properties. The Company believes that it is in
compliance in all material respects with all Environmental Laws. No assurance,
however, can be given that the Company will remain in compliance with all
Environmental Laws or that it is aware of all environmental liabilities that
relate to all of its present and former properties.
In 1992, prior to the Company's purchase of an interest in the EVR Poipu
Point, the resort was substantially destroyed by Hurricane Iniki. The resort was
rebuilt with insurance proceeds before the Company acquired its interest in the
resort, but could suffer similar damage in the future. In September 1995 and
July 1996, the Company's St. Maarten resorts were damaged by hurricanes and
could suffer similar damage in the future. In August 1998, the Company's
caribbean resorts were damaged by hurricane Georges. The Company is currently in
the process of recovering amounts for hurricane damage and business interruption
related to the hurricane. In addition, the Company's other resorts may be
subject to hurricanes and damaged as a result thereof. The Company's resorts
located in California and Hawaii may be subject to damage resulting from
earthquakes. The Company currently maintains insurance coverage that, in
management's opinion, is at least as comprehensive as the coverage maintained by
other prudent entities in the Company's line of business. However, there are
certain types of losses (such as losses arising from acts of war and civil
unrest) that are not generally insured because they are either uninsurable or
not economically insurable and for which the Company does not have insurance
coverage. Should an uninsured loss or a loss in excess of insured limits occur,
the Company could lose its capital invested in a resort, as well as the
anticipated future revenues from such resort and would continue to be obligated
on any mortgage indebtedness or other obligations related to the property. Any
such loss could have a material adverse effect on the Company.
EFFECTIVE VOTING CONTROL BY EXISTING STOCKHOLDERS
The Company's founders, Messrs. Kaneko, Gessow and Kenninger, hold
substantial shares of Common Stock, (9.5%, 9.9% and 3.0%, respectively, as of
the date hereof) which may allow them, collectively, to exert substantial
influence over the election of directors and the management and affairs of the
Company. Accordingly, if such persons vote their shares of Common Stock in the
same manner, they may have sufficient voting power to determine the outcome of
various matters submitted to the stockholders for approval,
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including mergers, consolidations and the sale of substantially all of the
Company's assets. Such control may result in decisions that are not in the best
interest of the Company.
ANTI-TAKEOVER EFFECT OF CERTAIN PROVISIONS OF MARYLAND LAW AND THE COMPANY'S
CHARTER AND BYLAWS
Certain provisions of the Company's articles of incorporation, as amended,
(the "Charter") and bylaws, as amended, (the "Bylaws"), as well as Maryland
corporate law, may be deemed to have anti-takeover effects and may delay, defer
or prevent a takeover attempt that a stockholder might consider to be in the
stockholder's best interest. For example, such provisions may (i) deter tender
offers for Common Stock, which offers may be beneficial to stockholders or (ii)
deter purchases of large blocks of Common Stock, thereby limiting the
opportunity for stockholders to receive a premium for their Common Stock over
then-prevailing market prices. These provisions include the following:
Preferred Shares. The Charter authorizes the Board of Directors to issue
preferred stock in one or more classes and to establish the preferences and
rights (including the right to vote and the right to convert into Common Stock)
of any class of preferred stock issued. No preferred stock is issued or
outstanding.
Staggered Board. The Board of Directors of the Company has three classes of
directors each serving a staggered term so that the directors' terms currently
will expire in 1999, 2000 and 2001. Directors for each class will be chosen for
a three-year term upon the expiration of the term of the current class. The
affirmative vote of two-thirds of the outstanding Common Stock is required to
remove a director.
Maryland Business Combination Statute. Under the Maryland General
Corporation Law ("MGCL"), certain "business combinations" (including the
issuance of equity securities) between a Maryland corporation and any person who
owns, directly or indirectly, 10% or more of the voting power of the
corporation's shares of capital stock (an "Interested Stockholder") must be
approved by a supermajority (i.e., 80%) of voting shares. In addition, an
Interested Stockholder may not engage in a business combination for five years
following the date he or she became an Interested Stockholder.
Maryland Control Share Acquisition. Maryland law provides that "Control
Shares" of a corporation acquired in a "Control Share Acquisition" have no
voting rights except to the extent approved by a vote of two-thirds of the votes
eligible under the statute to be cast on the matter. "Control Shares" are voting
shares of beneficial interest which, if aggregated with all other such shares of
beneficial interest previously acquired by the acquirer, would entitle the
acquirer directly or indirectly to exercise voting power in electing directors
within one of the following ranges of voting power: (i) one-fifth or more but
less than one-third, (ii) one-third or more but less than a majority or (iii) a
majority of all voting power. Control Shares do not include shares of beneficial
interest the acquiring person is then entitled to vote as a result of having
previously obtained stockholder approval. A "Control Share Acquisition" means
the acquisition of Control Shares, subject to certain exceptions.
If voting rights are not approved at a meeting of stockholders then,
subject to certain conditions and limitations, the issuer may redeem any or all
of the Control Shares (except those for which voting rights have previously been
approved) for fair value. If voting rights for Control Shares are approved at a
stockholders meeting and the acquirer becomes entitled to vote a majority of the
shares of beneficial interest entitled to vote, all other stockholders may
exercise appraisal rights.
RISKS OF YEAR 2000 SOFTWARE COMPATIBILITY
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 Company's Planning and Awareness and Inventory Phases are currently 90%
complete, and, with respect to certain information systems and products, the
Detailed Assessment Phase is currently 65%
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complete. 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 not yet determined 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.
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. 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 adversely affect the Company's
business or results of operations.
Widespread disruptions in the national or international economy, including
disruptions affecting the financial markets, resulting from Year 2000 issues, or
in certain industries, such as commercial or investment banks or airlines, could
also have an adverse impact on the Company. The likelihood and effect of such
disruptions is not determinable at this time.
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.
ITEM 3. LEGAL PROCEEDINGS
The Company is currently subject to litigation and claims respecting
employment, tort, contract, construction and commissions, among others. In the
judgment of the Company's management, none of such lawsuits or claims against
the Company is likely to have a material adverse effect on the Company or its
business.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted to a vote of the Company's equity holders during
the fourth quarter of 1998.
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PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
The Company's Common Stock is listed on the New York Stock Exchange under
the symbol "OWN." The following table sets forth, the high and low sale prices
for the Common Stock for each quarter during the fiscal years ended December 31,
1998 and December 31, 1997.
HIGH LOW
------ ------
YEAR ENDED DECEMBER 31, 1998
Fourth Quarter............................................. $15.25 $ 4.06
Third Quarter.............................................. 15.81 6.50
Second Quarter............................................. 19.81 13.75
First Quarter.............................................. 25.75 19.06
YEAR ENDED DECEMBER 31, 1997(1)
Fourth Quarter............................................. 31.75 20.75
Third Quarter.............................................. 32.00 20.92
Second Quarter............................................. 23.50 13.00
First Quarter.............................................. 25.08 14.50
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(1) As adjusted for the Company's three-for-two stock split on October 27, 1997.
On March 1, 1999, there were approximately 192 holders of record of the
Company's Common Stock and the approximate number of beneficial stockholders was
3,572.
The Company has never declared or paid any cash dividends on its capital
stock and does not anticipate paying cash dividends on its Common Stock. The
Company currently intends to retain future earnings to finance its operations
and fund the growth of its business. Any payment of future dividends will be at
the discretion of the Board of Directors of the Company and will depend upon,
among other things, the Company's earnings, financial condition, capital
requirements, level of indebtedness, contractual restrictions in respect of the
payment of dividends and other factors that the Company's Board of Directors
deems relevant.
The Company's ability to pay dividends is restricted. See "Item 7.
Management's Discussion and Analysis of Financial Condition and Results of
Operations -- Liquidity and Capital Resources."
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ITEM 6. SELECTED FINANCIAL DATA
The following table sets forth summarized consolidated financial data of
the Company and gives effect to the Company's initial public offering, which was
consummated in August 1996. For all of the periods presented, the financial data
presented below gives effect to the AVCOM, PRG and LSI Acquisitions by combining
the historical information of AVCOM, PRG, LSI and the Company and restating the
historical financial data of the Company using the pooling-of-interests method
of accounting. The following financial data should be read in conjunction with
"Management's Discussion and Analysis of Financial Condition and Results of
Operations" and the consolidated financial statements for the Company and the
notes thereto, each of which are contained elsewhere in this 10-K.
YEAR ENDED DECEMBER 31,
------------------------------------------------------
1998 1997 1996 1995 1994
---------- -------- -------- -------- --------
(DOLLARS IN THOUSANDS)
INCOME STATEMENT DATA:
Revenues:
Vacation Interests sales........... $ 359,426 $281,063 $182,300 $139,426 $116,356
Interest income.................... 52,529 42,856 25,415 20,339 15,965
Gain on sales of mortgages
receivable...................... 6,698 -- -- -- --
Other income....................... 31,301 13,774 12,132 8,553 1,547
---------- -------- -------- -------- --------
Total revenues............. 449,954 337,693 219,847 168,318 133,868
---------- -------- -------- -------- --------
Costs and Operating Expenses:
Vacation Interests cost of sales... 85,649 71,437 48,218 39,810 33,082
Advertising, sales and marketing... 163,828 126,739 89,040 62,258 54,098
Loan portfolio:
Provision for doubtful
accounts(a)..................... 12,616 8,579 8,311 3,666 2,045
Other expenses..................... 3,680 5,522 4,523 2,034 1,466
General and administrative(a)...... 50,699 42,254 37,436 19,263 12,629
Depreciation and amortization(a)... 11,188 6,499 5,027 2,514 1,196
Merger costs, organizational costs
and asset writedowns(a)(b)...... 5,056 9,973 2,620 -- --
---------- -------- -------- -------- --------
Total costs and operating
expenses................. 332,716 271,003 195,175 129,545 104,516
---------- -------- -------- -------- --------
Income from operations............. 117,238 66,690 24,672 38,773 29,352
Interest expense, net................ 43,767 22,426 17,245 11,805 9,741
Equity loss on investment in joint
ventures........................... 708 639 299 1,649 271
Minority interest in income of
consolidated limited partnership... 18 181 199 -- --
---------- -------- -------- -------- --------
Income before provision (benefit)
for income taxes, extraordinary
items and cumulative effect of
change in accounting
principle....................... 72,745 43,444 6,929 25,319 19,340
---------- -------- -------- -------- --------
Provision (benefit) for income taxes
from continuing operations......... 28,371 17,196 (4,105) 4,020 2,768
Provision for deferred income taxes
resulting from the cumulative
effect of previously non-taxable
acquired entities.................. -- 5,960 -- -- --
---------- -------- -------- -------- --------
Total provision (benefit) for
income taxes............... 28,371 23,156 (4,105) 4,020 2,768
---------- -------- -------- -------- --------
Income before extraordinary item
and cumulative effect of change
in accounting principle......... 44,374 20,288 11,034 21,299 16,572
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YEAR ENDED DECEMBER 31,
------------------------------------------------------
1998 1997 1996 1995 1994
---------- -------- -------- -------- --------
(DOLLARS IN THOUSANDS)
Extraordinary items, net of tax.... 129 766 -- -- --
Cumulative effect of change in
accounting principle, net of
taxes........................... 1,466 -- -- -- --
---------- -------- -------- -------- --------
Net income...................... $ 42,779 $ 19,522 $ 11,034 $ 21,299 $ 16,572
========== ======== ======== ======== ========
Pro forma net income(c)............ $ 4,380 $ 15,310 $ 11,954
OTHER DATA (UNAUDITED FOR ALL
PERIODS):
EBITDA(d).......................... $ 136,211 $ 85,424 $ 44,622 $ 41,553 $ 31,553
Number of resort locations at
period end...................... 87 70 31 20 16
Number of Vacation Intervals
sold............................ 17,379 17,271 11,946 10,024 10,695
Number of Vacation Intervals in
inventory at period end......... 31,563(e) 29,168 30,399 23,439 6,915
Average price of Vacation Intervals
sold............................ $ 14,806 $ 13,885 $ 13,146 $ 12,298 $ 10,078
Number of Vacation Points sold
Club Sunterra................... 2,809,333 -- -- -- --
Sunterra Europe -- GVC.......... 351,881 180,426(f) 132,878 102,270 65,325
Sunterra Pacific -- VTS
Program....................... 171,557 13,629 -- -- --
Sunterra Japan -- SJVC.......... 11,810 -- -- -- --
Number of Vacation Points in
Inventory at Period End
Club Sunterra................... --(e) -- -- -- --
Sunterra Europe -- GVC.......... 470,302 461,473(f) 291,674 205,943 233,802
Sunterra Pacific -- VTS
Program....................... 169,674 138,081 -- -- --
Sunterra Japan -- SJVC.......... 180,708 -- -- -- --
Average Price of Vacation Points
sold............................
Club Sunterra................... $ 2 -- -- -- --
Sunterra Europe -- GVC.......... 211 $ 220(f) $ 186 $ 181 $ 198
Sunterra Pacific -- VTS
Program....................... 119 119 -- -- --
Sunterra Japan -- SJVC.......... 93 -- -- -- --
BALANCE SHEET DATA (AT END OF
PERIOD):
Cash and cash equivalents,
including escrow and restricted
cash............................ $ 54,201 $ 47,972 $ 22,469 $ 22,779 $ 17,015
Mortgages receivable, net.......... 335,982 331,735 215,518 147,405 102,470
Total assets....................... 1,021,132 761,145 445,884 295,771 210,218
Total debt......................... 627,089 435,208 236,122 177,032 123,009
Stockholders' equity............... 251,713 207,910 126,425 75,448 61,187
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(a) Non recurring costs for the year ended 1998 include $5.1 million relating to
the consolidation of certain administrative functions to Orlando, Florida
and the writedown of certain assets. Non-recurring costs for the year ended
December 31, 1997 are merger costs relating to the AVCOM, PRG and LSI
Acquisitions. Non-recurring costs for the year ended December 31, 1996
include costs incurred at AVCOM for (i) an increase in the provision for
doubtful accounts of $2.0 million, (ii) $9.1 million in severance costs,
lease cancellations, litigation reserves and other integration costs and a
reserve for losses associated with certain property management and related
contracts, (iii) a $2.6 million writedown of certain property to estimated
fair market value, and (iv) a $0.7 million charge relating to amortization
of start-up costs over a period of one year.
(b) Merger-related costs include expenses related to fees paid to financial
advisors, legal fees, and other transaction expenses in connection with the
AVCOM, PRG and LSI Acquisitions.
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(c) Reflects the effect on the historical statement of operations data, assuming
the combined Company had been treated as a C corporation rather than as
individual limited partnerships and limited liability companies for federal
income tax purposes.
(d) EBITDA represents net income before interest expense, income taxes,
non-recurring costs and depreciation and amortization. EBITDA is presented
because it is a widely accepted financial indicator of a company's ability
to service and/or incur indebtedness. However, EBITDA should not be
construed as a substitute for income from operations, net income or cash
flows from operating activities in analyzing the Company's operating
performance, financial position and cash flows. The EBITDA measure presented
herein may not be comparable to EBITDA as presented by other companies. The
following table reconciles EBITDA to net income:
YEAR ENDED DECEMBER 31,
----------------------------------------------------
1998 1997 1996 1995 1994
-------- ------- ------- ------- -------
(DOLLARS IN THOUSANDS)
Net income.............................. $ 42,779 $19,522 $11,034 $21,299 $16,572
Interest expense........................ 43,767 22,426 17,245 11,805 9,741
Capitalized interest expense
included in Vacation Interest
cost of sales......................... 3,455 3,082 1,718 1,915 1,276
Income taxes (benefit).................. 28,371 23,156 (4,105) 4,020 2,768
Non-recurring costs..................... 5,056(g) 9,973(g) 14,381(g) -- --
Depreciation and amortization........... 11,188 6,499 4,349(g) 2,514 1,196
Extraordinary items, net of tax......... 129 766 -- -- --
Cumulative effect of change in
accounting principle.................. 1,466 -- -- -- --
-------- ------- ------- ------- -------
EBITDA............................. $136,211 $85,424 $44,622 $41,553 $31,553
======== ======= ======= ======= =======
- ---------------
(e) All Vacation Interests to be sold as SunOptions in Club Sunterra have been
included as Vacation Interval inventory.
(f) Vacation Points assumed through the Global Acquisition have been converted
to GVC at a rate of ten to one.
(g) Non-recurring costs for the year ended December 31, 1998 include $5.1
million for certain consolidation activities and the write-down of certain
assets. Non-recurring costs for the year ended December 31, 1997 are merger
costs relating to the AVCOM, PRG and LSI Acquisitions. Non-recurring costs
for the year ended December 31, 1996 include costs incurred at AVCOM for (i)
an increase in the provision for doubtful accounts of $2.0 million, (ii)
$9.1 million in severance costs, lease cancellations, litigation reserves
and other integration costs and a reserve for losses associated with certain
property management and related contracts, (iii) a $2.6 million writedown of
certain property to estimated fair market value, and (iv) a $0.7 million
charge relating to amortization of start-up costs over a period of one year.
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ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
The following discussion should be read in conjunction with the preceding
Selected Financial Data and the Company's Financial Statements and the notes
thereto and the other financial data included elsewhere in this 10-K.
Management's Discussion and Analysis of Financial Condition and Results of
Operations contains forward-looking statements that involve risks and
uncertainties. The Company's actual results could differ materially from those
anticipated in these forward-looking statements as a result of certain factors,
including those set forth in "Business and Properties."
RESULTS OF OPERATIONS
The following discussion of the results of operations includes the
Company's corporate and partnership predecessors and wholly-owned subsidiaries
and affiliates including AVCOM, PRG, LSI and their subsidiaries. The AVCOM (10
resort locations), PRG (two resort locations) and LSI (11 resort locations)
Acquisitions were consummated in February, May and August 1997, respectively,
and were accounted for using pooling-of-interests accounting treatment for
business combinations. Under such accounting treatment, the results of
operations are restated to include the operations of each acquired entity for
the years ended December 31, 1997 and 1996. The following discussion also
includes the results of operations for Marc, Sunterra Pacific, the Global Group,
MMG and HTD. The Marc, Sunterra Pacific, Global, MMG and HTD Acquisitions were
each accounted for using the purchase method of accounting for the business
combinations. The Marc (22 managed resort locations), Sunterra Pacific (21
resort locations) and Global (13 resort locations) Acquisitions were consummated
in October, November and December 1997, respectively, for a combined purchase
price of $68.9 million in assets and assumption of $31.6 million in liabilities.
The MMG (6 resort locations) and HTD (one resort location) Acquisitions were
consummated in February and July 1998, respectively, for a combined purchase
price of $143.9 million in assets and assumption of $44.5 million in
liabilities.
Prior to its acquisition by the Company on February 7, 1997, AVCOM
recognized a net loss of $12.4 million for the year ended December 31, 1996. As
a result of applying pooling-of-interests accounting treatment to the AVCOM
Acquisition, this net loss has been reflected in the Company's consolidated
financial statements for the year ended December 31, 1996, reducing the
Company's 1996 reported consolidated net income. In addition, as a result of the
Company's 1997 merger costs and 1998 organization and asset writedown charges,
the Company incurred non-recurring costs, reducing the Company's 1997 and 1998
reported consolidated net income. Therefore, to allow for a more meaningful
comparison of the 1998, 1997 and 1996 financial results and management's
discussion and analysis of such financial results, reported total revenues and
operating expenses have been adjusted for non-recurring charges resulting from
the
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aforementioned activities. The following table details the adjustments to
reported total revenues and costs and operating expenses for such non-recurring
charges and revenues:
YEAR ENDED DECEMBER 31,
--------------------------
1998 1997 1996
------ ------ ------
(DOLLARS IN MILLIONS)
Total reported revenues.......................... $450.0 $337.7 $219.8
Other income(a).................................. -- -- (1.7)
------ ------ ------
Adjusted total revenues........................ $450.0 $337.7 $218.1
------ ------ ------
Total reported costs and expenses................ $332.7 $271.0 $195.2
Provision for doubtful accounts(b)............... -- -- (2.0)
General and administrative expenses(b)........... -- -- (9.1)
Merger costs, organizational costs, and
assets writedowns(b)(c)(d).................. (5.1) (10.0) (2.6)
Amortization of start-up costs(b)................ -- -- (0.7)
------ ------ ------
Adjusted total costs and expenses.............. $327.6 $261.0 $180.8
====== ====== ======
Adjusted income from operations................ $122.4 $ 76.7 $ 37.3
====== ====== ======
- ---------------
(a) For the year ended December 31, 1996, the Company recognized $1.7 million of
other income as the result of the settlement of certain receivables from the
former owners of the St. Maarten Resorts.
(b) As the result of the AVCOM Acquisition, the Company recognized the following
non-recurring charges for the year ended December 31, 1996: (i) $2.0 million
in the provision for doubtful accounts; (ii) $9.1 million in general and
administrative expenses for severance costs, lease cancellations, litigation
reserves, and a reserve for losses associated with certain property
management and related expenses; (iii) $2.6 million in resort property
valuation allowance for the write-down of certain property to fair market
value; and (iv) $0.7 million in depreciation and amortization for the
amortization of startup costs over a period of one year.
(c) For the year ended December 31, 1997, the Company recognized $10.0 million
in non-recurring merger costs for the AVCOM, PRG and LSI Acquisitions. These
charges include investment banking, legal, accounting and other professional
fees.
(d) For the year ended December 31, 1998, the Company expensed $5.1 million for
certain consolidation activities and the writedown of certain assets.
The following table sets forth certain operating information, as adjusted
for the non-recurring charges and revenues described above.
YEAR ENDED DECEMBER 31,
------------------------------------
1998 1997 1996
---------- -------- --------
AS A PERCENTAGE OF TOTAL REVENUES:
Vacation Interests sales................ 79.8% 83.2% 83.6%
Interest income......................... 11.7% 12.7% 11.6%
Gain of sales of mortgages receivable... 1.5% -- --
Other income............................ 7.0% 4.1% 4.8%
---------- -------- --------
Total revenues................ 100.0% 100.0% 100.0%
AS A PERCENTAGE OF VACATION INTERESTS
SALES:
Vacation Interests costs of sales....... 23.8% 25.4% 26.4%
Advertising, sales and marketing........ 45.6% 45.1% 48.8%
AS A PERCENTAGE OF TOTAL REVENUES:
General and administrative.............. 11.3% 12.5% 13.0%
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COMPARISON OF 1998 TO 1997
Comparison of the Year Ended December 31, 1998 to the Year Ended December 31,
1997
Total revenues for the year ended December 31, 1998 were $450.0 million
compared with $337.7 million in 1997, an increase of $112.3 million, or 33%.
Vacation Interests sales increased 28% to $359.4 million from $281.1 million.
The increase in Vacation Interests sales reflects increased prices for both
Vacation Points and Vacation Intervals at the Company's resorts, increased sales
activities at certain of the Company's resorts, the recording of Vacation Points
sales resulting from the Sunterra Pacific and Global Acquisitions, both of which
were consummated in the fourth quarter of 1997, and the recording of Vacation
Interval sales resulting from the MMG Acquisition which was consummated in
February 1998. Included in Vacation Interests sales in 1998 are approximately
$6.4 million of Vacation Point sales from Club Sunterra, the Company's new
points-based vacation ownership system that was implemented at certain resorts
and off-site sales locations during the fourth quarter of 1998.
Interest income increased 23% to $52.5 million during 1998 from $42.9
million during 1997, reflecting the increase in net mortgages receivable of
$83.2 million, or 25%, prior to the December 1998 sale of approximately $79.0
million into the Conduit Facility.
During 1998, the Company recorded gains from the sale of mortgages
receivable of $6.7 million as the result of four transactions. During the third
quarter of 1998 the Company closed three receivable sales consisting of $69.1,
$21.5, and $11.3 million face value of mortgages receivable. In connection with
the HTD Acquisition in July 1998, the Company sold $69.1 million of mortgages
receivable at 96% of par, while retaining a majority interest in the excess
interest spread. Additionally, in the third quarter of 1998, the Company sold
$21.5 million of mortgages receivable at face value and retained a majority
interest in the excess spread. During the third quarter, the Company sold $11.3
million of mortgages receivable at face value for 105% of par. During the fourth
quarter of 1998, the Company entered into the Conduit Facility and recorded a
$5.6 million pre-tax gain on a sale of $79.0 million of mortgages receivable.
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 1997.
Other income increased 127% to $31.3 million during 1998 from $13.8 million
during 1997, reflecting a significant increase in recurring resort management
fee revenues paid by the Company's growing member base. Other income also
includes rental income, commissions paid for the origination of European
mortgages receivable for a U.K.-based financial institution, and interest income
from short-term investments. As a percentage of total revenue, other income
increased to 7% during 1998, from 4% during 1997.
As a percentage of adjusted total revenues, adjusted total costs and
operating expenses improved to 73% during 1998 from 77% during 1997. 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. Adjusted total costs and operating expenses increased 26% to
$327.6 million during 1998 from $261.0 million during 1997.
As a percentage of Vacation Interests sales, Vacation Interests cost of
sales improved to 24% during 1998 from 25% during 1997. This improvement was
largely the result of favorable product cost reductions at some of the Company's
more mature resorts, along with a greater percentage of revenue coming from the
Company's comparatively lower product cost of its European operations. Vacation
Interests cost of sales increased 20% to $85.6 million during 1998 from $71.4
million during 1997.
As a percentage of Vacation Interests sales, advertising, sales and
marketing expenses increased slightly to 46% from 45%, due to higher marketing
expenses incurred to ramp up sales at Sunterra Pacific, which was acquired
during the fourth quarter of 1997. In addition, the Company is building
infrastructure in off-site sales centers in the U.S. and Europe, the costs of
which were expensed during 1998, as well as other marketing initiatives to
support the transition to Club Sunterra, the Company's new points-based vacation
ownership
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system. Advertising, sales and marketing expenses increased 29% to $163.8
million during 1998 from $126.7 million during 1997.
Other loan portfolio expenses decreased to $3.7 million from $5.5 million,
due largely to the cost savings associated with centralizing the servicing
efforts of PRG and AVCOM.
The provision for doubtful accounts increased $4.0 million to $12.6 million
during 1998 from $8.6 million during 1997. As a percentage of total revenues,
the provision for doubtful accounts was 3% during 1998 and 1997. The increase in
the provision as a percentage of revenues, as compared with the prior period, is
related primarily to the Company's internal review of the aging and
collectability of accrued interest at certain of its properties during the
second quarter of 1998.
As a percentage of adjusted total revenues, general and administrative
expenses improved to 11% during 1998 from 13% in 1997, reflecting the continued
elimination of duplicative overhead costs in consolidating acquisitions and
greater efficiencies resulting from the Company's larger size. General and
administrative expenses increased 20% to $50.7 million during 1998 from $42.3
million during 1997. The increase in general and administrative expenses was due
primarily to the acquisition of additional resorts and the development of Club
Sunterra in the past year.
Depreciation and amortization increased $4.7 million, or 72%, to $11.2
million during 1998 from $6.5 million in 1997. As a percentage of adjusted total
revenues, depreciation and amortization increased to 3% during 1998 from 2% for
1997. The increase in depreciation and amortization was driven by the
amortization of goodwill associated with the Marc, Sunterra Pacific, Global and
MMG Acquisitions, as well as additional depreciation expense reflecting a larger
base of depreciable assets from the prior period, including hardware and
software costs related to the development of the Company's Club Sunterra
points-based vacation ownership system and other infrastructure additions.
Interest expense, net of capitalized interest, increased $21.4 million, or
95%, to $43.8 million during 1998 from $22.4 million during 1997. The increase
was due primarily to increases in debt from public securities offerings and
borrowings under its Senior Credit Facility, and from the Company's privately
placed on-balance sheet asset-backed securitization issued in June 1998.
Adjusted income from operations increased to $122.4 million during the year
ended December 31, 1998 from $76.7 million for the year ended December 31, 1997.
Income before provision for income taxes, excluding merger, organization,
and asset writedown costs, increased 46% to $77.8 million during the year ended
December 31, 1998 from $53.4 million for the year ended December 31, 1997.
During the fourth quarter of 1998, the Company recorded a $1.5 million
cumulative effect of change in accounting principle, net of taxes, as the result
of the early adoption of the AICPA's Statement of Position 98-5 (SOP 98-5),
"Reporting on the Costs of Start-up Activities." The SOP required the Company to
expense all previously capitalized start-up costs as of January 1, 1998 and
requires the Company to expense all such expenses as incurred after January 1,
1998.
The Company's income tax rate was 39% for both years ending December 31,
1998 and 1997, resulting in net income of $42.8 million for the year ending
December 31, 1998, a 119% increase over $19.5 million for the year ended
December 31, 1997.
COMPARISON OF 1997 TO 1996
The following discussion of financial results adjusts the reported
statement of operations data for the non-recurring charges incurred during the
years ended December 31, 1997 and 1996. For the year ended December 31, 1997,
the Company recognized $10.0 million in non-recurring merger-related expenses
for the acquisition by merger of AVCOM, PRG and LSI and a $6.0 million charge to
record deferred taxes related to cumulative temporary differences between
financial and tax reporting for entities acquired in the PRG Acquisition that
were previously taxed as partnerships at the partner level. For the year ended
December 31, 1996, the Company incurred the following non-recurring charges
related to the AVCOM Acquisition:
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(i) general and administrative expense increased by $9.1 million for severance
costs, lease cancellations, litigation reserves, reserves for losses associated
with certain property management and related contracts; (ii) provision for
doubtful accounts increased by $2.0 million; (iii) resort property valuation
allowance increased by $2.6 million to write down certain property to market
value for projects initiated by AVCOM which were subsequently abandoned; and
(iv) depreciation and amortization increased by $0.7 million related to the
amortization of start-up costs over a period of one year. Also, in 1996, the
Company recognized $1.7 million of other income as the result of a settlement of
certain receivables from the former owners of the St. Maarten resorts.
Total reported revenues for the year ended December 31, 1997 were $337.7
million, compared with adjusted total revenues of $218.1 million in 1996, an
increase of $119.6 million, or 55%. Vacation Interests sales increased 54% to
$281.1 million from $182.3 million. The increase in Vacation Interest sales
reflects increased prices for both Vacation Intervals and Vacation Points at the
Company's resorts and increased sales activities at certain of the Company's
resorts.
Vacation Points sales during 1997 increased 66% to $41.1 million from $24.7
million in 1996. The increase in the number of Vacation Points sold in 1997 is
the result of a 30% increase in Vacation Points sold in LSI, along with the
addition of Vacation Points sales resulting from the Sunterra Pacific and Global
Acquisitions which were consummated in the fourth quarter of 1997.
Interest income increased 69% to $42.9 million from $25.4 million in 1996,
reflecting the increase in net mortgages receivable of $116.2 million, or 54%.
Other income, which includes rental income, management fees, commissions on
the sale of European receivables, and other interest income, increased $3.4
million to reported other income of $13.8 million in 1997 from adjusted other
income of $10.4 million in 1996, an increase of 33%.
Vacation Interests cost of sales, as a percentage of Vacation Interests
sales, was 25% for 1997, compared with 26% for the prior year as the Company
continued to purchase and construct vacation units at a discount to historical
development costs, reducing the unit cost on average for each Vacation Interest
sold.
Advertising, sales and marketing expenses increased $37.7 million to $126.7
million for 1997 from $89.0 million for 1996. As a percentage of Vacation
Interests sales, advertising, sales and marketing expenses decreased to 45% for
1997 from 49% for 1996. The decrease resulted primarily from decreased expenses
at the resorts acquired in the AVCOM Acquisition as well as from the
company-wide application of best marketing practices taken from the Company's
best performing resorts.
The provision for doubtful accounts increased $2.3 million during 1997 to
$8.6 million at year end from an adjusted $6.3 million at the end of 1996. The
allowance for doubtful accounts as a percentage of gross mortgages receivable
decreased to a reported 6.5% at December 31, 1997 from an adjusted 6.6% at
December 31, 1996.
General and administrative expenses increased to a reported $42.3 million
in 1997 from adjusted general and administrative expenses of $28.3 million in
1996, an increase of 49%. General and administrative expenses were 13% of 1997
reported total revenues and 1996 adjusted total revenues. The increase in
general and administrative expenses was the result of (i) the addition of a
number of senior officers and key executives in order to build the management
and organizational infrastructure necessary to efficiently manage the Company's
growth, (ii) increased overhead due to the acquisition of additional resorts,
and (iii) added salary, travel and office expenses attributable to the growth in
the size of the Company.
Depreciation and amortization increased $2.2 million, or 51%, to a reported
$6.5 million during 1997 from adjusted depreciation and amortization of $4.3
million in 1996, reflecting an increase in capital expenditures and intangible
assets. Depreciation and amortization was 2% of reported total revenues in 1997
and 2.0% of adjusted total revenues in 1996.
Interest expense, net of capitalized interest of $6.8 million and $6.7
million at December 31, 1997 and 1996, respectively, increased $5.2 million, or
30%, to $22.4 million for 1997 from $17.2 million in 1996. The
31
33
increase was due primarily to the interest on the Convertible Notes and the
Senior Subordinated Notes issued in 1997.
As a result of the factors discussed above and the $2.6 million resort
property valuation allowance, total costs and operating expenses increased by
$80.2 million, or 44%, to an adjusted $261.0 million in 1997 from an adjusted
$180.8 million in 1996. Total adjusted costs and operating expenses as a
percentage of reported total revenues were 77% in 1997. This represents a
decrease of 8% from adjusted total costs and operating expenses as a percentage
of adjusted total revenues of 83% in 1996.
In addition, as a result of the factors discussed above, adjusted income
before provision for income taxes and extraordinary item and non-recurring costs
increased 172% to $53.4 million in 1997 from $19.6 million for 1996. An
extraordinary item of $0.8 million, net of income taxes, was charged to net
income in 1997 as the result of the early retirement of notes payable to
financial institutions.
For 1997, income taxes increased $27.3 million over 1996, reflecting a
change in the Company's status to a C corporation subsequent to its August 1996
initial public offering, as well as a $6.0 million charge to income tax expense
taken in the fourth quarter resulting from recording deferred taxes for
previously non-taxable entities acquired in the PRG Acquisition. Previously, the
Company's predecessor entities only incurred federal income taxes with regard to
AVCOM and foreign income taxes with respect to LSI and the Company's
wholly-owned subsidiaries located in St. Maarten, Netherlands Antilles.
Reported income before extraordinary items and cumulative effect of change
in accounting principle was $20.3 million for 1997, an increase of $9.3 million,
or 85%, from $11.0 million in 1996. Reported net income was $19.5 million for
1997, compared with $11.0 million for 1996, an increase of $8.5 million or 77%.
Assuming the Company had been taxed as a C corporation in 1996, pro forma net
income would have been $4.4 million, compared with $19.5 million net income for
1997, an increase of 343%.
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) principal payments and customer prepayments of principal from its
mortgages receivable portfolio, (iv) interest from its mortgages receivable
portfolio, (v) rental of unsold Vacation Interests, (vi) receipt of management,
reservations and points-based vacation club fees, and (vii) commissions paid for
the origination of European mortgages receivable, where the Company is paid a
commission of 14% of the face value of certain mortgages originated for a third
party U.K. financial institution.
For the years ended December 31, 1998 and 1997, the Company used $54.1
million and $50.0 million in cash flows from operations, respectively. Excluding
investment in real estate and development costs of $183.1 million and $137.0
million, respectively, the Company generated cash flows from operations of
$129.0 million and $87.0 million for the year ended December 31, 1998 and 1997,
respectively. Approximately 80% of the Company's total revenues during 1998 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 the
sales of Vacation Interests. Prior to 1998, this strategy required the Company
to increase its levels of indebtedness on its Senior Credit Facility or other
existing revolving lines of credit.
During 1998, the Company began selling or securitizing its mortgages
receivable. The Company (i) completed a $100.3 million on-balance sheet
asset-backed securitization in the second quarter of 1998, (ii) sold $101.9
million in the third quarter of 1998 and (iii) sold $79.0 million through the
Conduit Facility in the fourth quarter of 1998.
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The Company intends to continue to convert its mortgages receivable to cash
through (i) whole mortgages receivable sales, (ii) off-balance sheet
asset-backed securitizations or (iii) the origination of mortgages receivable
for a third party institution and receipt of an origination fee, as the Company
currently does in its European operations.
The Company may warehouse mortgages receivable through the existing Senior
Credit Facility or Conduit Facility, until such mortgages receivable are sold.
The proceeds of the mortgages receivable sale would be used to repay the Senior
Credit Facility or Conduit Facility.
As of December 31, 1998, the Company had approximately $98.2 million
available on its Senior Credit Facility and $24.9 million on its Conduit
Facility. The Company also had available approximately $209.0 million of
unencumbered mortgages receivable. In addition, the Company is currently
negotiating an additional conduit facility and an off-balance sheet asset-backed
securitization. Both transactions are expected to close in the second quarter of
1999.
In April 1998, the Company completed its offering of $140 million aggregate
principal amount of its Senior Notes. The Company used most of the proceeds to
retire existing indebtedness under the Senior Credit Facility. The Company used
the balance of the net proceeds primarily to finance the acquisition and
development of additional resort locations and vacation ownership related
assets, and for working capital and other general corporate purposes.
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. This sale
will be without recourse to the Company for defaults experienced by the
mortgages receivable portfolios.
During 1998, the Company spent $99.3 million for the acquisition of
additional resort locations; $44.2 million for property and equipment, primarily
for the development of computer systems for property and Club Sunterra
management systems; and $183.1 million for expansion and development activities
at the Company's resort locations. The Company funded these activities through
(i) the issuance of $140 million Senior Notes, (ii) $101.9 million in mortgages
receivable sales, (iii) the $100.3 million on-balance sheet securitization and
(iv) borrowings on the Senior Credit Facility and (v) the sale of $79.0 million
of mortgages receivable through the Conduit Facility.
The Company expects to incur approximately $100.8 million in 1999 to
complete real estate and development projects, including $14.3 million to
complete projects currently under construction and $86.5 million for projects
planned to be constructed in 1999. However, the Company has not made any binding
commitments for such planned construction.
The Company believes that, with respect to its current operations, the
Senior Credit Facility and the Conduit Facility, together with cash on hand and
cash generated from operations, future borrowings, 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
December 31, 1998, 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 restricted 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
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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 sale 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.
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
will 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. The Project is expected to be completed
by the fourth quarter of 1999 and encompasses the following phases:
Phase 1 -- Planning and Awareness. Key tasks in the Planning and Awareness
Phase include defining Year 2000 compliance throughout the Company, developing
an initial project plan and budget, ensuring organizational awareness of Year
2000 compliance, and assessing the Project's potential impact and resource
requirements on the Company. The Company is in the process of developing an
Enterprise Schematic showing relationships for all computer systems and
networks. The Company will accomplish this by conducting a complete inventory of
all sites and resorts worldwide. The Company believes it is currently
approximately 90% complete with Phase 1, based on all currently identified
tasks.
Phase 2 -- Inventory. In the Inventory Phase, the Company will establish a
Year 2000 repository, which will contain all automated systems or inventory
elements and every electronic partner and interface. The Company will assess
known business and technical risks associated with each system and will assign a
business priority to each system or inventory element. The Company will also
develop plans, costs and schedules for the Detailed Assessment Phase. The
Company believes it is approximately 65% complete with Phase 2 based on all
currently identified tasks.
Phase 3 -- Detailed Assessment. The Detailed Assessment Phase will identify
and classify all Year 2000 problems the Company has had and will group these
problems into logical partitions for movement through the correction cycle
(resolution, test and deployment). The Company will assess whether or not to
repair, replace or retire specific affected systems. The Company believes it is
approximately 60% complete with Phase 3 based on all currently identified tasks.
Phase 4 -- Resolution. In the Resolution Phase, the Company will implement
resolution decisions and define system level go/no go decision criteria. The
Company will obtain and apply any needed commercial off the shelf (COTS) Year
2000 resolution products and/or will develop and execute required customized
solutions. The Company believes it is approximately 25% complete with Phase 4
based on all currently identified tasks.
Phase 5 -- Test Planning. The Test Planning Phase will include developing
comprehensive test plans to prevent non-compliant solutions from reaching
production operations. In addition, the Company will
34
36
coordinate with third parties and electronic partner interfaces, formulate
contingency plans, and obtain and construct mirror test environments and data.
The Company believes it is approximately 35% complete with Phase 5 based on all
currently identified tasks.
Phase 6 -- Test Execution. In the Test Execution Phase, the Company will
verify that all related development and test preparations are completed. The
Company will fully test each partition or deployment entity, including bridges
and data conversions. Included in this phase is the involvement of end users in
test execution and user signoff for each compliant partition. The Company
believes it is approximately 35% complete with Phase 6 based on all currently
identified tasks.
Phase 7 -- Deployment. The Deployment Phase will ensure that contingency
plans are in place. The Company will conduct final coordination with third
parties and electronic partners, stage appropriate bridges and data conversion
for deployment, deploy systems into the production environment, and execute
final system validation. The Company believes it is approximately 20% complete
with Phase 7 based on all currently identified tasks.
Phase 8 -- Follow-up. In the Follow-up Phase, the Company will regulate
continued Year 2000 compliance throughout its worldwide operations and will
develop procedures to minimize the impact of compliance efforts on its business
operations. Phase 8 is being conducted as Phases 1 to 7 progress.
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. A vendor has warranted the Company's financial portion of
this system to be Year 2000 compliant. The Company has been reviewing and will
continue to review its financial and operating systems at each of its offices
and resort locations.
The assessment, testing and resolution phases of the project are being
performed concurrently. As each mission critical system is tested, the
remediation, upgrade, or replacement if needed is begun. The Company currently
has found that four of its priority applications are Year 2000 compliant based
on the vendor representation or through testing by the Company. Two priority
applications are currently being remediated and the remaining ten applications
are in the process of being tested.
It is the Company's goal to have the Project completed for mission critical
systems by the fourth quarter of 1999. Based upon the analyses conducted to
date, the Company believes the mission critical systems at the Company's offices
and resort locations are either currently compliant or will be compliant by the
fourth quarter of 1999.
Costs. The Company has prepared a preliminary estimate of costs with regard
to making its mission critical systems Year 2000 compliant. At this time, the
Company's preliminary estimate of such is approximately $6 million. The Company
incurred approximately $0.8 million in 1998 and expects to incur an additional
$5.2 million in 1999 in costs associated with Year 2000 issues. The Company
expects that expenditures relating these issues will be funded from operating
cash flows. The preliminary estimate of costs includes administrative expenses,
testing, and hardware, software and facility replacement costs. The Company will
capitalize and depreciate the cost of any hardware, software and facility
replacement cost 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.
The preceding discussion should be read in conjunction with the financial
statements and notes included elsewhere in this 10-K. 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 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 this 10-K.
35
37
ITEM 7A. 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 year ended December 31, 1998 (primarily revenues derived from
the United Kingdom and Japan) were approximately 26% of total revenues. The
Company's net assets maintained in a functional currency other than U.S. dollars
at December 31, 1998 (primarily assets located in western Europe and Japan) were
approximately 8% 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 December 31, 1998, the Company had fixed interest rate debt of
approximately $572.4 million and floating interest rate debt of approximately
$54.7 million. The floating interest rates are based upon the prevailing LIBOR
rate or the prevailing prime interest rate for the Company's Senior Credit
Facility and endpaper debt, respectively. In addition, the Company sold $79.0
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 effect 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 effect 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 $0.8 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 $22 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.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
See the information set forth on Index to Financial Statements appearing on
page F-1 of the 10-K.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
Not Applicable.
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The information required by this Item will be set forth under "Directors
and Executive Officers" and "Proxy Statement -- Compliance with Section 16(a)
Under the Securities Exchange Act of 1934" in the Company's Definitive Proxy
Statement and reference is expressly made thereto for the specific information
incorporated herein by reference.
ITEM 11. EXECUTIVE COMPENSATION
The information required by this Item will be set forth under "Executive
Compensation" in the Company's Definitive Proxy Statement and reference is
expressly made thereto for the specific information incorporated herein by
reference.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The information required by this Item will be set forth under "Proxy
Statement -- Share Ownership of Directors and Executive Officers," "Other
Information -- Certain Stockholders" and "Proposal No. 1:
36
38
Election of Directors -- Compensation of Directors" in the Company's Definitive
Proxy Statement and reference is expressly made thereto for the specific
information incorporated herein by reference.
ITEM 13. CERTAIN RELATIONSHIP AND RELATED TRANSACTIONS
The information required by this Item will be set forth under "Certain
Transactions" in the Company's Definitive Proxy Statement, and reference is
expressly made thereto for the specific information incorporated herein by
reference.
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
(a) The following documents are filed as part of this report:
EXHIBIT
NUMBER DESCRIPTION
------- -----------
*3.1 Restated Articles of Incorporation of Sunterra Corporation
3.2 Bylaws of Sunterra Corporation, as amended (incorporated by
reference to Exhibit 3.2 to Registrant's Annual Report on
Form 10-K for the fiscal year ended December 31, 1996)
4.1 Indenture dated as of January 15, 1997 by and between
Sunterra Corporation and Norwest Bank Minnesota, National
Association, as trustee, for the 5 3/4% Convertible
Subordinated Notes of Sunterra Corporation due 2007
(incorporated by reference to Exhibit 4 to Registrant's
Registration Statement on Form S-1 (No. 333-30285))
4.2 Indenture dated as of August 1, 1997 by and between Sunterra
Corporation and Norwest Bank Minnesota, National
Association, as trustee, for the 9 3/4% Senior Subordinated
Notes of Sunterra Corporation due 2007 (incorporated by
reference to Exhibit 4.2 to Amendment No. 1 on Form S-3 to
Registrant's Registration Statement on Form S-1 (No.
333-30285))
4.3 Indenture dated as of April 15, 1998 by and between Sunterra
Corporation and Norwest Bank Minnesota, National
Association, as trustee for the 9 1/4% Senior Notes of
Sunterra Corporation due 2006 (incorporated by reference to
Exhibit 4.3 to the Registrant's Registration Statement on
Form S-4 (No. 333-51803))
4.4 Indenture dated a of May 1, 1998, by and between Sunterra
Finance L.L.C. as issuer of the bonds, Sunterra Corporation
as Servicer, and LaSalle National Bank as Trustee and
Back-up Servicer for Signature Resorts Vacation Ownership
Receivables -- Backed Notes 1998-A (incorporated by
reference to Exhibit 10.1 to the Registrant's Quarterly
Report on Form 10-Q for the quarter ended June 30, 1998)
*10.1 Credit Agreement dated as of February 18, 1998 by and among
Sunterra Corporation, certain lender parties thereto,
NationsBank of Texas, N.A., as administrative lender and
Societe Generale, as document agent, including Amendments 1,
2 and 3 thereto
10.2 Servicing Agreement dated as of May 1, 1998, by and between
Sunterra Finance L.L.C. as issuer of the bonds, Sunterra
Corporation as Servicer, and LaSalle National Bank as
Trustee and Back-up Servicer for Signature Resorts Vacation
Ownership Receivables -- Backed Notes 1998-A (incorporated
by reference to Exhibit 10.8 to the Registrant's quarterly
report on Form 10-Q for the quarter ended June 30, 1998)
*10.3 Receivables Purchase Agreement dated as of December 17, 1998
among Blue Bison Funding Corp., Sunterra Corporation and
Barton Capital Corporation
37
39
EXHIBIT
NUMBER DESCRIPTION
------- -----------
10.4 Construction Loan Agreement between Lake Tahoe Resort
Partners, LLC, and FINOVA Capital Corporation dated as of
April 29, 1996 (incorporated by reference to Exhibit 10.8.8
to Registrant's Registration Statement on Form S-1 (No.
333-18447))
10.5 Agreement of Limited Partnership of Pointe Resort Partners,
L.P. (subsequently renamed Poipu Resort Partners L.P.) dated
October 11, 1994 (incorporated by reference to Exhibit 10.4
to Registrant's Registration Statement on Form S-1 (No.
333-06027))
10.6 Joint Development Agreement dated as of January 16, 1998
between Westin Hotel Company and Sunterra Corporation
(incorporated by reference to Exhibit 10.1 to Registrant's
Current Report on Form 8-K filed with the Securities and
Exchange Commission on January 20, 1998))
10.7 Registration Rights Agreement dated as of August 20, 1996 by
and among Sunterra Corporation and the persons named therein
(incorporated by reference to Exhibit 10.1 to Registrant's
Registration Statement on Form S-1 (No. 333-30285))
10.8 Registration Rights Agreement dated as of May 15, 1997 by
and among Signature Resorts Inc. and the persons named
therein (incorporated by reference to Exhibit 4 to
Registrant's current report on Form 8-K filed with the
Commission on May 29, 1997)
10.9 Registration Rights Agreement dated as of August 28, 1997 by
and among Sunterra Corporation and Ian K. Ganney and Richard
Harrington (incorporated by reference to Exhibit 10.10 to
Amendment No. 1 on Form S-3 to Registrant's Registration
Statement on Form S-1 (No. 333-30285))
10.10 Registration Rights Agreement dated as of October 10, 1997
by and among Sunterra Corporation and Michael V. Paulin,
Rosemarie Paulin, Maya K. Paulin and Annemarie H. Paulin
(incorporated by reference to Exhibit 10.5 to Registrant's
Annual Report on Form 10-K for the fiscal year ended
December 31, 1997)
10.11 Employment Agreement between Sunterra Corporation and Andrew
J. Gessow (incorporated by reference to Exhibit 10.2.2 to
Registrant's Registration Statement on Form S-1 (No.
333-30285))
10.12 Employment Agreement between Sunterra Corporation and Steven
C. Kenninger (incorporated by reference to Exhibit 10.2.3 to
Registrant's Registration Statement on Form S-1 (No.
333-30285))
10.13 Employment Agreement between Sunterra Corporation and L.
Steven Miller (incorporated by reference to Exhibit 10.1 to
Registrant's Quarterly Report on Form 10-Q for the quarter
ended September 30, 1998)
*10.14 Employment Agreement between Sunterra Corporation and
Richard Goodman
10.15 Employment Agreement between Sunterra Corporation and James
E. Noyes (incorporated by reference to Exhibit 10.2.4 to
Registrant's Registration Statement on Form S-1 (No.
333-06027))
*10.16 Amended and Restated 1996 Equity Participation Plan of
Sunterra Corporation, including form of stock option
agreement thereunder
10.17 Sunterra Corporation Employee Stock Purchase Plan
(incorporated by reference to Exhibit 10.5 to Registrant's
Registration Statement on Form S-1 (No. 333-06027))
10.18 First Amendment to Employee Stock Plan of Sunterra
Corporation effective as of November 1, 1997 (incorporated
by reference to Exhibit 10.2 to Registrant's Registration
Statement on Form S-8 (No. 333-15361))
*10.19 1998 New-Hire Stock Option Plan of Sunterra Corporation
38
40
EXHIBIT
NUMBER DESCRIPTION
------- -----------
10.20 Amended Consulting Agreement dated as of August 1, 1997 by
and between Sunterra Corporation, Resort Services, Inc. and
Dr. Kay F. Gow and Robert T. Gow (incorporated by reference
to Exhibit 10.12 to Amendment No. 1 on Form S-3 to
Registrant's Registration Statement on Form S-1 (No.
333-30285))
*21 Subsidiaries of Sunterra Corporation
*23.1 Consent of Arthur Andersen LLP
*23.2 Consent of KPMG
*23.3 Consent of Schreeder, Wheeler & Flint, LLP
*27 Financial Data Schedule (for the fiscal year ended December
31, 1998)
- ---------------
* Filed herewith
(b) Reports on Form 8-K.
Current Report on Form 8-K dated November 4, 1998 filed with the Commission
on November 10, 1998 relating to the announcement of the Company's third
quarter 1998 earnings.
(c) The exhibits required by Item 601 of Regulation S-K have been listed above.
(d) Financial Statement Schedules
None. Schedules are omitted because of the absence of the conditions under
which they are required or because the information required by such omitted
schedules is set forth in the financial statements or the notes thereto.
39
41
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) 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/ THOMAS A. BELL
------------------------------------
Thomas A. Bell
Senior Vice President, General
Counsel
and Secretary
Dated: March 31, 1999
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below on behalf of the Registrant in the capacities and
on the dates indicated.
SIGNATURE TITLE DATE
--------- ----- ----
/s/ ANDREW J. GESSOW Co-Chairman of the Board March 31, 1999
- -----------------------------------------------------
Andrew J. Gessow
/s/ STEVEN C. KENNINGER Co-Chairman of the Board March 31, 1999
- -----------------------------------------------------
Steven C. Kenninger
/s/ L. STEVEN MILLER Director, President and Chief March 31, 1999
- ----------------------------------------------------- Executive Officer (Principal
L. Steven Miller Executive Officer)
/s/ RICHARD GOODMAN Executive Vice President and March 31, 1999
- ----------------------------------------------------- Chief Financial Officer
Richard Goodman (Principal Financial and
Accounting Officer)
/s/ JAMES E. NOYES Executive Vice March 31, 1999
- ----------------------------------------------------- President -- Sales and Director
James E. Noyes
/s/ OSAMU KANEKO Director March 31, 1999
- -----------------------------------------------------
Osamu Kaneko
/s/ ADAM M. ARON Director March 31, 1999
- -----------------------------------------------------
Adam M. Aron
/s/ SANFORD R. CLIMAN Director March 31, 1999
- -----------------------------------------------------
Sanford R. Climan
/s/ J. TAYLOR CRANDALL Director March 31, 1999
- -----------------------------------------------------
J. Taylor Crandall
/s/ JOSHUA S. FRIEDMAN Director March 31, 1999
- -----------------------------------------------------
Joshua S. Friedman
/s/ W. LEO KIELY III Director March 31, 1999
- -----------------------------------------------------
W. Leo Kiely III
40
42
INDEX TO FINANCIAL STATEMENTS
PAGE
----
Sunterra Corporation and Subsidiaries
Report of Independent Certified Public Accountants (Sunterra
Corporation for the years ending 1998, 1997, 1996)........ F-2
Independent Auditors' Report (LSI Group Holdings plc for the
year ended 1996).......................................... F-3
Consolidated Balance Sheets as of December 31, 1998 and
1997...................................................... F-4
Consolidated Statements of Income for each of the three
years ended December 31, 1998............................. F-5
Consolidated Statements of Cash Flows for each of the three
years ended December 31, 1998............................. F-6
Consolidated Statements of Equity for each of the three
years ended December 31, 1998............................. F-7
Notes to Consolidated Financial Statements.................. F-8
F-1
43
REPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS
To Sunterra Corporation:
We have audited the accompanying consolidated balance sheets of Sunterra
Corporation (formerly Signature Resorts, Inc.) (a Maryland corporation) and
subsidiaries as of December 31, 1998 and 1997, and the related consolidated
statements of income, equity and cash flows for each of the years in the
three-year period ended December 31, 1998. These financial statements are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these financial statements based on our audits. We did not audit the
1996 financial statements of LSI Group Holdings plc, a company acquired during
1997 in a transaction accounted for as a pooling of interests, as discussed in
Note 17. Such statements are included in the consolidated financial statements
of Sunterra Corporation and subsidiaries and reflect total revenues of 13
percent of the consolidated totals. These statements were audited by other
auditors whose report has been furnished to us and our opinion, insofar as it
relates to amounts included for LSI Group Holdings plc, is based solely upon the
report of the other auditors.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits and the report of other auditors provide a reasonable
basis for our opinion.
In our opinion, based on our audits and the report of the other auditors,
the financial statements referred to above present fairly, in all material
respects, the financial position of Sunterra Corporation and subsidiaries as of
December 31, 1998 and 1997, and the results of their operations and their cash
flows for each of the years in the three-year period ended December 31, 1998, in
conformity with generally accepted accounting principles.
Arthur Andersen LLP
Orlando, Florida,
February 10, 1999
F-2
44
INDEPENDENT AUDITORS' REPORT
Board of Directors and Shareholders
LSI Group Holdings Plc
We have audited the consolidated balance sheet of LSI Group Holdings plc
and subsidiaries as of December 31, 1996, and the related consolidated
statements of income, equity, and cash flows for the year ended December 31,
1996 (not presented separately herein). These financial statements are the
responsibility of Company's management. Our responsibility is to express an
opinion on these financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards in the United States of America. Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the financial position of LSI Group
Holdings plc and subsidiaries as of December 31, 1996, and the results of their
operations and their cash flows for the year ended December 31, 1996, in
conformity with generally accepted accounting principles in the United States of
America.
KPMG
Chartered Accountants
Registered Auditors
Preston, England
March 27, 1997
F-3
45
CONSOLIDATED BALANCE SHEETS
(AMOUNTS IN THOUSANDS EXCEPT SHARE AND PER SHARE DATA)
ASSETS
DECEMBER 31,
----------------------
1998 1997
---------- --------
Cash and cash equivalents................................... $ 28,250 $ 38,487
Cash in escrow and restricted cash.......................... 25,951 9,485
Mortgages receivable, net of an allowance of $22,869 and
$22,916 at December 31, 1998 and 1997, respectively....... 335,982 331,735
Retained interests.......................................... 12,518 --
Due from related parties.................................... 25,849 25,576
Other receivables, net...................................... 38,207 17,669
Income tax refund receivable................................ -- 4,719
Prepaid expenses and other assets........................... 22,031 13,047
Investment in joint ventures................................ 17,876 15,657
Real estate and development costs........................... 336,620 219,299
Property and equipment, net................................. 81,125 35,024
Intangible assets, net...................................... 96,723 50,447
---------- --------
Total assets...................................... $1,021,132 $761,145
========== ========
LIABILITIES AND STOCKHOLDERS' EQUITY
Accounts payable............................................ 21,864 $ 25,196
Accrued liabilities......................................... 80,242 68,047
Due to related parties...................................... -- 1,032
Income taxes payable........................................ 9,240 --
Deferred taxes.............................................. 30,984 23,752
Notes payable............................................... 627,089 435,208
---------- --------
Total liabilities................................. 769,419 553,235
---------- --------
Commitments and contingencies (Note 11)
Stockholders' equity:
Preferred stock (25,000,000 shares authorized; none issued
or outstanding)........................................ -- --
Common stock ($0.01 par value, 50,000,000 shares
authorized; 35,902,671 and 35,875,287 shares
outstanding at December 31, 1998 and 1997,
respectively).......................................... 359 359
Additional paid-in capital................................ 163,290 162,969
Retained earnings......................................... 86,581 43,797
Accumulated other comprehensive income.................... 1,483 785
---------- --------
Total stockholders' equity........................ 251,713 207,910
---------- --------
Total liabilities and stockholders' equity........ $1,021,132 $761,145
========== ========
The accompanying notes are an integral part of these consolidated financial
statements.
F-4
46
CONSOLIDATED STATEMENTS OF INCOME
(AMOUNTS IN THOUSANDS EXCEPT PER SHARE DATA)
YEAR ENDED DECEMBER 31,
--------------------------------
1998 1997 1996
-------- -------- --------
REVENUES:
Vacation Interests sales.................................... $359,426 $281,063 $182,300
Interest income............................................. 52,529 42,856 25,415
Gain on sales of mortgages receivable....................... 6,698 -- --
Other income................................................ 31,301 13,774 12,132
-------- -------- --------
Total revenues..................................... 449,954 337,693 219,847
-------- -------- --------
COSTS AND OPERATING EXPENSES:
Vacation Interest cost of sales............................. 85,649 71,437 48,218
Advertising, sales, and marketing........................... 163,828 126,739 89,040
Loan portfolio:
Provision for doubtful accounts........................... 12,616 8,579 8,311
Other expenses............................................ 3,680 5,522 4,523
General and administrative.................................. 50,699 42,254 37,436
Depreciation and amortization............................... 11,188 6,499 5,027
Merger costs, organizational costs and asset writedowns..... 5,056 9,973 2,620
-------- -------- --------
Total costs and operating expenses................. 332,716 271,003 195,175
-------- -------- --------
Income from operations...................................... 117,238 66,690 24,672
Interest expense (net of capitalized interest of $8,942,
$6,774, and $6,723 in 1998, 1997 and 1996,
respectively)............................................. 43,767 22,426 17,245
Equity loss on investment in joint ventures................. 708 639 299
Minority interest in income of consolidated limited
partnership............................................... 18 181 199
-------- -------- --------
Income before provision (benefit) for income taxes,
extraordinary items and cumulative effect of change in
accounting principle...................................... 72,745 43,444 6,929
-------- -------- --------
Provision (benefit) for income taxes from continuing
operations................................................ 28,371 17,196 (4,105)
Provision for deferred income taxes resulting from the
cumulative effect of previously non-taxable acquired
entities.................................................. -- 5,960 --
-------- -------- --------
Total provision (benefit) for income taxes......... 28,371 23,156 (4,105)
-------- -------- --------
Income before extraordinary items and cumulative effect of
change in accounting principle............................ 44,374 20,288 11,034
Extraordinary items, net of taxes........................... 129 766 --
Cumulative effect of change in accounting principle, net of
taxes..................................................... 1,466 -- --
-------- -------- --------
Net income.................................................. $ 42,779 $ 19,522 $ 11,034
======== ======== ========
PRO FORMA INCOME DATA (UNAUDITED):
Income before provision for income taxes.................... $ 6,929
Provision for income taxes.................................. 2,549
--------
Pro forma net income........................................ $ 4,380
========
EARNINGS PER SHARE (NOTE 3):
Basic:
Income before extraordinary item and cumulative effect of
change in accounting principle.......................... $ 1.24 $ 0.57 $ 0.41
Extraordinary item, net of taxes.......................... -- (0.02) --
Cumulative effect of change in accounting principle, net
of taxes................................................ (0.05) -- --
-------- -------- --------
Net income.................................................. $ 1.19 $ 0.55 $ 0.41
======== ======== ========
Diluted:
Income before extraordinary item and cumulative effect of
change in accounting principle.......................... $ 1.20 $ 0.56 $ 0.40
Extraordinary item, net of taxes.......................... -- (0.02) --
Cumulative effect of change in accounting principle, net
of taxes................................................ (0.04) -- --
-------- -------- --------
Net income................................................ $ 1.16 $ 0.54 $ 0.40
======== ======== ========
PRO FORMA EARNINGS PER SHARE: (UNAUDITED)
Basic..................................................... $ 0.16
Diluted................................................... $ 0.16
Weighted average number of common shares outstanding (Note
3)........................................................ 35,888 35,373 27,232
Weighted average number of common and potentially dilutive
common shares outstanding (Note 3)........................ 40,995 36,180 27,640
The accompanying notes are an integral part of these consolidated financial
statements.
F-5
47
CONSOLIDATED STATEMENTS OF CASH FLOWS
(AMOUNTS IN THOUSANDS)
YEAR ENDED DECEMBER 31,
-----------------------------------
1998 1997 1996
--------- --------- ---------
OPERATING ACTIVITIES:
Net income.............................................. $ 42,779 $ 19,522 $ 11,034
Adjustments to reconcile net income to net cash used in
operating activities:
Depreciation and amortization......................... 11,188 6,499 5,027
Provision for doubtful accounts....................... 12,616 8,579 8,311
Gain on sales of mortgages receivable................. (6,698) -- --
Writedown of certain assets........................... 3,506 -- 2,620
Cumulative effect of change in accounting principle... 2,403 -- --
Equity loss on investment in joint venture............ 708 639 299
Minority interest in income of consolidated limited
partnership........................................ 18 181 199
Other................................................. -- -- 573
Changes in operating assets and liabilities, net of
effect of acquisitions:
Cash in escrow and restricted cash................. (16,460) (6,916) 1,037
Due from related parties........................... (5,420) (12,504) (1,712)
Prepaid expenses and other assets.................. (7,814) 2,068 (5,878)
Investment in real estate and development costs.... (97,488) (65,595) (73,086)
Other receivables, net............................. (20,119) (4,448) (2,017)
Accounts payable and accrued liabilities........... 6,730 (10,398) 36,499
Income taxes....................................... 13,701 (6,518) 1,653
Deferred income taxes.............................. 7,237 19,481 (8,605)
Due to related parties............................. (1,032) (636) (250)
--------- --------- ---------
Net cash used in operating activities................... (54,145) (50,046) (24,296)
--------- --------- ---------
INVESTING ACTIVITIES:
Cash paid for acquisition of subsidiaries............... (99,340) (31,296) --
Property and equipment.................................. (44,241) (19,973) (8,214)
Intangible assets....................................... (8,247) (1,637) (2,206)
Mortgages receivable.................................... (117,526) (108,942) (76,424)
Proceeds from sales of mortgages receivable............. 173,146 -- --
Investment in joint ventures............................ (1,347) (8,899) (63)
--------- --------- ---------
Net cash used in investing activities................... (97,555) (170,747) (86,907)
--------- --------- ---------
FINANCING ACTIVITIES:
Proceeds from notes payable............................. 237,188 353,264 170,394
Payments on notes payable and mortgage-backed
securities............................................ (112,697) (167,229) (101,436)
Proceeds from Senior Credit Facility, net of debt
issuance costs........................................ 240,568 -- --
Payments on Senior Credit Facility...................... (224,615) -- --
Proceeds from notes payable to related parties.......... -- -- 5,606
Payments on notes payable to related parties............ -- -- (15,074)
Proceeds from stock offerings........................... -- 52,643 73,324
Acquisition of minority limited partners' interests..... -- -- (7,465)
Distributions........................................... -- (738) (14,413)
Other................................................... 321 648 420
--------- --------- ---------
Net cash provided by financing activities............... 140,765 238,588 111,356
--------- --------- ---------
Net (decrease)increase in cash and cash equivalents..... (10,935) 17,795 153
Effect of exchange rates on cash and cash equivalents... 698 (65) 574
Cash and cash equivalents, beginning of period.......... 38,487 20,757 20,030
--------- --------- ---------
Cash and cash equivalents, end of period................ $ 28,250 $ 38,487 $ 20,757
========= ========= =========
The accompanying notes are an integral part of these consolidated financial
statements.
F-6
48
CONSOLIDATED STATEMENTS OF EQUITY
(AMOUNTS IN THOUSANDS)
ADDITIONAL GENERAL
SHARES PAID-IN RETAINED MEMBERS PARTNERS'
OUTSTANDING AMOUNT CAPITAL EARNINGS EQUITY (DEFICIT) EQUITY
----------- ------ ---------- -------- ---------------- ---------
BALANCE AT DECEMBER 31, 1995................. 6,923 $ 89 $ 3,895 $35,607 $ (1,432) $ 4,176
------ ---- -------- ------- -------- --------
Distributions of partnership equity and other
equity interests........................... -- -- -- (7,191) (5,394) --
Conversion of convertible notes payable to
AVCOM common stock......................... -- -- 400 -- -- --
Proceeds from the sale of common stock to the
public, net of offering costs, including
16,212 shares issued in exchange for
partners' and members' equity.............. 25,268 253 73,071 -- -- --
Stock issued and goodwill recorded in
connection with the acquisition of
investment in joint venture................ 820 8 4,981 -- -- --
Acquisition of minority limited partners'
interests.................................. -- -- (7,465) -- -- --
Deferred taxes recorded in connection with
the Consolidation Transactions............. -- -- (9,464) -- -- --
Net income (loss)............................ -- -- -- 3,875 3,568 (164)
Exchange of partners' and members' equity for
stock in connection with the consolidation
transactions............................... -- (20) 37,380 (1,370) 3,258 (4,012)
Assignment to venturers' of receivable due
from related party......................... -- -- -- (3,449) -- --
Write-off of receivable from related party... -- -- -- (3,890) -- --
Other........................................ -- -- (820) (38) -- --
------ ---- -------- ------- -------- --------
BALANCE AT DECEMBER 31, 1996................. 33,011 330 101,978 23,544 -- --
------ ---- -------- ------- -------- --------
Comprehensive income for the year ending
December 31, 1996..........................
Net income................................... -- -- -- 19,522 -- --
Proceeds from the sale of common stock, net
of offering costs.......................... 2,400 24 52,619 -- -- --
Common stock issued in connection with
purchase of subsidiary..................... 213 2 6,008 -- -- --
Distributions................................ -- -- -- (738) -- --
Other........................................ 251 3 2,364 1,469 -- --
------ ---- -------- ------- -------- --------
BALANCE AT DECEMBER 31, 1997................. 35,875 359 162,969 43,797 -- --
------ ---- -------- ------- -------- --------
Comprehensive income for the year ending
December 31, 1997..........................
Net income................................... -- -- -- 42,779 -- --
Other........................................ 28 -- 321 5 -- --
------ ---- -------- ------- -------- --------
BALANCE AT DECEMBER 31, 1998................. 35,903 $359 $163,290 $86,581 $ -- $ --
====== ==== ======== ======= ======== ========
Comprehensive income for the year ending
December 31, 1998..........................
ACCUMULATED
LIMITED OTHER COM-
PARTNERS' PREHENSIVE TOTAL COMPREHENSIVE
EQUITY INCOME EQUITY INCOME
--------- ----------- -------- -------------
BALANCE AT DECEMBER 31, 1995................. $ 33,114 $ (1) $ 75,448
-------- ------ --------
Distributions of partnership equity and other
equity interests........................... (1,633) -- (14,218)
Conversion of convertible notes payable to
AVCOM common stock......................... -- -- 400
Proceeds from the sale of common stock to the
public, net of offering costs, including
16,212 shares issued in exchange for
partners' and members' equity.............. -- -- 73,324
Stock issued and goodwill recorded in
connection with the acquisition of
investment in joint venture................ -- -- 4,989
Acquisition of minority limited partners'
interests.................................. -- -- (7,465)
Deferred taxes recorded in connection with
the Consolidation Transactions............. -- -- (9,464)
Net income (loss)............................ 3,755 -- 11,034 $11,034
Exchange of partners' and members' equity for
stock in connection with the consolidation
transactions............................... (35,236) -- --
Assignment to venturers' of receivable due
from related party......................... -- -- (3,449)
Write-off of receivable from related party... -- -- (3,890)
Other........................................ -- 574 (284) 574
-------- ------ -------- -------
BALANCE AT DECEMBER 31, 1996................. -- 573 126,425
-------- ------ --------
Comprehensive income for the year ending
December 31, 1996.......................... $11,608
=======
Net income................................... -- -- 19,522 $19,522
Proceeds from the sale of common stock, net
of offering costs.......................... -- -- 52,643
Common stock issued in connection with
purchase of subsidiary..................... -- -- 6,010
Distributions................................ -- -- (738)
Other........................................ -- 212 4,048 212
-------- ------ -------- -------
BALANCE AT DECEMBER 31, 1997................. -- 785 207,910
-------- ------ --------
Comprehensive income for the year ending
December 31, 1997.......................... $19,734
=======
Net income................................... -- -- 42,779 $42,779
Other........................................ -- 698 1,024 698
-------- ------ -------- -------
BALANCE AT DECEMBER 31, 1998................. $ -- $1,483 $251,713
======== ====== ========
Comprehensive income for the year ending
December 31, 1998.......................... $43,477
=======
The accompanying notes are an integral part of these consolidated financial
statements.
F-7
49
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1998 AND 1997
1. NATURE OF BUSINESS
Sunterra Corporation (formerly Signature Resorts, Inc.) and its
wholly-owned subsidiaries ("the Company") generate revenues from the sale and
financing of vacation ownership interests in its resorts, which entitle the
buyer to use a fully-furnished vacation residence, generally for a one-week
period each year, in perpetuity (Vacation Intervals). The Company's operations
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 vacation 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 resort
management and maintenance services for which it receives fees paid by the
resorts' homeowners' associations.
The Company was incorporated in May 1996. On August 20, 1996, the Company
consummated an initial public offering of a portion of its Common Stock (the
"Initial Public Offering") by offering 9,056,250 shares to the public. The gross
proceeds from the public offering were $84.5 million. The Company incurred $11.2
million of costs associated with this offering. Concurrent with the Initial
Public Offering, certain predecessor limited partnerships, limited liability
companies and corporations (the "Entities") exchanged their direct or indirect
interest in, and obligations of the entities, for 16,211,558 shares of the
Company's common stock (the "Consolidation Transactions"). The accompanying
consolidated financial statements reflect the financial position and results of
operations of the Entities since the date they were acquired or formed, which
range from November 1986 to June 1996. Concurrent with the Initial Public
Offering, the Company exchanged 820,500 shares of Common Stock with the former
holders of interests in the Embassy Vacation Resort at Poipu Point, Koloa,
Kauai, Hawaii.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Principles of Consolidation -- The accompanying financial statements
include the combined accounts of Sunterra Corporation and the Company's
wholly-owned subsidiaries that were acquired or formed prior to August 20, 1996,
which became wholly-owned subsidiaries in connection with the Consolidation
Transactions. In addition, the financial statements give effect to the
acquisitions of AVCOM International, Inc. ("AVCOM"), Plantation Resorts Group,
Inc. ("PRG") and LSI Group Holdings plc ("LSI") that occurred during 1997 and
were treated as poolings-of-interests (see Note 17). All significant
intercompany transactions and balances have been eliminated from these
consolidated financial statements.
The Consolidation Transactions have been accounted for as a reorganization
of entities under common control. Accordingly, the net assets of the Entities
were recorded at the Entities' historical cost. In addition, the accompanying
consolidated financial statements reflect the historical results of operations
of the predecessor partnerships on a combined basis.
Cash and Cash Equivalents -- Cash and cash equivalents consist of cash,
money market, and all highly liquid investments purchased with an original
maturity of three months or less.
Cash in Escrow and Restricted Cash -- Cash in escrow is restricted cash
consisting of deposits received on sales of Vacation Interests that are held in
escrow until a certificate of occupancy is obtained or the legal rescission
period has expired. Restricted cash includes a cash reserve of approximately
$7.6 million required by the Securitized Notes (Note 8) and Conduit Facility
(Note 5).
Real Estate and Development Costs -- Real estate is valued at the lower of
cost or net realizable value. Development costs include both hard and soft
construction costs and together with real estate costs are allocated to Vacation
Interests. Interest, taxes, and other carrying costs incurred during the
construction period are capitalized.
F-8
50
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1998 AND 1997
Property and Equipment -- Property and equipment are recorded at cost and
depreciated using the straight-line method over the estimated useful life of 3
to 7 years. Administrative office buildings are amortized over the estimated
useful life of 40 years.
Depreciation and amortization expense related to property and equipment was
$6.5 million, $2.8 million and $1.5 million in 1998, 1997 and 1996,
respectively.
Investment in Joint Ventures -- The Company accounts for its investment in
its various joint ventures under the equity method of accounting. Any goodwill
associated with each joint venture is amortized as Vacation Interests are sold.
Intangible Assets -- In 1996 and 1997, organizational costs incurred in
connection with the formation of the Company were capitalized and were amortized
on a straight-line basis over a period of three to five years. In 1996 and 1997,
start-up costs related to costs incurred to develop marketing programs prior to
receiving regulatory approval to market the related property were amortized on a
straight-line basis over a period of one year. In 1998, the Company elected
early adoption of the AICPA's Statement of Position 98-5 (SOP 98-5), "Reporting
on Costs of Start-up Activities." As a result, the Company recorded a $1.5
million cumulative effect of change in accounting principle, net of taxes, which
represented the writeoff of all organizational and start-up costs capitalized
prior to January 1, 1998. All such costs were expensed as incurred in 1998.
Financing, loan origination fees and debt issuance costs incurred in
connection with obtaining funding for the Company have been capitalized and are
being amortized over three to ten years as interest expense.
Goodwill in connection with the acquisition of subsidiaries is being
amortized over the estimated useful lives of 10 to 30 years.
At each balance sheet date, the Company evaluates the reliability of its
goodwill based upon expectations of undiscounted cash flows and operating
income. Based upon its most recent analysis, the Company believes that no
material impairment of its goodwill exists at December 31, 1998.
Foreign Currency Translation -- Financial statements for the Company's
subsidiaries outside the United States are translated into U.S. dollars at
year-end exchange rates for assets and liabilities and weighted average exchange
rates for income and expenses. The resulting translation adjustments are
recorded as cumulative other comprehensive income in the consolidated statements
of equity.
Fourth Quarter Adjustments -- During the fourth quarter of 1998, the
Company recorded certain organization charges and asset writedowns totaling $5.1
million. The organizational charges related to anticipated severance and other
charges associated with its consolidation of certain corporate functions to the
Company's headquarters in Orlando, Florida.
Revenue Recognition -- The Company recognizes sales of Vacation Interests
on an accrual basis after a binding sales contract has been executed, a 10%
minimum down payment has been received, the rescission period has expired,
construction is substantially complete, and certain minimum sales levels have
been achieved. If all the criteria are met except that construction is not
substantially complete, then revenues are recognized on the
percentage-of-completion (cost to cost) basis. For sales that do not qualify for
either accrual or percentage-of-completion accounting, all revenue is deferred
using the deposit method.
Income Taxes -- Prior to August 20, 1996, the Entities were taxed either as
a corporation at the corporate level, as an S corporation taxable at the
shareholder level, or as a partnership taxable at the partner level. The Company
became subject to federal, state, and foreign income taxes from the effective
date of the Initial Public Offering. The 1996 pro forma net income per common
and common equivalent share uses the historical net income of the Company as
adjusted by the unaudited pro forma provision for income taxes to reflect the
net income per common and common equivalent share, as if the Company had been
treated as a C corporation rather than as individual limited partnerships and
limited liability companies for federal income tax purposes for the year ended
December 31, 1996.
F-9
51
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1998 AND 1997
The Company accounts for income taxes using an asset and liability approach
in accordance with Statement of Financial Accounting Standards (SFAS) No. 109,
Accounting for Income Taxes, which requires the recognition of deferred tax
assets and liabilities for the expected future tax consequences of events that
have been recognized in the Company's financial statements or tax returns.
Deferred tax assets and liabilities are measured by applying enacted statutory
tax rates applicable to the future years in which the related deferred tax
assets or liabilities are expected to be settled or realized. Income tax expense
consists of the taxes payable for the current period and the change during the
period in deferred tax assets and liabilities.
Use of Estimates -- The preparation of financial statements in conformity
with generally accepted accounting principles requires management to make
estimates and assumptions that affect the reported amounts of assets and
liabilities and disclosure of contingent assets and liabilities at the date of
the financial statements and the reported amounts of revenues and expenses
during the reporting period. Actual results could differ from those estimates.
Comprehensive Income -- In June 1997, the Financial Accounting Standards
Board (the "FASB") issued SFAS No. 130, Reporting Comprehensive Income (SFAS
130). SFAS 130 establishes standards for reporting and the display of
comprehensive income and its components in a financial statement that is
displayed with the same prominence as other financial statements. Comprehensive
income as defined includes all changes in equity (net assets) during a period
from non-owner sources. Examples of items to be included in comprehensive
income, which are excluded from net income, include foreign currency translation
adjustments and unrealized gain/loss on available-for-sale securities. The
disclosures prescribed by SFAS 130 were made beginning with the first quarter of
fiscal 1998.
Segment Reporting -- In June 1997, the FASB issued Statement No. 131,
Disclosures about Segments of an Enterprise and Related Information (SFAS 131).
This statement establishes standards for the way companies report information
about operating segments in annual financial statements. It also establishes
standards for related disclosures about products and services, geographic areas,
and major customers. The Company adopted SFAS 131 during 1998.
Reclassifications -- Certain reclassifications were made to the 1997 and
1996 accompanying consolidated financial statements to conform to the 1998
presentation.
F-10
52
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1998 AND 1997
3. 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 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 each of the three years in the period ended December 31,
1998.
YEAR ENDED DECEMBER 31,
-----------------------------
1998 1997 1996
------- ------- -------
(AMOUNT IN THOUSANDS)
Net income............................................ $42,779 $19,522 $11,034
Interest on convertible bonds(a)...................... 4,840 -- --
------- ------- -------
Net income available to common stockholders after
assumed conversion of dilutive securities(a)........ $47,619 $19,522 $11,034
======= ======= =======
Weighted average number of common shares used in basic
EPS................................................. 35,888 35,373 27,232
Effect of dilutive convertible bonds(a)............... 4,537 -- --
Effect of dilutive stock options...................... 570 807 408
------- ------- -------
Weighted average number of common shares and dilutive
potential common shares used in diluted EPS(a)...... 40,995 36,180 27,640
======= ======= =======
- ---------------
(a) The potential effect on net income and on common stock shares related to the
Convertible Notes have not been included in the 1997 or 1996 calculation of
net income or weighted average number of common shares and dilutive
potential common shares outstanding used in diluted EPS because the effect
would be anti-dilutive.
4. MORTGAGES RECEIVABLE, NET
The Company provides financing to the purchasers of Vacation Interests that
are collateralized by their interest in such Vacation Interests. The mortgages
receivable generally bear interest at the time of issuance of between 12% and
17%, which remain fixed over the term of the loan, which typically averages
seven to ten years. The mortgages receivable may be prepaid at any time without
penalty. The weighted average rate of interest on outstanding mortgages
receivable is 14.5% as of December 31, 1998.
Consumer loans in excess of 60 days past due, including defaulted loans and
loans in the deed-in-lieu process at December 31, 1998, were 7.4%, as a
percentage of gross mortgages receivable.
Additionally, the Company has accrued interest receivable related to
mortgages receivable of $9.1 million and $4.1 million at December 31, 1998 and
1997, respectively. The accrued interest receivable at December 31, 1998 and
1997 is net of an allowance for doubtful accounts of $0.6 million and $1.0
million, respectively, and is included in other receivables, net.
F-11
53
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1998 AND 1997
The following schedule reflects the scheduled contractual principal
maturities of mortgages receivable (amounts in thousands):
YEAR ENDING DECEMBER 31:
1999........................................................ $ 33,320
2000........................................................ 32,087
2001........................................................ 30,526
2002........................................................ 24,453
2003........................................................ 39,588
Thereafter.................................................. 198,877
--------
Total principal maturities of mortgages receivable.......... 358,851
Less allowance for doubtful accounts........................ (22,869)
--------
Net principal maturities of mortgages receivable............ $335,982
========
The activity in the mortgages receivable allowance for doubtful accounts is
as follows (amounts in thousands):
DECEMBER 31,
----------------------
1998 1997
------- -------
Balance, beginning of the period............................ $22,916 $17,328
Decrease in allowance for purchased mortgages receivable.... (584) (718)
Decrease in allowance for mortgages sold.................... (1,956) --
Increase in allowance for company acquired.................. 4,930 1,265
Provision for mortgages receivable doubtful accounts........ 11,409 7,234
Receivables charged off..................................... (13,846) (2,193)
------- -------
Balance, end of the period................................ $22,869 $22,916
======= =======
The provision for doubtful accounts for 1998 and 1997 includes $1.2 million
and $1.4 million, respectively, for other receivables.
5. SALES OF MORTGAGES RECEIVABLE
On December 31, 1998, the Company sold $79.0 million of Mortgages
Receivables 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 $5.6
million, net of expenses, as a result of the $79.0 million sale and a retained
interest held for sale in these mortgages receivable of $11.3 million. The
retained interest was valued by the Company assuming a 4.8% default rate (net of
recoveries), a 15% prepayment rate, an 18% discount rate, a 2.5% interest rate
on the 5% required reserve account, and a 6.5% annual interest rate on the
monthly balance of the financing. In addition, the receivables had a 8.4 year
weighted average remaining life and a weighted average interest rate of 15.1%.
The retained interest is classified as held for sale based on management's
intent and the existence of prepayment options.
During 1998, the Company also sold $101.9 million of gross mortgages
receivable for $99.7 million in cash in three separate transactions. As a result
of these sales, the Company recorded a $1.1 million gain on the sale of
mortgages receivable and a retained interest of $1.3 million. The Company sold
these receivables at prices from 96% to 105% of par value with a participation
in the remaining interest of 0% to 65%.
F-12
54
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1998 AND 1997
6. REAL ESTATE AND DEVELOPMENT COSTS
Real estate and development costs and accumulated Vacation Interests cost
of sales consist of the following (amounts in thousands):
DECEMBER 31,
--------------------------
1998 1997
--------- ---------
Land..................................................... 102,653 74,527
Development cost, excluding capitalized interest......... 536,053 370,151
Capitalized interest..................................... 28,992 20,050
--------- ---------
Total real estate and development costs................ 667,698 464,728
Less accumulated Vacation Interest cost of sales......... (328,458) (242,809)
Less resort property valuation allowance................. (2,620) (2,620)
--------- ---------
Net real estate and development costs.................. $ 336,620 $ 219,299
========= =========
During 1996, the Company recorded a $2.6 million property valuation
allowance to reduce real estate and development costs. During 1998 and 1997
there was no change in the resort property valuation allowance.
As of December 31, 1998, the Company commenced sales of Vacation Interests
at certain projects, or phases of certain projects, that are expected to be
completed during 1999. The estimated cost to complete the projects, or the
specific phases of the projects is approximately $14.3 million.
7. INTANGIBLE ASSETS
Intangible assets and accumulated amortization consist of the following
(amounts in thousands):
DECEMBER 31,
----------------------
1998 1997
------- -------
Goodwill.................................................... $74,600 $35,227
Debt issuance costs......................................... 22,119 15,257
Other....................................................... 10,364 7,471
------- -------
Total intangible assets................................... 107,083 57,955
Less accumulated amortization............................... (10,360) (7,508)
------- -------
Net intangible assets..................................... $96,723 $50,447
======= =======
Amortization expense was $4.7 million, $3.7 million and $3.5 million in
1998, 1997 and 1996, respectively. In addition, $2.7 million of amortized
intangibles were retired from the related asset and accumulated amortization
accounts in 1998.
F-13
55
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1998 AND 1997
8. NOTES PAYABLE
Notes payable consist of the following at December 31 (amounts in
thousands):
1998 1997
-------- --------
Endpaper loans with interest payable monthly at prime plus
2% to prime plus 3% (9.75% to 10.75% at December 31,
1998), payable in monthly installments of principal and
interest equal to 100% of all proceeds of the receivables
collateral collected during the month; due from
2003 - 2007............................................... $ 30,537 $ 62,676
Endpaper loans collateralized by specific mortgages
receivable with interest payable at prime plus 1.5% to
prime plus 1.75% (9.25% to 9.5% at December 31, 1998) or
LIBOR plus 4.25% (9.37% at December 31, 1998), payable in
monthly installments of principal and interest equal to
100% of all proceeds of the receivables collateral
collected during the month................................ -- 11,931
Senior Credit Facility of $117.5 million with interest
payable quarterly at rates ranging from LIBOR plus 7/8% to
LIBOR plus 1 3/8% (6.00 % to 6.50% on December 31, 1998);
collateralized by specific mortgages receivable due
February 2001............................................. 17,110 --
Securitized notes, collateralized by certain mortgages
receivable. Interest and principal is payable monthly at
an average interest rate of 6.7% due 2014................. 87,578 --
Securitized notes, collateralized by certain mortgages
receivable. Interest and principal is payable monthly at
an average interest rate of 7.75% due 2004................ 6,900 11,572
9.25% Senior Notes, interest due May and November, principal
due May 2006.............................................. 140,000 --
9.75% Senior Subordinated Notes, interest due April and
October and principal due October 2007.................... 200,000 200,000
5.75% Convertible Subordinated Notes, interest payments due
January and July, principal due January 2007.............. 138,000 138,000
Other notes payable......................................... 6,964 11,029
-------- --------
Total notes payable......................................... $627,089 $435,208
======== ========
In 1998, the Company entered into a $117.5 million senior bank credit
facility (the "Senior Credit Facility"). The Senior Credit Facility has a
variable borrowing rate based on the percentage of the Company's mortgages
receivable pledged under such facility and the amount of funds advanced
thereunder. The interest rate will vary between LIBOR plus 7/8% and LIBOR plus
1 3/8%, depending on the amount advanced against mortgages receivable. The
Senior Credit Facility has a three year term and contains covenants,
representations and warranties and conditions to borrow on the funds. At
December 31, 1998, the Company had $98.2 million available on the Senior Credit
Facility, $24.9 million available on its Conduit Facility and no amounts
available on its endpaper loans. At December 31, 1997, the Company had
approximately $186.0 million of borrowing capacity from various endpaper loans
and had no amounts available on its Senior Credit Facility and its Conduit
Facility.
The Convertible Notes are convertible into Common Stock at any time prior
to maturity, unless previously redeemed, at a conversion price of $30.417 per
share, subject to adjustment under certain events.
The Company's loan agreements contain certain covenants, the most
restrictive of which require certain of the consolidated entities to maintain a
minimum net worth and require certain expenses to not exceed certain percentages
of sales. At December 31, 1998, the Company was in compliance with all
covenants. Dividends are restricted by certain of the Company's debt agreements.
F-14
56
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1998 AND 1997
The expected maturities of the remaining long-term debt are as follows
(amounts in thousands):
DUE IN FISCAL YEAR
------------------
1999.............................. $ 37,504
2000.............................. 32,087
2001.............................. 30,525
2002.............................. 24,453
2003.............................. 24,520
2004 and thereafter............... 478,000
--------
$627,089
========
9. RELATED PARTY TRANSACTIONS
At December 31, 1998 and 1997, respectively, the Company had accrued $7.3
million and $6.0 million as net receivables from various homeowners'
associations at its resorts. The Company generally accrues receivables from
homeowners' associations for management fees and certain other expenses.
Payables to the homeowners' associations consist primarily of maintenance fees
for units owned by the Company. All of these amounts are classified as due from
and due to related parties in the accompanying consolidated balance sheets.
As of December 31, 1998, the Company had accounts receivable and notes
receivable of $2.8 million, and $11.9 million, respectively, from the Company's
joint ventures in Poipu Point, Hawaii, Kaanapali, Hawaii and St. John, U.S.
Virgin Islands. As of December 31, 1997, these accounts receivable and notes
receivable balances due from Poipu Point, Hawaii and St. John, U.S. Virgin
Islands were $2.7 million and $11.8 million, respectively. The accounts
receivable relate to certain reimbursable operating and development expenses.
The notes receivable represent loans made to the projects for start-up and
development activities.
In 1997, Messrs. Gessow, Kaneko and Kenninger transferred 100% of their
interest in the Embassy Vacation Resort at Kaanapali Beach (the "Kaanapali
Resort") in exchange for the Company's agreement to reimburse to them expenses
they had incurred to acquire the Kaanapali Resort. On June 9, 1998, the Board of
Directors of the Company approved the reimbursement by the Company of an
aggregate of $626,858 to Messrs. Gessow ($250,743), Kaneko ($250,743) and
Kenninger ($125,372) for expenses incurred by them individually in connection
with the acquisition of the Kaanapali Resort. The Company has been previously
reimbursed $275,639 by The Whitehall Fund of Goldman Sachs and Apollo, the
Company's partners in the Kaanapali Resort for their pro rata portion of such
expenses.
F-15
57
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1998 AND 1997
10. SUPPLEMENTAL CASH FLOW DISCLOSURE
The following schedule provides certain supplemental disclosure of cash
flows as well as supplemental disclosure of non-cash transactions that should be
read in conjunction with the accompanying consolidated statements of cash flows.
YEAR ENDED DECEMBER 31,
-----------------------------
1998 1997 1996
------- ------- -------
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Cash paid for interest...................................... $52,607 $18,508 $24,127
Cash paid for taxes, net of tax refunds..................... $ 1,968 $ 7,918 $ 1,629
SUPPLEMENTAL DISCLOSURE OF NON-CASH INFORMATION:
Stock issued in connection with acquisition of Marc
Resorts................................................... $ -- $ 6,010 --
Costs incurred in conjunction with debt issuances........... $ 9,295 $12,824 --
Tax benefit resulting from exercise of common stock
options................................................... $ -- $ 1,469 --
Stock issued and goodwill recorded in connection with the
acquisition of investment in joint venture................ -- -- $ 4,989
Deferred taxes recorded in connection with the Consolidation
Transactions.............................................. -- -- $ 9,464
Interest accrued on deferred installment gains in connection
with the Consolidation Transactions....................... -- -- $ 820
Net assets of predecessor partnership acquired in exchange
for 17,032,058 shares of common stock in connection with
the Consolidation Transactions............................ -- -- $37,380
Assignment to venturers of receivable due from related party
recorded as a reduction of venturers' equity.............. -- -- $ 3,449
Write-off of receivable from related party recorded as a
reduction of stockholders' equity......................... -- -- $ 3,890
Conversion of convertible notes payable to AVCOM common
stock..................................................... -- -- $ 400
11. COMMITMENTS AND CONTINGENCIES
The Company is currently subject to litigation and claims regarding
employment, tort, contract, construction, and commission disputes, among others.
In the judgment of management, none of such litigation or claims against the
Company is likely to have a material adverse effect on the Company's financial
statements or its business.
The Company owns a partnership interest in the Embassy Vacation Resort at
Poipu Point, Koloa, Kauai, Hawaii. Under the terms of the partnership agreement,
the Company could be required to purchase the other partner's interest. At
December 31, 1998, the Company does not believe that the events requiring such
purchase are likely to occur.
12. FAIR VALUE OF FINANCIAL INSTRUMENTS
SFAS No. 107, Disclosures about Fair Value of Financial Instruments,
requires that the Company disclose estimated fair values for its financial
instruments. The following methods and assumptions were used by the Company in
estimating its fair value disclosures for financial instruments:
Cash and cash equivalents and cash in escrow: The carrying amount reported
in the balance sheet for cash and cash equivalents and cash in escrow
approximates their fair value because of the short maturity of these
instruments.
F-16
58
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1998 AND 1997
Retained Interests: The carrying amount reported is reported at its fair
value based on the assumptions disclosed in Note 5.
Mortgages receivable: The carrying amount reported in the balance sheet for
mortgages receivable approximates its fair value because the weighted average
interest rate on the portfolio of mortgages receivable approximates current
interest rates to be received on similar current mortgages receivable.
Notes payable: The carrying amount reported in the balance sheet for notes
payable approximates its fair value because the interest rates on these
instruments approximate current interest rates charged on similar current
borrowings.
13. STOCK OPTIONS
The Company issued 2,749,600 and 1,054,500 stock options during 1998 and
1997, respectively. The Company accounts for these options under APB Opinion No.
25, Accounting for Stock Issued to Employees, under which no compensation cost
has been recognized. Under SFAS 123, Accounting for Stock-Based Compensation,
the Company's net income would have been $38.7 million and basic and diluted
earnings per share would have been, $1.08 and $1.06, respectively, on an
unaudited pro forma basis for the year ended December 31, 1998. The Company's
unaudited net income would have been $16.9 million, and basic and diluted
unaudited earnings per share would have been $0.48 and $0.47, respectively, for
the year ended December 31, 1997. As of December 31, 1998, 163,000 options were
available for grant under the Company's equity participation plans. A summary of
the Company's stock options for the years ended December 31, 1998 and 1997 is
presented in the following table:
1998 1997
------------------------------ ------------------------------
WEIGHTED AVERAGE WEIGHTED AVERAGE
OPTIONS EXERCISE PRICE OPTIONS EXERCISE PRICE
---------- ---------------- ---------- ----------------
Outstanding options,
beginning of year........ 3,289,407 $14.45 2,653,500 $10.29
Granted.................... 2,749,600 13.49 1,054,500 23.99
Exercised.................. (600) 9.33 (250,180) 9.33
Forfeited.................. (846,207) 28.60 (168,413) 16.42
Expired.................... -- -- -- --
---------- ------ ---------- ------
Outstanding options, end of
year..................... 5,192,200 $10.21 3,289,407 $14.45
Exercisable at end of
year..................... 1,078,490 $10.41 817,528 $10.50
========== ====== ========== ======
Weighted average fair value
of options granted....... $ 5.64 $ 5.32
All stock options issued by the Company were issued to employees at fair
market value on the grant date. The options range from 3 to 5 years for full
maturity and the exercise prices range from $8.00 to $28.25.
The weighted average fair value of options granted is estimated on the date
of the grant using the Black-Scholes option pricing model with the following
assumptions: risk free interest rate of 6.0%, expected dividend yield of zero,
expected volatility of 35%, and expected lives of 3 to 5 years in 1998 and 1997.
14. EMPLOYEE BENEFIT PLANS
The Company has established the Sunterra Resorts, Inc. Employee Stock
Purchase Plan to assist eligible employees to acquire stock ownership in the
Company and to encourage them to remain in the employment of the Company. The
Employee Stock Purchase Plan is intended to meet the requirements of an
"employee stock purchase plan" under Section 423 of the Internal Revenue Code of
1986, as amended, and generally allows eligible employees to purchase common
stock at 85% of fair market value, subject to dollar limitations.
F-17
59
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1998 AND 1997
The Company has reserved a maximum of 750,000 shares of Common Stock for
issuance pursuant to the Employee Stock Purchase Plan. As of December 31, 1998
and 1997, an aggregate of 29,269 and 2,482 shares, respectively, had been issued
pursuant to the Employee Stock Purchase Plan.
The Company also has established a qualified retirement plan, with a salary
deferral feature designed to qualify under Section 401 of the Internal Revenue
Code of 1986, as amended. Subject to certain limitations, the 401(k) Plan allows
participating employees to defer up to 15% of their eligible compensation on a
pre-tax basis. Although the 401(k) Plan allows the Company to make discretionary
matching contributions of up to 50% of employee contributions, the Company did
not make any such matching contributions during 1998, 1997, or 1996.
15. INCOME TAXES
The Entities and PRG were taxed prior to August 20, 1996 and May 15, 1997,
respectively either as a corporation at the corporate level, as an S corporation
taxable at the shareholder level, or as a partnership taxable at the partner
level. Accordingly, the table below summarizes the unaudited pro forma provision
for income taxes that would have been reported had the Company been treated as a
C corporation for federal income tax purposes for the year ended December 31,
1996. AVCOM's and LSI's actual deferred income taxes and provision for income
taxes are included in the pro forma schedule and 1996 actuals. The Company's
actual income tax provision is presented for the periods subsequent to August
20, 1996.
YEAR ENDED DECEMBER 31,
-----------------------------------------
1998 1997 1996 1996
------- ------- ------- -----------
(PRO FORMA)
(UNAUDITED)
(AMOUNTS IN THOUSANDS)
Current:
Federal....................................... $ 8,570 $ 2,194 $ 2,785 $4,990
State......................................... 1,666 461 481 846
Foreign....................................... 5,691 2,533 1,240 1,233
------- ------- ------- ------
Total current provision for income taxes...... 15,927 5,188 4,506 7,069
------- ------- ------- ------
Deferred:
Federal....................................... 11,385 16,125 (7,182) (3,675)
State......................................... 1,301 1,843 (1,393) (809)
Foreign....................................... (242) -- (36) (36)
------- ------- ------- ------
Total deferred provision (benefit) for income
taxes...................................... 12,444 17,968 (8,611) (4,520)
------- ------- ------- ------
Provision (benefit) for income taxes.......... $28,371 $23,156 $(4,105) $2,549
======= ======= ======= ======
F-18
60
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1998 AND 1997
The reconciliation between the statutory provision for income taxes and the
actual provision (benefit) for income taxes is shown as follows (amounts in
thousands):
YEAR ENDED DECEMBER 31,
--------------------------------------------
1998 1997 1996 1996
------- ------- ------- -----------
(PRO FORMA)
(UNAUDITED)
Income tax at U.S. federal statutory
rate.................................... $25,461 $15,205 $ 2,357 $2,357
State tax, net of federal benefit......... 1,929 1,738 163 163
Difference in foreign tax rates........... (202) (994) (34) (34)
Non-deductible expenses................... 610 3,192 598 63
Deferred income taxes recorded upon
acquisition of previously non-taxable
entities................................ -- 5,960 -- --
Write-off of receivable from related
party................................... -- -- (1,478) --
Non-taxable income from entities.......... -- (1,050) (5,711) --
Other..................................... 573 (895) -- --
------- ------- ------- ------
Provision (benefit) for income taxes.... $28,371 $23,156 $(4,105) $2,549
======= ======= ======= ======
Deferred income taxes reflect the net tax effects of temporary differences
between the carrying amounts of assets and liabilities for financial reporting
purposes and the amounts used for income tax purposes. The significant
components of the net deferred tax liabilities were as follows (amounts in
thousands):
DECEMBER 31,
------------------------
1998 1997
-------- --------
Deferred tax assets:
Allowance for doubtful accounts............................ $ 12,084 $ 8,867
Fixed assets and inventory................................. 1,666 1,305
Accrued expenses........................................... 1,961 4,152
Adjustment to basis of partnership property................ 1,429 3,474
Net operating loss carryover............................... 33,250 29,439
Foreign tax credit carryover............................... 991 62
Minimum tax credit carryover............................... 8,840 5,776
Other...................................................... 1,963 367
-------- --------
Total gross deferred tax assets.................. 62,184 53,442
Valuation allowance........................................ -- (2,367)
-------- --------
Total net deferred tax asset..................... $ 62,184 $ 51,075
-------- --------
Deferred tax liabilities:
Installment sales.......................................... (87,536) (73,818)
Percentage of completion................................... (4,784) (160)
Other...................................................... (848) (849)
-------- --------
Total deferred tax liabilities................... $(93,168) $(74,827)
-------- --------
Net deferred taxes......................................... $(30,984) $(23,752)
======== ========
At December 31, 1998, the Company has available approximately $85 million
of unused net operating loss carryforwards (the "NOLs") that may be applied
against future taxable income. These NOLs expire on various dates from 2004
through 2018.
The valuation allowance of $2.4 million in 1997 was related to loss
carryforwards acquired in a 1997 company purchase. Deferred tax liabilities
generated during the current year favorably impacted the future realization of
these loss carryforwards resulting in the reversal of this reserve. Income taxes
currently payable
F-19
61
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1998 AND 1997
have not been affected by the change in reserve. The reversal of the reserve
reduced the goodwill recorded on the 1997 company acquisition.
Provision has not been made for taxes on approximately $5.3 million of
undistributed earnings of foreign subsidiaries. Those earnings have been and are
expected to be reinvested in the foreign subsidiaries. These earnings could
become subject to additional tax if they were remitted to the Company, or if the
Company were to sell its stock in the subsidiaries. It is not practicable to
estimate the amount of additional tax that might be payable on the foreign
earnings; however, the Company believes that U.S. foreign tax credits would
largely eliminate any U.S. tax and offset any foreign tax.
16. 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). 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 (amounts in thousands):
UNITED STATES FOREIGN TOTAL
------------- -------- ----------
1998
Total revenues.................................... $336,060 $113,894 $ 449,954
Income before provision for income taxes,
extraordinary items and cumulative effect...... 55,181 17,564 72,745
Identifiable assets............................... 939,332 81,800 1,021,132
1997
Total revenues.................................... $270,296 $ 67,397 $ 337,693
Income before provision for income taxes,
extraordinary items............................ 31,177 12,267 43,444
Identifiable assets............................... 701,509 59,636 761,145
1996
Total revenues.................................... $179,003 $ 40,844 $ 219,847
Income before provision for income taxes.......... 356 6,573 6,929
Identifiable Assets............................... 412,339 33,545 445,884
17. ACQUISITIONS
On February 7, 1997, the Company consummated its acquisition by merger of
AVCOM (the "AVCOM Acquisition"). AVCOM is the parent company of All Seasons
Resorts, Inc., a developer, marketer and operator of vacation ownership resorts
in Arizona, California and Texas. Under the terms of the AVCOM merger agreement,
the Company issued 1,324,554 shares of its common stock in exchange for all the
outstanding capital stock of AVCOM. The AVCOM Acquisition has been treated as a
pooling-of-interests and is reflected in the accompanying consolidated financial
statements as if it took place at the beginning of the earliest period
presented.
F-20
62
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1998 AND 1997
On May 15, 1997, the Company consummated its acquisition by merger ("the
PRG Acquisition") of (PRG), a Williamsburg, Virginia, based developer, owner and
operator of vacation ownership resorts in Williamsburg, Virginia. PRG was
incorporated in April 1997 through a private placement of its common stock in
which certain predecessor joint ventures and corporations (the "PRG Entities")
exchanged their interests for shares of PRG's common stock (the "PRG Exchange").
The PRG Acquisition was consummated through the issuance of 3,601,844 shares of
the Company's common stock. The PRG Acquisition has been treated as a
pooling-of-interests and is reflected in the accompanying consolidated financial
statements as if it took place at the beginning of the earliest period
presented.
On August 28, 1997, the Company consummated its acquisition by merger of
100% of the capital stock of LSI in exchange for 1,996,401 newly-issued shares
of the Company's common stock and approximately $1.0 million in cash (the "LSI
Acquisition"). United Kingdom-based LSI is a developer, owner and operator of
vacation ownership resorts located in Europe. Through its Grand Vacation Club,
LSI operates a points-based club system. The LSI Acquisition has been treated as
a pooling-of-interests and is reflected in the accompanying consolidated
financial statements as if it took place at the beginning of the earliest period
presented.
During 1998, the Company acquired MMG Holding Corporation, Harich Tahoe
Development, and ten resorts located in the United States, Europe, and Japan,
all in separate transactions. During 1997, the Company acquired Marc Hotels &
Resorts, Inc., Vacation International, Ltd., and Global Development Ltd. all in
separate transactions. Each of the aforementioned acquisitions in 1998 and 1997
were accounted for under the purchase method for business combinations. Assets
acquired and liabilities assumed in connection with the Company's 1998 and 1997
purchases are as follows (amounts in thousands):
1998 1997
-------- -------
Assets acquired in acquisitions:
Cash in escrow............................................ $ 6 $ 857
Mortgages receivable, net................................. 74,655 14,509
Due from related parties.................................. 317 1,175
Other receivables, net.................................... 2,091 2,719
Prepaid expenses and other................................ 1,170 377
Real estate and development costs......................... 19,833 10,834
Property and equipment, net............................... 8,362 3,202
Goodwill in conjunction with acquisitions................. 37,421 35,186
-------- -------
Total assets acquired in acquisitions............. $143,855 $68,859
======== =======
Liabilities assumed in acquisitions:
Accounts payable.......................................... 5,995 8,666
Accrued liabilities....................................... 3,005 21,359
Due to related parties.................................... -- 12
Deferred income taxes..................................... 258 1,012
Notes payable............................................. 35,257 227
Cumulative translation adjustments........................ -- 277
-------- -------
Total liabilities assumed in acquisitions......... $ 44,515 $31,553
======== =======
F-21
63
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1998 AND 1997
The following table sets forth certain unaudited pro forma information for
the Company's purchases as if they had occurred as of the beginning of the year
acquired and the immediately preceding year for 1998, 1997 and 1996 (amounts in
thousands, except per share data).
PRO FORMA
ACTUAL ADJUSTMENTS TOTAL
-------- ----------- -----------
(UNAUDITED) (UNAUDITED)
Year ended December 31, 1998
Total Revenues......................................... $449,954 $(17,362) $432,592
Net Income............................................. 42,779 (2,510) 40,269
Basic EPS.............................................. $ 1.19 $ 1.12
Diluted EPS............................................ $ 1.16 $ 1.10
Year ended December 31, 1997
Total revenues......................................... $337,693 $ 67,932 $405,625
Net income............................................. 19,522 (1,758) 17,764
Basic EPS.............................................. $ 0.55 $ 0.50
Diluted EPS............................................ $ 0.54 $ 0.49
Year ended December 31, 1996
Total revenues......................................... $219,847 $ 74,014 $293,861
Net income............................................. 11,034 261 11,295
Basic EPS.............................................. $ 0.41 $ 0.41
Diluted EPS............................................ $ 0.40 $ 0.41
Total revenues and net income for the Company, AVCOM and its subsidiaries,
PRG and LSI, all acquired by pooling of interests in 1997, are shown in the
following table (amounts in millions) for the year ended 1996, which represents
the period prior to the poolings:
1996
------
Revenues
Consolidated...................... $219.8
AVCOM............................. 48.4
PRG............................... 48.4
LSI............................... 27.9
Net income (loss)
Consolidated...................... $ 11.0
AVCOM............................. (12.4)
PRG............................... 7.0
LSI............................... 2.3
F-22
64
EXHIBIT INDEX
EXHIBIT
NUMBER DESCRIPTION
------- -----------
*3.1 Restated Articles of Incorporation of Sunterra Corporation
3.2 Bylaws of Sunterra Corporation, as amended (incorporated by
reference to Exhibit 3.2 to Registrant's Annual Report on
Form 10-K for the fiscal year ended December 31, 1996)
4.1 Indenture dated as of January 15, 1997 by and between
Sunterra Corporation and Norwest Bank Minnesota, National
Association, as trustee, for the 5 3/4% Convertible
Subordinated Notes of Sunterra Corporation due 2007
(incorporated by reference to Exhibit 4 to Registrant's
Registration Statement on Form S-1 (No. 333-30285))
4.2 Indenture dated as of August 1, 1997 by and between Sunterra
Corporation and Norwest Bank Minnesota, National
Association, as trustee, for the 9 3/4% Senior Subordinated
Notes of Sunterra Corporation due 2007 (incorporated by
reference to Exhibit 4.2 to Amendment No. 1 on Form S-3 to
Registrant's Registration Statement on Form S-1 (No.
333-30285))
4.3 Indenture dated as of April 15, 1998 by and between Sunterra
Corporation and Norwest Bank Minnesota, National
Association, as trustee for the 9 1/4% Senior Notes of
Sunterra Corporation due 2006 (incorporated by reference to
Exhibit 4.3 to the Registrant's Registration Statement on
Form S-4 (No. 333-51803))
4.4 Indenture dated a of May 1, 1998, by and between Sunterra
Finance L.L.C. as issuer of the bonds, Sunterra Corporation
as Servicer, and LaSalle National Bank as Trustee and
Back-up Servicer for Signature Resorts Vacation Ownership
Receivables -- Backed Notes 1998-A (incorporated by
reference to Exhibit 10.1 to the Registrant's Quarterly
Report on Form 10-Q for the quarter ended June 30, 1998)
*10.1 Credit Agreement dated as of February 18, 1998 by and among
Sunterra Corporation, certain lender parties thereto,
NationsBank of Texas, N.A., as administrative lender and
Societe Generale, as document agent, including Amendments 1,
2 and 3 thereto
10.2 Servicing Agreement dated as of May 1, 1998, by and between
Sunterra Finance L.L.C. as issuer of the bonds, Sunterra
Corporation as Servicer, and LaSalle National Bank as
Trustee and Back-up Servicer for Signature Resorts Vacation
Ownership Receivables -- Backed Notes 1998-A (incorporated
by reference to Exhibit 10.8 to the Registrant's quarterly
report on Form 10-Q for the quarter ended June 30, 1998)
*10.3 Receivables Purchase Agreement dated as of December 17, 1998
among Blue Bison Funding Corp., Sunterra Corporation and
Barton Capital Corporation
10.4 Construction Loan Agreement between Lake Tahoe Resort
Partners, LLC, and FINOVA Capital Corporation dated as of
April 29, 1996 (incorporated by reference to Exhibit 10.8.8
to Registrant's Registration Statement on Form S-1 (No.
333-18447))
10.5 Agreement of Limited Partnership of Pointe Resort Partners,
L.P. (subsequently renamed Poipu Resort Partners L.P.) dated
October 11, 1994 (incorporated by reference to Exhibit 10.4
to Registrant's Registration Statement on Form S-1 (No.
333-06027))
10.6 Joint Development Agreement dated as of January 16, 1998
between Westin Hotel Company and Sunterra Corporation
(incorporated by reference to Exhibit 10.1 to Registrant's
Current Report on Form 8-K filed with the Securities and
Exchange Commission on January 20, 1998))
65
EXHIBIT
NUMBER DESCRIPTION
------- -----------
10.7 Registration Rights Agreement dated as of August 20, 1996 by
and among Sunterra Corporation and the persons named therein
(incorporated by reference to Exhibit 10.1 to Registrant's
Registration Statement on Form S-1 (No. 333-30285))
10.8 Registration Rights Agreement dated as of May 15, 1997 by
and among Signature Resorts Inc. and the persons named
therein (incorporated by reference to Exhibit 4 to
Registrant's current report on Form 8-K filed with the
Commission on May 29, 1997)
10.9 Registration Rights Agreement dated as of August 28, 1997 by
and among Sunterra Corporation and Ian K. Ganney and Richard
Harrington (incorporated by reference to Exhibit 10.10 to
Amendment No. 1 on Form S-3 to Registrant's Registration
Statement on Form S-1 (No. 333-30285))
10.10 Registration Rights Agreement dated as of October 10, 1997
by and among Sunterra Corporation and Michael V. Paulin,
Rosemarie Paulin, Maya K. Paulin and Annemarie H. Paulin
(incorporated by reference to Exhibit 10.5 to Registrant's
Annual Report on Form 10-K for the fiscal year ended
December 31, 1997)
10.11 Employment Agreement between Sunterra Corporation and Andrew
J. Gessow (incorporated by reference to Exhibit 10.2.2 to
Registrant's Registration Statement on Form S-1 (No.
333-30285))
10.12 Employment Agreement between Sunterra Corporation and Steven
C. Kenninger (incorporated by reference to Exhibit 10.2.3 to
Registrant's Registration Statement on Form S-1 (No.
333-30285))
10.13 Employment Agreement between Sunterra Corporation and L.
Steven Miller (incorporated by reference to Exhibit 10.1 to
Registrant's Quarterly Report on Form 10-Q for the quarter
ended September 30, 1998)
*10.14 Employment Agreement between Sunterra Corporation and
Richard Goodman
10.15 Employment Agreement between Sunterra Corporation and James
E. Noyes (incorporated by reference to Exhibit 10.2.4 to
Registrant's Registration Statement on Form S-1 (No.
333-06027))
*10.16 Amended and Restated 1996 Equity Participation Plan of
Sunterra Corporation, including form of stock option
agreement thereunder
10.17 Sunterra Corporation Employee Stock Purchase Plan
(incorporated by reference to Exhibit 10.5 to Registrant's
Registration Statement on Form S-1 (No. 333-06027))
10.18 First Amendment to Employee Stock Plan of Sunterra
Corporation effective as of November 1, 1997 (incorporated
by reference to Exhibit 10.2 to Registrant's Registration
Statement on Form S-8 (No. 333-15361))
*10.19 1998 New-Hire Stock Option Plan of Sunterra Corporation
10.20 Amended Consulting Agreement dated as of August 1, 1997 by
and between Sunterra Corporation, Resort Services, Inc. and
Dr. Kay F. Gow and Robert T. Gow (incorporated by reference
to Exhibit 10.12 to Amendment No. 1 on Form S-3 to
Registrant's Registration Statement on Form S-1 (No.
333-30285))
*21 Subsidiaries of Sunterra Corporation
*23.1 Consent of Arthur Andersen LLP
*23.2 Consent of KPMG
*23.3 Consent of Schreeder, Wheeler & Flint, LLP
*27 Financial Data Schedule (for the fiscal year ended December
31, 1998)
- ---------------
* Filed herewith