Attached files

file filename
EX-32.2 - EX-32.2 - Diamond Resorts Corpd253518dex322.htm
EX-31.2 - EX-31.2 - Diamond Resorts Corpd253518dex312.htm
EX-32.1 - EX-32.1 - Diamond Resorts Corpd253518dex321.htm
EX-31.1 - EX-31.1 - Diamond Resorts Corpd253518dex311.htm
Table of Contents

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, DC 20549

 

 

FORM 10-Q

 

 

(Mark One)

x QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended September 30, 2011

OR

 

¨ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

Commission file number: 333-172772

 

 

DIAMOND RESORTS CORPORATION

(Exact name of registrant as specified in its charter)

 

 

 

Maryland   95-4582157

(State or other jurisdiction of

incorporation or organization)

 

(I.R.S. Employer

Identification No.)

10600 West Charleston Boulevard

Las Vegas, Nevada 89135

(Address of principal executive offices and zip code)

Tel: (702) 684-8000

(Registrant’s telephone number, including area code)

 

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  x    No  ¨

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  x    No  ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. (See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act). (Check One):

 

Large Accelerated Filer   ¨    Accelerated Filer   ¨
Non-Accelerated Filer   x (Do not check if a smaller reporting company)    Smaller Reporting Company   ¨

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes  ¨    No  x

There is no public trading market for the common stock of Diamond Resorts Corporation. As of November 14, 2011, there

were 100 outstanding shares of the common stock, par value $0.01 per share, of Diamond Resorts Corporation.

 

 

 


Table of Contents

DIAMOND RESORTS PARENT, LLC AND SUBSIDIARIES

TABLE OF CONTENTS

 

          PAGE
NUMBER
 
   PART I. FINANCIAL INFORMATION   
Item 1.    Financial Statements:   
   Condensed Consolidated Balance Sheets as of September 30, 2011 (Unaudited) and December 31, 2010 (Audited)      3   
   Condensed Consolidated Statements of Operations for the three and nine months ended September 30, 2011 and 2010 (Unaudited)      4   
   Condensed Consolidated Statements of Member Capital (Deficit) and Comprehensive Income (Loss) for the nine months ended September 30, 2011 and 2010 (Unaudited)      5   
   Condensed Consolidated Statements of Cash Flows for the nine months ended September 30, 2011 and 2010 (Unaudited)      6   
   Notes to the Condensed Consolidated Financial Statements      8   
Item 2.    Management’s Discussion and Analysis of Financial Condition and Results of Operations      48   
Item 3.    Quantitative and Qualitative Disclosures About Market Risk      75   
Item 4.    Controls and Procedures      75   
   PART II. OTHER INFORMATION   
Item 1.    Legal Proceedings      76   
Item 1A.    Risk Factors      76   
Item 2.    Unregistered Sales of Equity Securities and Use of Proceeds      76   
Item 3.    Defaults Upon Senior Securities      76   
Item 4.    Removed and Reserved      76   
Item 5.    Other Information      76   
Item 6.    Exhibits      76   
   Signatures      77   

 

2


Table of Contents

PART I – FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS

DIAMOND RESORTS PARENT, LLC AND SUBSIDIARIES

CONDENSED CONSOLIDATED BALANCE SHEETS

September 30, 2011 and December 31, 2010

(In thousands, except share data)

 

     September 30,
2011
(Unaudited)
    December 31,
2010
(Audited)
 
ASSETS     

Cash and cash equivalents

   $ 19,384      $ 27,329   

Cash in escrow and restricted cash

     32,425        30,048   

Mortgages and contracts receivable, net of allowance of $81,186 and $55,151, respectively

     297,084        245,287   

Due from related parties, net

     25,886        20,958   

Other receivables, net

     24,851        35,980   

Income tax receivable

     27        10   

Prepaid expenses and other assets, net

     62,681        46,248   

Unsold Vacation Interests, net

     246,445        190,564   

Property and equipment, net

     53,207        29,097   

Assets held for sale

     5,730        9,517   

Intangible assets, net

     66,203        45,713   
  

 

 

   

 

 

 

Total assets

   $ 833,923      $ 680,751   
  

 

 

   

 

 

 
LIABILITIES AND MEMBER CAPITAL (DEFICIT)     

Accounts payable

   $ 11,257      $ 7,655   

Due to related parties, net

     69,372        36,251   

Accrued liabilities

     57,075        67,533   

Income taxes payable

     3,092        3,936   

Deferred revenues

     46,965        67,706   

Senior secured notes, net of unamortized original issue discount of $9,672 and $10,278, respectively

     415,328        414,722   

Securitization notes and conduit facility, net

     258,839        186,843   

Derivative liabilities

     —          79   

Notes payable

     65,590        23,273   
  

 

 

   

 

 

 

Total liabilities

     927,518        807,998   
  

 

 

   

 

 

 

Commitments and contingencies

    

Redeemable preferred units (0 and 1,000 shares authorized, issued and outstanding, respectively)

     —          84,502   
  

 

 

   

 

 

 

Member capital (deficit):

    

Member capital (authorized 1,387.8 common units, no par value; issued 1,387.8 and 1,090 common units, respectively)

     152,294        7,335   

Accumulated deficit

     (227,959     (201,338

Accumulated other comprehensive loss

     (17,930     (17,746
  

 

 

   

 

 

 

Total member capital (deficit)

     (93,595     (211,749
  

 

 

   

 

 

 

Total liabilities and member capital (deficit)

   $ 833,923      $ 680,751   
  

 

 

   

 

 

 

The accompanying notes are an integral part of these condensed consolidated financial statements.

 

3


Table of Contents

DIAMOND RESORTS PARENT, LLC AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

For the three and nine months ended September 30, 2011 and 2010

(Unaudited)

(In thousands)

 

     Three Months Ended     Nine Months Ended  
     September 30,
2011
    September 30,
2010
    September 30,
2011
    September 30,
2010
 

Revenues:

        

Vacation Interest sales

   $ 60,228      $ 56,515      $ 154,631      $ 158,833   

Provision for uncollectible Vacation Interest sales revenue

     (4,516     (2,051     (11,259     (2,919
  

 

 

   

 

 

   

 

 

   

 

 

 

Vacation Interest, net

     55,712        54,464        143,372        155,914   

Management, member and other services

     29,487        25,620        89,328        76,160   

Consolidated resort operations

     7,601        6,563        21,789        20,057   

Interest

     14,650        9,876        34,280        29,363   
  

 

 

   

 

 

   

 

 

   

 

 

 

Total revenues

     107,450        96,523        288,769        281,494   
  

 

 

   

 

 

   

 

 

   

 

 

 

Costs and Expenses:

        

Vacation Interest cost of sales

     1,854        11,765        (3,760     33,630   

Advertising, sales and marketing

     34,488        30,321        96,121        83,585   

Vacation Interest carrying cost, net

     4,156        6,693        20,063        20,875   

Management, member and other services

     7,165        5,322        19,459        17,496   

Consolidated resort operations

     6,620        5,520        19,894        18,045   

Loan portfolio

     2,749        2,618        7,906        7,848   

General and administrative

     21,074        18,326        58,797        50,218   

Depreciation and amortization

     3,853        3,451        10,165        8,899   

Interest

     22,102        17,456        60,382        48,866   

Loss on extinguishment of debt

     —          1,081        —          1,081   

Impairments and other write-offs

     693        9        1,016        989   

Gain on disposal of assets

     (76     (289     (448     (1,049

Gain on bargain purchase from business combination

     (34,183     —          (34,183     —     
  

 

 

   

 

 

   

 

 

   

 

 

 

Total costs and expenses

     70,495        102,273        255,412        290,483   
  

 

 

   

 

 

   

 

 

   

 

 

 

Income (loss) before benefit for income taxes

     36,955        (5,750     33,357        (8,989

Benefit for income taxes

     (646     (1,994     (64     (569
  

 

 

   

 

 

   

 

 

   

 

 

 

Net income (loss)

   $ 37,601      $ (3,756   $ 33,421      $ (8,420
  

 

 

   

 

 

   

 

 

   

 

 

 

The accompanying notes are an integral part of these condensed consolidated financial statements.

 

4


Table of Contents

DIAMOND RESORTS PARENT, LLC AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF MEMBER CAPITAL (DEFICIT)

AND COMPREHENSIVE INCOME (LOSS)

For the nine months ended September 30, 2011 and 2010

(Unaudited)

($ in thousands)

 

    Temporary Capital     Permanent Capital  
    Redeemable
Preferred Units
    Common
Units
    Member
Capital
    Accumulated
Deficit
    Accumulated
Other
Comprehensive

Income (Loss)
    Total  Member
Capital

(Deficit)
    Comprehensive
Loss
 
    Shares     Amount     Shares            

Balance at December 31, 2009

    1,000      $ 103,528        1,000      $ 7,335      $ (198,317   $ (16,407   $ (207,389  

Guggenheim equity investment

      75,000               

Repurchase of equity previously held by another minority institutional investor

      (75,000            

Costs related to issuance of preferred units

            (2,915       (2,915  

Priority returns and redemption premiums

      (22,372         22,372          22,372     

Net loss for the nine months ended September 30, 2010

            (8,420       (8,420   $ (8,420

Other comprehensive loss:

               

Currency translation adjustments, net of tax of $0

              (23     (23     (23
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Balance at September 30, 2010

    1,000      $ 81,156        1,000      $ 7,335      $ (187,280   $ (16,430   $ (196,375  
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

Comprehensive loss for the nine months ended September 30, 2010

                $ (8,443
               

 

 

 

Balance at December 31, 2010

    1,000      $ 84,502        1,090      $ 7,335      $ (201,338   $ (17,746   $ (211,749  

Issuance of common and preferred units

    133.3        10,151        332.5        149,404            149,404     

Costs related to issuance of common and preferred units

          (4,498     (87       (4,585  

Priority returns and redemption premiums

      8,412            (8,412       (8,412  

Repurchase of a portion of outstanding warrants

          (159     (16,439       (16,598  

Repurchase of redeemable preferred units

    (1,133.3     (103,065         (18,540       (18,540  

Repurchase of common units

        (34.7     212        (16,564       (16,352  

Net income for the nine months ended September 30, 2011

            33,421          33,421      $ 33,421   

Other comprehensive income:

               

Currency translation adjustments, net of tax of $0

              (151     (151     (151

Unrealized loss on available-for-sale securities

              (33     (33     (33
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Balance at September 30, 2011

    —        $ —          1,387.8      $ 152,294      $ (227,959   $ (17,930   $ (93,595  
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

Comprehensive income for the nine months ended September 30, 2011

                $ 33,237   
               

 

 

 

The accompanying notes are an integral part of these condensed consolidated financial statements.

 

5


Table of Contents

DIAMOND RESORTS PARENT, LLC AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

For the nine months ended September 30, 2011 and 2010

(Unaudited)

(In thousands)

 

     Nine months ended  
     September 30,
2011
    September 30,
2010
 

Operating Activities:

    

Net income (loss)

   $ 33,421      $ (8,420

Adjustments to reconcile net income (loss) to net cash (used in) provided by operating activities:

    

Provision for uncollectible Vacation Interest sales revenue

     11,259        2,919   

Amortization of capitalized financing costs and original issue discounts

     4,744        2,211   

Amortization of capitalized loan origination costs and portfolio discount

     2,001        1,464   

Depreciation and amortization

     10,165        8,899   

Loss on extinguishment of debt

     —          1,081   

Impairments and other write-offs

     1,016        989   

Gain on disposal of assets

     (448     (1,049

Gain on bargain purchase from business combination

     (34,183     —     

Deferred income taxes

     —          114   

Loss on foreign currency exchange

     13        24   

Gain on mortgage repurchase

     (158     (171

Unrealized gain on derivative instruments

     (79     (237

Gain on insurance settlement

     (3,535     —     

Changes in operating assets and liabilities excluding acquisitions:

    

Mortgages and contracts receivable

     3,723        10,828   

Due from related parties, net

     (4,557     6,216   

Other receivables, net

     16,274        20,762   

Prepaid expenses and other assets, net

     (14,204     (11,008

Unsold Vacation Interests, net

     (30,829     8,325   

Accounts payable

     3,160        (1,851

Due to related parties, net

     36,072        7,093   

Accrued liabilities

     (10,629     8,163   

Income taxes payable

     (889     2,207   

Deferred revenues

     (24,754     (16,970
  

 

 

   

 

 

 

Net cash (used in) provided by operating activities

     (2,417     41,589   
  

 

 

   

 

 

 

Investing activities:

    

Property and equipment capital expenditures

     (5,124     (3,831

Purchase of assets from ILX Resorts, Inc.

     —          (30,722

Purchase of assets from Tempus Resorts International, net of $2,517 and $0 cash acquired

     (102,398     —     

Disbursement of Tempus Acquisition note receivable

     (3,493     —     

Proceeds from sale of assets

     1,949        1,459   
  

 

 

   

 

 

 

Net cash used in investing activities

   $ (109,066   $ (33,094
  

 

 

   

 

 

 

 

The accompanying notes are an integral part of these condensed consolidated financial statements.

 

6


Table of Contents

DIAMOND RESORTS PARENT, LLC AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS—Continued

For the nine months ended September 30, 2011 and 2010

(Unaudited)

(In thousands)

 

     Nine months ended  
     September 30,
2011
    September 30,
2010
 

Financing activities:

    

Changes in cash in escrow and restricted cash

   $ 543      $ 913   

Proceeds from issuance of senior secured notes, net of original issue discount of $0 and $10,570, respectively

     —          414,430   

Proceeds from issuance of securitization notes and conduit facility

     181,164        33,913   

Proceeds from issuance of notes payable

     44,678        17,513   

Payments on securitization notes and conduit facility

     (105,250     (56,100

Payments on line of credit agreements

     —          (397,609

Payments on notes payable

     (13,658     (6,521

Payments of debt issuance costs

     (4,415     (18,444

Proceeds from issuance of common and preferred units

     146,651        75,000   

Repurchase of a portion of outstanding warrants

     (16,598     —     

Repurchase of a portion of outstanding common units

     (16,352     —     

Repurchase of redeemable preferred units

     (108,701     —     

Repurchase of equity previously held by another minority institutional investor

     —          (75,000

Payments of costs related to issuance of common and preferred units

     (4,585     (2,915

Payments for derivative instrument

     —          (71
  

 

 

   

 

 

 

Net cash provided by (used in) financing activities

     103,477        (14,891
  

 

 

   

 

 

 

Net decrease in cash and cash equivalents

     (8,006     (6,396

Effect of changes in exchange rates on cash and cash equivalents

     61        (49

Cash and cash equivalents, beginning of period

     27,329        17,186   
  

 

 

   

 

 

 

Cash and cash equivalents, end of period

   $ 19,384      $ 10,741   
  

 

 

   

 

 

 

SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:

    

Cash paid for interest

   $ 67,222      $ 40,053   
  

 

 

   

 

 

 

Cash paid for taxes, net of cash refunds

   $ 684      $ (2,917
  

 

 

   

 

 

 

SUPPLEMENTAL SCHEDULE OF NON-CASH INVESTING AND FINANCING ACTIVITIES:

    

Priority returns and redemption premiums (adjustments) on preferred units

   $ 8,412      $ (22,372
  

 

 

   

 

 

 

Insurance premiums financed through issuance of note payable

   $ 6,141      $ 6,052   
  

 

 

   

 

 

 

Assets held for sale reclassified to unsold Vacation Interests

   $ 2,994      $ —     
  

 

 

   

 

 

 

Purchase of assets from Tempus Resorts International and ILX Resorts, Inc., respectively:

    

Fair value of assets acquired

   $ 146,974      $ 34,626   

Goodwill recognized

     —          696   

Gain from bargain purchase recognized

     (34,183     —     

Cash paid

     (104,915     (30,722
  

 

 

   

 

 

 

Liabilities assumed

   $ 7,876      $ 4,600   
  

 

 

   

 

 

 

The accompanying notes are an integral part of these condensed consolidated financial statements.

 

7


Table of Contents

DIAMOND RESORTS PARENT, LLC AND SUBSIDIARIES

NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

Note 1—Background, Business and Basis of Presentation

Business and Background

Diamond Resorts Parent, LLC is a Nevada limited liability company created on March 28, 2007 through the contribution of $62.4 million cash by a third-party investor and $7.1 million of net assets from Cloobeck Diamond Parent, LLC (“CDP”), the Company’s majority equity holder. The third-party investor was issued common and preferred units with a liquidation preference as well as a priority return of 17% per annum, compounded quarterly, payable upon certain events. The preferred units did not provide to the holder any participation or conversion rights. The common and preferred members’ liability was limited to their respective capital contributions. Diamond Resorts Parent, LLC (“DRP”), together with its wholly-owned subsidiaries, is hereafter referred to as “Diamond Resorts” or the “Company.” The capitalization of the Company occurred on April 27, 2007 simultaneously with the acquisition of and merger with Sunterra Corporation (“Sunterra” or the “Predecessor Company”) and cancellation of Sunterra’s outstanding common stock for $16.00 per share (the “Merger” or the “April 27, 2007 Merger”). On July 21, 2011, DRP completed an equity recapitalization transaction, pursuant to which it repurchased all of its preferred units and issued and redeemed common units in a series of private placement transactions. See Note 18Common and Preferred Units for further details.

The Company operates in the vacation ownership industry, with an ownership base of more than 418,000 families and a network of 214 destinations located in 28 countries including the United States, Canada, Mexico, and throughout the Caribbean, Europe, Asia, Australia and Africa. The Company’s resort network includes 71 Diamond Resorts International-branded and managed properties, 137 affiliated resorts and six cruise ships, which are a part of the Company’s network and available for its members to use as vacation destinations, although the Company does not manage them. As referenced in these financial statements, Diamond Resorts International® and THE Club® are trademarks of the Company.

The Company’s operations consist of three interrelated businesses: (i) hospitality and management services; (ii) marketing and sales of Vacation Ownership Interests (“VOI” or “Vacation Interests”); and (iii) consumer financing for purchasers of the Company’s Vacation Interests.

 

   

Hospitality and Management Services. The Company manages 71 branded resort properties, which are located in the continental United States, Hawaii, Mexico, the Caribbean and Europe. The Company also manages five multi-resort trusts or similar arrangements (the “Collections”). Each Collection holds real estate in the Company’s resort properties underlying the Vacation Interests that the Company sells. As manager of the Company’s branded resorts and Collections, it provides billing services, account collections, accounting and treasury functions and information technology services. In addition, for branded resorts, the Company also provides an online reservation system and customer service contact center, operates the front desks and amenities and furnishes housekeeping, maintenance and human resources services. Management contracts typically have an initial term of three to five years with automatic renewals and are structured on a cost-plus basis, thereby providing the Company with a recurring and stable revenue stream. In addition, the Company earns recurring fees by operating THE Club, the points-based exchange and member services program that enables members to vacation at any of the 214 resorts in the Company’s network. These items are included in management, member and other services revenue and expense in the accompanying condensed consolidated statements of operations.

In addition, the Company serves as the homeowners’ association (“HOA”) for its two resorts in St. Maarten and earns maintenance fees and incurs operating expenses at these two resorts. At certain resorts, the Company also operates golf courses, food and beverage venues, retail shops, a campground and a marina and earns incidental revenue and incurs operating expense. Finally, the Company provides cable, telephone, and technology services to HOAs. These items are included in consolidated resort operations revenue and expense in the accompanying condensed consolidated statements of operations.

 

8


Table of Contents

DIAMOND RESORTS PARENT, LLC AND SUBSIDIARIES

NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - Continued

(Unaudited)

 

   

Marketing and Sales of Vacation Interests. The Company markets and sells Vacation Interests in its resort network. Sales prospects are generated by utilizing a variety of marketing programs. Currently, the Company sells Vacation Interests in the form of points, which can be utilized for vacations for varying lengths of stay at any resort in its network. The Company’s Vacation Interests generally have either use rights into perpetuity or that expire in 2054 as is the case in the European Collections. The Company also sells shorter term vacation intervals, exercisable annually over a term of 36 months, and offers exchange programs into its resort network to consumers owning intervals at resorts managed by the Company. In the past, the Company also sold Vacation Interests in the form of deeded intervals, which provide the right to vacation at a particular resort for a specified length of time.

 

   

Consumer Financing of Vacation Interests. The Company provides loans to eligible customers who purchase Vacation Interests through sales centers and choose to finance their purchase. These loans are collateralized by the underlying Vacation Interests and bear interest at a fixed rate. The Company’s consumer finance servicing operations include underwriting, collection and servicing of its consumer loan portfolio.

Basis of Presentation

The following is a list of entities included in the accompanying condensed consolidated financial statements:

AKGI St. Maarten, NV and subsidiaries

Citrus Insurance Company, Inc.

DRI Quorum 2010 LLC

Diamond Resorts (Europe) Ltd. and subsidiaries

Diamond Resorts Centralized Services Company

Diamond Resorts Corporation

Diamond Resorts Developer and Sales Holding Company and subsidiaries

Diamond Resorts Finance Holding Company and subsidiaries

Diamond Resorts Holdings, LLC

Diamond Resorts Issuer 2008, LLC

Diamond Resorts Management and Exchange Holding Company and subsidiaries

Diamond Resorts Owner Trust 2009-1

Diamond Resorts Owner Trust 2011-1

Diamond Resorts Polo Development, LLC

Diamond Resorts Services, LLC

FLRX, Inc. and subsidiaries

George Acquisition Subsidiary, Inc.

ILX Acquisition, Inc. and subsidiaries

Sunterra Owner Trust 2004-1

Tempus Acquisition, LLC and subsidiaries

Some of the above entities, which include corporations, limited liability companies and partnerships, each have several subsidiaries.

On August 31, 2010, the Company acquired a majority of the assets and assumed certain liabilities of ILX Resorts, Inc. (the “ILX Acquisition”) through its wholly-owned subsidiary, ILX Acquisition, Inc. (“ILXA”). See Note 19Business Combinations for further details.

On July 1, 2011, the Company completed the acquisition of certain assets of Tempus Resorts International, Ltd. and certain of its affiliates (the “Tempus Resorts Acquisition”) through Mystic Dunes, LLC, a wholly-owned subsidiary of Tempus Acquisition, LLC (“Tempus Acquisition”). Prior to the completion of the acquisition, Tempus Acquisition entered into the Credit and Security Agreement on November 23, 2010 for the revolving loan facility (“Tempus Acquisition Loan”) as the borrower and the Post-Petition Term Credit and Security Agreement for the debtor-in-possession financing (“DIP Financing” or “Tempus Note Receivable”) as the lender. See Note 6—Other Receivables, Net, and Note 12—Borrowings for further details.

 

9


Table of Contents

DIAMOND RESORTS PARENT, LLC AND SUBSIDIARIES

NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - Continued

(Unaudited)

 

The accompanying condensed consolidated financial statements of Diamond Resorts Parent, LLC and its subsidiaries have been prepared in accordance with the accounting policies described in the Company’s prospectus filed with the Securities and Exchange Commission (the “SEC”) on July 8, 2011, pursuant to Rule 424(b)(3) of the Securities Act of 1933 as amended (the “Prospectus”). Certain information and footnote disclosures normally included in annual consolidated financial statements prepared in accordance with accounting principles generally accepted in the United States of America (“U.S. GAAP”) have been condensed or omitted, although the Company believes that the disclosures are adequate to make the information presented not misleading. In the opinion of management, all adjustments considered necessary for a fair presentation have been included and are of a normal and recurring nature. The accompanying condensed consolidated financial statements should be reviewed in conjunction with the Company’s annual consolidated financial statements as of December 31, 2010 and 2009 and for the years ended December 31, 2010, 2009 and 2008 included in the Prospectus. Operating results for the three months and nine months ended September 30, 2011 are not necessarily indicative of the results that may be expected for the year ending December 31, 2011.

Liquidity

Vacation Interest receivables collateralizing the Company’s borrowings were $329.4 million at September 30, 2011. On April 27, 2011, the Company completed a securitization transaction with a face value of $64.5 million. A portion of the net proceeds from this transaction was used to pay off in full the $36.4 million outstanding principal balance under the 2008 conduit facility on April 27, 2011. During the period from April 28 to September 30, 2011, the Company had borrowings of $14.3 million, net of repayments, under the 2008 Conduit Facility. See Note 12—Borrowings for further details. On October 14, 2011, the Company entered into an amended and restated 2008 Conduit Facility with a maturity date of April 12, 2013. See Note 24-Subsequent Events for further details.

Cash used in operations was $2.4 million for the nine months ended September 30, 2011, compared to cash provided by operations of $41.6 million for the nine months ended September 30, 2010. Cash and cash equivalents were $19.4 million and $27.3 million as of September 30, 2011 and December 31, 2010, respectively. The Company believes there will be sufficient existing cash resources and cash flows from operations, in addition to future refinancing activities, to meet the anticipated debt maturities and the Company’s other cash requirements during 2011. If cash flows from operations are less than expected, the Company would need to curtail its sales and marketing operations or raise additional capital.

Note 2—Summary of Significant Accounting Policies

Principles of Consolidation— The accompanying condensed consolidated financial statements include all subsidiaries of the Company. With the exception of the hotel properties in Europe that the Company owns and provides to a trust in Europe under a rental agreement, the Company does not have any interests in any variable interest entities for which the Company is considered the primary beneficiary under Accounting Standards Codification (“ASC”) 810, “Consolidation.” All significant intercompany transactions and balances have been eliminated from the accompanying condensed consolidated financial statements.

Use of Estimates— The preparation of financial statements in conformity with U.S. GAAP requires the Company 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. Significant estimates were used by the Company to estimate the fair value of the assets acquired and liabilities assumed in the ILX Acquisition and the Tempus Resorts Acquisition. These estimates included projections of future cash flows derived from sales of Vacation Interests, mortgages and contracts receivable, management services revenue and rental income. Additionally, the Company made significant estimates of costs associated with such projected revenues including but not limited to loan defaults, recoveries and discount rates.

In preparation of its condensed consolidated financial statements, the Company also made significant estimates which include: (1) allowance for loan and contract losses, and provision for uncollectible Vacation Interest sales

 

10


Table of Contents

DIAMOND RESORTS PARENT, LLC AND SUBSIDIARIES

NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - Continued

(Unaudited)

 

revenue; (2) useful lives of property and equipment; (3) estimated useful lives of intangible assets acquired; (4) estimated costs to build or acquire any additional Vacation Interests, estimated total revenues expected to be earned on a project, related estimated provision for uncollectible Vacation Interest sales revenue and sales incentives, estimated projected future cost and volume of recoveries of Vacation Interests, estimated sales price per point and estimated number of points sold used to allocate certain unsold Vacation Interests to Vacation Interest cost of sales under the relative sales value method; and (5) the valuation allowance recorded against deferred tax assets. It is at least reasonably possible that a material change in one or more of these estimates may occur in the near term and that such change may materially affect actual results.

Recently Adopted Accounting Pronouncements

In January 2010, the FASB issued Accounting Standards Update (“ASU”) No. 2010-06, Improving Disclosures about Fair Value Measurements, which, among other things, amends ASC 820, “Fair Value Measurements and Disclosures” to require entities to separately present purchases, sales, issuances, and settlements in their reconciliation of Level 3 fair value measurements (i.e., to present such items on a gross basis rather than on a net basis), and which clarifies existing disclosure requirements provided by ASC 820 regarding the level of disaggregation and the inputs and valuation techniques used to measure fair value for measurements that fall within either Level 2 or Level 3 of the fair value hierarchy. ASU No. 2010-06 is effective for interim and annual periods beginning after December 15, 2009, except for the disclosures about purchases, sales, issuances and settlements in the roll forward of activity in Level 3 fair value measurements which are effective for fiscal years beginning after December 15, 2010 and for interim periods within those fiscal years. The Company adopted ASU No. 2010-06 on January 1, 2011. The adoption did not have a material impact on the Company’s condensed consolidated financial statements or the disclosures, as the Company did not have any transfers between Level 1 and Level 2 fair value measurements and did not have material classes of assets and liabilities that required additional disclosure.

In December 2010, the FASB issued ASU 2010-28, Intangibles—Goodwill and Other (Topic 350): When to Perform Step 2 of the Goodwill Impairment Test for Reporting Units with Zero or Negative Carrying Amounts. The amendments in this update modify Step 1 of the goodwill impairment test for reporting units with zero or negative carrying amounts. For those reporting units, an entity is required to perform Step 2 of the goodwill impairment test if it is more likely than not that a goodwill impairment exists. For SEC reporting companies, the amendments in this update are effective for fiscal years, and interim periods within those years, beginning after December 15, 2010. Early adoption is not permitted. The Company adopted ASU 2010-28 as of January 1, 2011, which did not have a material impact on the Company’s financial statements.

In December 2010, the FASB issued ASU 2010-29, Business Combinations (Topic 805): Disclosure of Supplementary Pro Forma Information for Business Combinations. The amendments in this update specify that if a SEC reporting company presents comparative financial statements, the entity should disclose revenue and earnings of the combined entity as though the business combination(s) that occurred during the current year had occurred as of the beginning of the comparable prior annual reporting period only. The amendments also expand the supplemental pro forma disclosures to include a description of the nature and amount of material, nonrecurring pro forma adjustments directly attributable to the business combination included in the reported pro forma revenue and earnings. The amendments affect any SEC reporting company as defined by Topic 805 that enters into business combinations that are material on an individual or aggregate basis. The amendments in this update are effective prospectively for business combinations for which the acquisition date is on or after the beginning of the first annual reporting period beginning on or after December 15, 2010. Early adoption is permitted. The Company adopted ASU 2010-29 for all business combinations for which the acquisition date is on or after January 1, 2011. The adoption of this update primarily resulted in increased disclosures.

In April 2011, the FASB issued ASU 2011-02, Receivables (Topic 310): A Creditor’s Determination of Whether a Restructuring Is a Troubled Debt Restructuring. The amendments in this update provide additional guidance to assist creditors in determining whether a restructuring of a receivable meets the criteria to be considered a troubled debt restructuring. The amendments in this update are effective for the first interim or annual period beginning on or after June 15, 2011, and should be applied retrospectively to the beginning of the annual period of adoption. As a result of applying these amendments, an entity may identify receivables that are newly considered

 

11


Table of Contents

DIAMOND RESORTS PARENT, LLC AND SUBSIDIARIES

NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - Continued

(Unaudited)

 

impaired. For purposes of measuring impairment of those receivables, an entity should apply the amendments prospectively for the first interim or annual period beginning on or after June 15, 2011. The Company adopted ASU 2011-02 as of the Company’s interim period ended June 30, 2011. The adoption of this update did not have a material impact on its financial statements.

In May 2011, the FASB issued ASU 2011-04, Fair Value Measurement (Topic 820): Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and IFRSs. The amendments in this update generally represent clarifications of Topic 820, but also include some instances where a particular principle or requirement for measuring fair value or disclosing information about fair value measurements has changed. This update results in common principles and requirements for measuring fair value and for disclosing information about fair value measurements in accordance with U.S. GAAP and IFRSs. The amendments in this update are to be applied prospectively. For SEC reporting companies, the amendments are effective during interim and annual periods beginning after December 15, 2011. The Company will adopt ASU 2011-04 as of the Company’s interim period ending March 31, 2012. The Company believes that the adoption of this update will not have a material impact on its financial statements.

In June 2011, the FASB issued ASU 2011-05, Comprehensive Income (Topic 220): Presentation of Comprehensive Income. Under the amendments to Topic 220, Comprehensive Income, in this update, an entity has the option to present the total of comprehensive income, the components of net income, and the components of other comprehensive income either in a single continuous statement of comprehensive income or in two separate but consecutive statements. In both choices, an entity is required to present each component of net income along with total net income, each component of other comprehensive income along with a total for other comprehensive income, and a total amount for comprehensive income. This update eliminates the option to present the components of other comprehensive income as part of the statement of changes in member capital. The amendments in this update do not change the items that must be reported in other comprehensive income or when an item of other comprehensive income must be reclassified to net income. The amendments in this update should be applied retrospectively. For SEC reporting companies, the amendments are effective for fiscal years, and interim periods within those years, beginning after December 15, 2011. Early adoption is permitted, because compliance with the amendments is already permitted. The amendments do not require any transition disclosures. The Company will adopt ASU 2011-05 as of the Company’s interim period ending March 31, 2012. The Company believes that the adoption of this update will primarily result in increased disclosures.

In September 2011, the FASB issued ASU 2011-08, Intangibles—Goodwill and Other (Topic 350): Testing Goodwill for Impairment. The objective of this update is to simplify how entities test goodwill for impairment. The amendments in the update permit an entity to first assess qualitative factors to determine whether it is more likely than not that the fair value of a reporting unit is less than its carrying amount as a basis for determining whether it is necessary to perform the two-step goodwill impairment test described in Topic 350. The more-likely-than-not threshold is defined as having a likelihood of more than 50 percent. The amendments are effective for annual and interim goodwill impairment tests performed for fiscal years beginning after December 15, 2011. The Company will adopt ASU 2011-08 as of January 1, 2012. The Company believes that the adoption of this update will not have a material impact on its financial statements.

 

12


Table of Contents

DIAMOND RESORTS PARENT, LLC AND SUBSIDIARIES

NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - Continued

(Unaudited)

 

Note 3—Cash in Escrow and Restricted Cash

Cash in escrow and restricted cash consisted of the following as of September 30, 2011 and December 31, 2010 (in thousands):

 

     September 30,
2011
     December 31,
2010
 

Securitization and conduit collection and reserve cash

   $ 12,639       $ 14,040   

Collected on behalf of HOAs and other

     7,219         5,447   

Rental trust

     5,278         3,717   

Escrow

     4,955         4,615   

Bonds and deposits

     2,334         2,229   
  

 

 

    

 

 

 

Total cash in escrow and restricted cash

   $ 32,425       $ 30,048   
  

 

 

    

 

 

 

Note 4—Mortgages and Contracts Receivable and Allowance for Loan and Contract Losses

The Company provides financing to purchasers of Vacation Interests at U.S. sales centers that is collateralized by their Vacation Interests. Eligibility for this financing is determined based on the customers’ Fair Isaac Corporation (“FICO”) credit scores. The mortgages and contracts bear interest at fixed rates between 0% and 17.9%. The term of the mortgages and contracts are from one year to fifteen years and may be prepaid at any time without penalty. The weighted average interest rate of outstanding mortgages and contracts receivable was 15.9% and 15.4% at September 30, 2011 and December 31, 2010, respectively. Mortgages and contracts receivable in excess of 90 days past due at September 30, 2011 and December 31, 2010 were 3.5% and 3.9%, respectively, of gross mortgages and contracts receivable.

Mortgages and contracts receivable originated by the Company are recorded at amortized cost, including deferred loan and contract origination costs, less the related allowance for loan and contract losses. Loan and contract origination costs incurred in connection with providing financing for Vacation Interests are capitalized and amortized over the estimated life of the mortgages or contracts receivable (based on historical prepayments) as a decrease to interest revenue using the effective interest method. Amortization of deferred loan and contract origination costs charged to interest revenue was $0.7 million and $0.9 million for the three months ended September 30, 2011 and 2010, respectively, and $2.0 million and $2.6 million for the nine months ended September 30, 2011 and 2010, respectively.

The Company recorded a $3.3 million discount at April 27, 2007 on the acquired Polo mortgage pool, which is being amortized over the life of the related acquired mortgage pool. At September 30, 2011 and December 31, 2010, the net unamortized discount was $0.6 million and $0.8 million, respectively. During the three months ended September 30, 2011 and 2010, amortization of $0.1 million and $0.1 million, respectively, was recorded as an increase to interest revenue. During the nine months ended September 30, 2011 and 2010, amortization of $0.3 million and $0.2 million, respectively, was recorded as an increase to interest revenue.

The Company recorded a $3.9 million premium at July 1, 2011 on the purchased Mystic Dunes mortgage pool, which is being amortized over the life of the related acquired mortgage pool. At September 30, 2011, the net unamortized premium was $3.7 million. During the three and nine months ended September 30, 2011, amortization of $0.2 million was recorded as a decrease to interest revenue.

 

13


Table of Contents

DIAMOND RESORTS PARENT, LLC AND SUBSIDIARIES

NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - Continued

(Unaudited)

 

Mortgages and contracts receivable, net, consisted of the following as of September 30, 2011 and December 31, 2010 (in thousands):

 

     September 30,
2011
    December 31,
2010
 

Mortgages and contracts receivable, acquired - April 27, 2007 Merger

   $ 52,812      $ 71,200   

Mortgages and contracts receivable, contributed

     3,920        11,125   

Mortgages and contracts receivable, originated

     208,982        198,959   

Mortgages and contracts receivable, purchased (unrestricted subsidiaries)

     100,432        12,043   

Mortgages and contracts receivable, originated (unrestricted subsidiaries)

     1,423        —     
  

 

 

   

 

 

 

Mortgages and contracts receivable, gross

     367,569        293,327   

Allowance for loan and contract losses

     (47,641     (51,551

Allowance for loan and contract losses (unrestricted subsidiaries)

     (33,545     (3,600

Deferred profit on Vacation Interest transactions

     (2,697     (2,349

Deferred loan and contract origination costs, net of accumulated amortization

     2,633        2,823   

Inventory value of defaulted mortgages that were previously contributed and acquired

     7,627        7,439   

Premium on mortgages and contracts receivable, net of accumulated amortization

     3,712        —     

Discount on mortgages and contracts receivable, net of accumulated amortization

     (574     (802
  

 

 

   

 

 

 

Mortgages and contracts receivable, net

   $ 297,084      $ 245,287   
  

 

 

   

 

 

 

At September 30, 2011 and December 31, 2010, $329.4 million and $247.4 million, respectively, of the gross amount of mortgages and contracts receivable were collateralized against the Company’s various debt instruments included in the “Securitization notes and conduit facilities” caption in the accompanying condensed consolidated balance sheets. See Note 12 – Borrowings for further details.

Deferred profit on Vacation Interest transactions represents the revenues less the related direct costs (sales commissions, sales incentives, cost of revenues and allowance for loan losses) related to sales that do not qualify for revenue recognition under the provisions of ASC 978, “Real Estate-Time-Sharing Activities.” See Note 2—Summary of Significant Accounting Policies of the Company’s annual consolidated financial statements included in the Prospectus for a description of revenue recognition criteria.

Inventory value of defaulted mortgages that were previously contributed and acquired represents the inventory underlying mortgages that have defaulted. Upon recovery of the inventory, the value is transferred to unsold Vacation Interests, net.

 

14


Table of Contents

DIAMOND RESORTS PARENT, LLC AND SUBSIDIARIES

NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - Continued

(Unaudited)

 

Activity in the allowance for loan and contract losses associated with the Company’s mortgages and contracts receivable for the three and nine months ended September 30, 2011 and 2010 is as follows (in thousands):

 

     Three Months Ended     Nine Months Ended  
     September 30,
2011
    September 30,
2010
    September 30,
2011
    September 30,
2010
 

Balance, beginning of period

   $ 51,356      $ 51,930      $ 55,151      $ 60,911   

Provision for uncollectible Vacation Interest sales revenue

     4,534        1,966        11,174        2,685   

Provision for uncollectible Vacation Interest sales revenue (unrestricted subsidiaries)

     100        —          183        —     

Mortgages and contracts receivable charged off

     (6,539     (5,594     (19,205     (17,192

Mortgages and contracts receivable charged off

        

(unrestricted subsidiaries)

     (4,075     —          (5,571     —     

Recoveries

     2,147        1,347        4,118        3,356   

Increase in allowance based on final ILX and preliminary Tempus appraisal (unrestricted subsidiaries)

     33,674        —          35,334        —     

Effect of translation rate

     (11     99        2        (12
  

 

 

   

 

 

   

 

 

   

 

 

 

Balance, end of period

   $ 81,186      $ 49,748      $ 81,186      $ 49,748   
  

 

 

   

 

 

   

 

 

   

 

 

 

A summary of credit quality as of September 30, 2011 is as follows (in thousands):

 

FICO Scores

   Diamond
Resorts
Mortgages and
Contracts
     Unrestricted
Subsidiaries
Mortgages and
Contracts
     Total  

>799

   $ 20,799       $ 1,587       $ 22,386   

700 - 799

     135,013         20,424         155,437   

600 - 699

     88,529         38,915         127,444   

<600

     14,447         20,926         35,373   

No FICO Scores

     6,926         20,003         26,929   
  

 

 

    

 

 

    

 

 

 
   $ 265,714       $ 101,855       $ 367,569   
  

 

 

    

 

 

    

 

 

 

A summary of credit quality as of December 31, 2010 is as follows (in thousands):

 

FICO Scores

   Diamond
Resorts
Mortgages and
Contracts
     Unrestricted
Subsidiaries
Mortgages and
Contracts
     Total  

>799

   $ 17,055       $ 90       $ 17,145   

700 - 799

     123,558         2,888         126,446   

600 - 699

     96,087         3,977         100,064   

<600

     38,373         2,128         40,501   

No FICO Scores

     6,211         2,960         9,171   
  

 

 

    

 

 

    

 

 

 
   $ 281,284       $ 12,043       $ 293,327   
  

 

 

    

 

 

    

 

 

 

FICO credit scores were updated in January 2011 for all existing mortgages and contracts. The FICO scores for Tempus mortgages and contracts acquired in July 2011 will be included in the Company’s FICO update in January 2012.

As of December 31, 2010, the ILXA mortgages and contracts receivable acquired on August 31, 2010 were recorded at an aggregate balance of $9.8 million, net of allowance, based on a preliminary appraisal. During the quarter ended March 31, 2011, the allowance for loan and contract losses related to the ILXA mortgages and contracts receivable was increased by $1.7 million based on the issuance of the final appraisal.

In connection with the Tempus Resorts Acquisition completed in July 2011, the Company recorded $70.5 million of mortgages and contracts receivable, net based on a preliminary appraisal. The mortgages and contracts receivable balance was calculated based on a discounted cash flow model. See Note 19 Business Combinations for further details.

 

15


Table of Contents

DIAMOND RESORTS PARENT, LLC AND SUBSIDIARIES

NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - Continued

(Unaudited)

 

Note 5—Transactions with Related Parties

Due from Related Parties, Net and Due to Related Parties, Net

Amounts due from related parties, net and due to related parties, net consist primarily of transactions with HOAs at properties at which the Company acts as the management company or Collections that hold the real estate underlying the Vacation Interests that the Company sells. Due from related parties, net transactions include management fees for the Company’s role as the management company, certain expenses reimbursed by HOAs, and the allocation of a portion of the Company’s resort management and general and administrative expenses according to a pre-determined schedule approved by the board of directors at each HOA. Due to related parties, net transactions include (1) the amounts due to HOAs under inventory recovery agreements the Company enters into regularly with certain HOAs and similar agreements with the Collections pursuant to which the Company recaptures Vacation Interests, either in the form of vacation points or vacation intervals, and brings them into the Company’s inventory for sale to customers; (2) the maintenance fee and special assessment fee liability owed to HOAs for Intervals or to the Collections for points owned by the Company; (3) cleaning fees owed to HOAs for room stays incurred by the Company’s customers; and (4) subsidy liabilities owed to certain HOAs to fund the negative cash flows at these HOAs according to certain subsidy agreements, which ceased as of December 31, 2008. Amounts due from related parties and due to related parties, some of which are due on demand, carry no interest. Due to the fact that the right of offset exists between the Company and the HOAs, the Company evaluates amounts due to and from each HOA at each reporting period to present the balances as either a net due to or a net due from related parties in accordance with the requirements of ASC 210-20, “Balance Sheet — Offsetting.”

Due from related parties, net consisted of the following as of September 30, 2011 and December 31, 2010 (in thousands):

 

     September 30,
2011
     December 31,
2010
 

Amounts due from HOAs

   $ 24,290       $ 19,941   

Amounts due from trusts

     1,291         1,017   

Amounts due from other

     305         —     
  

 

 

    

 

 

 

Total due from related parties, net

   $ 25,886       $ 20,958   
  

 

 

    

 

 

 

Due to related parties, net consisted of the following as of September 30, 2011 and December 31, 2010 (in thousands):

 

     September 30,
2011
     December 31,
2010
 

Amounts due to HOAs

   $ 45,935       $ 30,377   

Amounts due to trusts

     22,673         5,874   

Amounts due to other

     764         —     
  

 

 

    

 

 

 

Total due to related parties, net

   $ 69,372       $ 36,251   
  

 

 

    

 

 

 

Management Services

Included within the amounts reported as management, member and other services revenue are revenues from resort management services provided to the HOAs, which totaled $9.7 million and $7.7 million for the three months ended September 30, 2011 and 2010, respectively, and $27.2 million and $22.6 million for the nine months ended September 30, 2011 and 2010, respectively. See “Due from Related Parties, Net and Due to Related Parties, Net” section above for detail of these services performed.

 

16


Table of Contents

DIAMOND RESORTS PARENT, LLC AND SUBSIDIARIES

NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - Continued

(Unaudited)

 

Also included within the amount reported as management, member and other services revenue are revenues earned from managing the U.S. trusts which hold legal title to the vacation property real estate out of which the Company conveys vacation points to its customers. These amounts total $5.3 million and $4.2 million for the three months ended September 30, 2011 and 2010, respectively, and $14.8 million and $12.4 million for the nine months ended September 30, 2011 and 2010, respectively.

Allocation of Expenses

In addition to management services revenues, the Company also has entered into agreements with the HOAs to be reimbursed for a portion of the Company’s resort management and general and administrative expenses to the HOAs. The following table presents the amounts passed through to the HOAs for the three months and nine months ended September 30, 2011 and 2010, respectively (in thousands):

 

     Three Months Ended      Nine Months Ended  
     September 30,
2011
     September 30,
2010
     September 30,
2011
     September 30,
2010
 

Reduction of management, member and other services expenses

   $ 2,199       $ 1,684       $ 6,599       $ 5,006   

Reduction of general and administrative expenses

     6,486         5,942         19,549         17,858   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total allocation of expenses

   $ 8,685       $ 7,626       $ 26,148       $ 22,864   
  

 

 

    

 

 

    

 

 

    

 

 

 

Note 6—Other Receivables, Net

Other receivables, net consisted of the following as of September 30, 2011 and December 31, 2010 (in thousands):

 

     September 30,
2011
    December 31,
2010
 

THE Club dues receivable

   $ 9,748      $ 29,534   

Tempus Participation Loan

     7,267        —     

Rental receivables and other resort management-related receivables

     6,253        2,893   

Mortgage interest receivable

     3,905        3,651   

Owner maintenance fee receivable

     3,780        2,097   

Mini-vacation and sampler programs receivable

     1,833        1,060   

THE Club conversion receivable

     734        1,409   

Insurance claims receivable

     204        533   

Other receivables

     3,633        2,970   

Tempus Note Receivable

     —          3,005   

Proceeds from ILXA Inventory Loan in Transit

     —          1,028   
  

 

 

   

 

 

 

Total other receivables, gross

     37,357        48,180   

Allowance for doubtful accounts

     (12,506     (12,200
  

 

 

   

 

 

 

Total other receivables, net

   $ 24,851      $ 35,980   
  

 

 

   

 

 

 

On November 23, 2010, Tempus Acquisition entered into the Tempus Note Receivable with Tempus Resorts International, Ltd. and certain of its affiliates (the “Borrower”) to provide debtor-in-possession financing. The Tempus Note Receivable was a term loan facility with a maximum principal amount of $6.5 million. The Borrower used the proceeds for general working capital purposes and other purposes as permitted under the Tempus Note Receivable Agreement. The term of the Tempus Acquisition Loan ended on July 1, 2011, when the Tempus Note Receivable was discharged in connection with the Tempus Resorts Acquisition. See Note 12—Borrowings for details related to the Tempus Acquisition Loan.

 

17


Table of Contents

DIAMOND RESORTS PARENT, LLC AND SUBSIDIARIES

NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - Continued

(Unaudited)

 

On July 1, 2011, Tempus Acquisition purchased a 10% participating interest in the Loan and Security Agreement with Resort Finance America, LLC (the “Tempus Receivables Loan”) for $7.5 million. The outstanding balance of the Tempus Participation Loan is $7.3 million at September 30, 2011. See Note 12—Borrowings and Note 19—Business Combinations for details related to the Tempus Receivables Loan.

Note 7—Prepaid Expenses and Other Assets, Net

The nature of selected balances included in prepaid expenses and other assets, net of the Company includes:

Prepaid and unamortized maintenance fees—unamortized portion of annual maintenance fees billed by the HOAs on unsold Vacation Interests owned by the Company, which are charged to expense ratably over the year.

Deferred commissions—commissions paid to sales agents related to deferred mini-vacations and sampler program revenue, which are charged to expense as the associated revenue is recognized.

Unamortized exchange fees—unamortized portion of annual membership fees billed by an exchange company, which is amortized ratably over a one-year period.

Vacation Interest purchases in transit—purchases of vacation points from prior owners for which the titles have not been officially transferred to the Company. These Vacation Interest purchases in transit are reclassified to unsold Vacation Interest, net, upon successful transfer of title.

Prepaid rent—portion of rent paid in advance and charged to expense in accordance with lease agreements.

Prepaid expenses and other assets, net consisted of the following as of September 30, 2011 and December 31, 2010 (in thousands):

 

     September 30,
2011
     December 31,
2010
 

Debt issuance costs, net

   $ 24,602       $ 24,098   

Prepaid and/or unamortized maintenance fees

     14,832         5,663   

Deferred commissions

     3,271         2,494   

Other inventory/consumables

     2,793         3,019   

Prepaid insurance

     2,631         2,061   

Deposits and advances

     2,571         2,457   

Assets to be disposed (not actively marketed)

     2,188         2,169   

Unamortized exchange fees

     2,146         —     

Deferred interval recovery and remarketing agreement expenses

     879         —     

Vacation Interest purchases in transit

     797         1,099   

Prepaid rent

     483         255   

Prepaid sales and marketing costs

     381         239   

Other

     5,107         2,694   
  

 

 

    

 

 

 

Total prepaid expenses and other assets, net

   $ 62,681       $ 46,248   
  

 

 

    

 

 

 

With the exception of Vacation Interest purchases in transit, prepaid expenses are expensed as the underlying assets are used or amortized. Debt issuance costs incurred in connection with obtaining funding for the Company have been capitalized and are being amortized over the lives of the related funding agreements as a component of interest expense using a method which approximates the effective interest method. Amortization of capitalized debt issuance costs included in interest expense was $1.1 million and $0.8 million for the three months ended September 30, 2011 and 2010, respectively, and $3.9 million and $1.3 million for the nine months ended September 30, 2011 and 2010, respectively. See Note 12—Borrowings for more detail.

 

18


Table of Contents

DIAMOND RESORTS PARENT, LLC AND SUBSIDIARIES

NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - Continued

(Unaudited)

 

Debt issuance costs, net of amortization as of September 30, 2011 were comprised of $15.1 million related to the senior secured notes, $5.1 million related to the Diamond Resorts Owners Trust Series 2009-1 Class A and Class B Notes, $1.9 million related to the Diamond Resorts Owners Trust Series 2011-1 Notes, $1.5 million related to the TAC loans, $0.6 million related to the ILXA loans, $0.2 million related to the 2008 conduit facility, and $0.1 million related to the Quorum Facility.

Note 8—Unsold Vacation Interests, Net

Unsold Vacation Interests, net consisted of the following as of September 30, 2011 and December 31, 2010 (in thousands):

 

     September 30,
2011
     December 31,
2010
 

Completed unsold Vacation Interests, net

   $ 213,217       $ 157,491   

Undeveloped land

     31,620         32,159   

Vacation Interest construction in progress

     1,608         914   
  

 

 

    

 

 

 

Unsold Vacation Interests, net

   $ 246,445       $ 190,564   
  

 

 

    

 

 

 

Unsold VOIs are valued at the lower of cost or fair market value. The cost of unsold VOIs includes acquisition costs, hard and soft construction costs (which are comprised of architectural and engineering costs incurred during construction), the cost incurred to recover inventory and other carrying costs (including interest, real estate taxes and other costs incurred during the construction period). Costs are expensed to Vacation Interest cost of sales under the relative sales value method. In accordance with ASC 978, under the relative sales value method, cost of sales is calculated as a percentage of Vacation Interest sales revenue using a cost of sales percentage ratio of total estimated development costs to total estimated Vacation Interest sales revenue, including estimated future revenue and incorporating factors such as changes in prices and the recovery of VOIs generally as a result of maintenance fee and contracts receivable defaults. In accordance with ASC 978-340-25, the selling, marketing and administrative costs associated with any sale, whether the original sale or subsequent resale of recovered inventory, are expensed as incurred.

The costs capitalized for recovered intervals differ based on a variety of factors, including the method of recovery and the timing of the original sale and/or loan origination. Interest, real estate taxes and other carrying costs incurred during the construction period are capitalized and such costs incurred on completed Vacation Interests are expensed.

In accordance with ASC 978, on a quarterly basis, the Company calculates the total estimated Vacation Interest sales revenue and total estimated costs. The effects of changes in these estimates are accounted for as a current period adjustment so that the balance sheet at the end of the period of change and the accounting in subsequent periods are as they would have been if the revised estimates had been the original estimates. These adjustments can be material.

The changes in these estimates resulted in an increase in unsold Vacation Interests, net and a corresponding decrease in Vacation Interest cost of sales of $8.4 million and $0.3 million for the three months ended September 30, 2011 and September 30, 2010, respectively, and $32.9 million and $1.9 million for the nine months ended September 30, 2011 and September 30, 2010, respectively, which were primarily the result of an increase in the estimated sales price per point and a decline in average inventory cost per point related to recoveries.

In October 2011, the Company was levied a $9.8 million water intrusion assessment related to the intervals and points equivalent owned by the Company at a resort managed by the Company to cover the costs required to repair water intrusion damage. The water intrusion assessment will be recorded as Vacation Interest carrying cost during the quarter ending December 31, 2011. This assessment is payable in annual installments over the next five years.

In connection with the Tempus Resorts Acquisition completed in July 2011, the Company recorded $22.7 million of unsold Vacation Interests based on a preliminary appraisal. See Note 19 Business Combinations for further details.

 

19


Table of Contents

DIAMOND RESORTS PARENT, LLC AND SUBSIDIARIES

NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - Continued

(Unaudited)

 

Note 9—Property and Equipment, Net

Property and equipment are recorded at historical cost. The costs of improvements that extend the useful life of property and equipment are capitalized when incurred. These capitalized costs may include structural costs, equipment, fixtures, floor, and wall coverings. All repair and maintenance costs are expensed as incurred.

Buildings and leasehold improvements are depreciated using the straight-line method over the lesser of the estimated useful lives, which range from four to forty years, or the remainder of the lease terms. Furniture, office equipment, computer software and computer equipment are depreciated using the straight-line method over their estimated useful lives, which range from three to seven years.

Property and equipment, net consisted of the following as of September 30, 2011 and December 31, 2010 (in thousands):

 

     September 30,
2011
    December 31,
2010
 

Land and improvements

   $ 19,416      $ 4,021   

Buildings and leasehold improvements

     27,168        18,468   

Furniture and office equipment

     10,299        8,674   

Computer software

     10,972        9,110   

Computer equipment

     5,840        4,776   

Construction in progress

     525        433   
  

 

 

   

 

 

 

Property and equipment, gross

     74,220        45,482   

Less accumulated depreciation

     (21,013     (16,385
  

 

 

   

 

 

 

Property and equipment, net

   $ 53,207      $ 29,097   
  

 

 

   

 

 

 

Depreciation expense related to property and equipment was $2.0 million and $2.1 million for the three months ended September 30, 2011 and 2010, respectively, and $5.6 million and $5.3 million for the nine months ended September 30, 2011 and 2010, respectively.

As of December 31, 2010, the ILXA property and equipment acquired on August 31, 2010 were recorded at $5.7 million based on a preliminary appraisal. During the quarter ended March 31, 2011, the ILXA property and equipment were increased by $1.7 million based on the final appraisal.

In connection with the Tempus Resorts Acquisition completed in July 2011, the Company recorded $19.5 million of property and equipment based on a preliminary appraisal. See Note 19 Business Combinations for further details.

Note 10—Intangible Assets, Net

Intangible assets, net consisted of the following as of September 30, 2011 (in thousands):

 

     Gross
Carrying
Cost
     Accumulated
Amortization
    Net Book
Value
 

Management contracts

   $ 71,951       $ (12,663   $ 59,288   

Member relationships

     28,944         (22,915     6,029   

Distributor relationships and other

     1,232         (346     886   
  

 

 

    

 

 

   

 

 

 
   $ 102,127       $ (35,924   $ 66,203   
  

 

 

    

 

 

   

 

 

 

 

20


Table of Contents

DIAMOND RESORTS PARENT, LLC AND SUBSIDIARIES

NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - Continued

(Unaudited)

 

Intangible assets, net consisted of the following as of December 31, 2010 (in thousands):

     Gross
Carrying
Cost
     Accumulated
Amortization
    Net Book
Value
 

Management contracts

   $ 48,700       $ (9,239   $ 39,461   

Member relationships

     26,953         (21,753     5,200   

Distributor relationships and other

     1,227         (175     1,052   
  

 

 

    

 

 

   

 

 

 
   $ 76,880       $ (31,167   $ 45,713   
  

 

 

    

 

 

   

 

 

 

In connection with the ILX Acquisition in August 2010, the Company recorded $8.9 million of intangible assets based on a preliminary appraisal. During the quarter ended March 31, 2011, the ILXA intangible assets were decreased by $0.1 million based on the final appraisal.

In connection with the Tempus Resorts Acquisition completed in July 2011, the Company recorded $24.9 million of intangible assets based on a preliminary appraisal. These intangible assets include the estimated fair value of management contracts, property management agreements, and member relationships based on a discounted cash flow model. See Note 19 Business Combinations for further details.

Amortization expense for management contracts is recognized on a straight-line basis over the estimated useful lives ranging from five to twenty-five years. Amortization expense for management contracts was $1.3 million and $0.7 million for the three months ended September 30, 2011 and 2010, respectively, and $3.3 million and $2.0 million for the nine months ended September 30, 2011 and 2010, respectively. Amortization expense for member relationships, distributor relationships and other is amortized over the period of time that the relationships are expected to produce cash flows. Amortization expense for member relationships, distributor relationships and other intangibles was $0.5 million and $0.6 million for the three months ended September 30, 2011 and 2010, respectively, and $1.3 million and $1.6 million for the nine months ended September 30, 2011 and 2010, respectively. Membership relationships and distributor relationships have estimated useful lives ranging from three to thirty years. However, the Company expects to generate significantly more cash flows during the earlier years of the relationships than the later years. Consequently, amortization expenses on these relationships generally decrease significantly over the lives of the relationships.

The estimated aggregate amortization expense for intangible assets is expected to be $7.3 million, $6.7 million, $6.4 million, $5.7 million and $4.2 million for the twelve month periods ending September 30, 2012 through 2016, respectively.

Note 11—Assets Held for Sale

Assets held for sale are recorded at the lower of cost or their estimated fair value less costs to sell and are not subject to depreciation. Sale of the assets classified as such is probable, and transfer of the assets is expected to qualify for recognition as a completed sale, generally within one year of the balance sheet date. During 2010, the Company made the decision to sell certain resorts and certain units in its European operations. A portion of the units were sold by September 30, 2011. The $5.7 million balance in assets held for sale as of September 30, 2011 consisted of the points equivalent of unsold units and resorts that are either held for sale or pending the consummation of sale. During the nine months ended September 30, 2011, the Company entered into sales contracts for approximately $3.5 million of units that are classified as held for sale. The proceeds will be paid over several years and the Company will retain title to the properties until the full amounts due under the sales contracts are received. According to guidance included in ASC 360, “Property, Plant, and Equipment,” the sales shall not be considered consummated until all consideration has been exchanged. Consequently, the assets pending consummation of sale will continue to be included in assets held for sale until all proceeds are received.

 

21


Table of Contents

DIAMOND RESORTS PARENT, LLC AND SUBSIDIARIES

NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - Continued

(Unaudited)

 

Note 12—Borrowings

Diamond Resorts Owners Trust Series 2011-1 Timeshare Loan Backed Notes, Series 2011-1

On April 27, 2011, the Company completed a securitization transaction and issued Diamond Resorts Owners Trust Series 2011-1 Timeshare Loan Backed Notes, Series 2011-1 (the “DROT 2011 Notes”), with a face value of $64.5 million. The DROT 2011 Notes mature March 20, 2023 and have an interest rate of 4.0%. The net proceeds were used to pay off in full the $36.4 million outstanding principal balance under the 2008 conduit facility, to paydown approximately $7 million of the Quorum Facility, to pay requisite accrued interest and fees associated with both facilities, and to pay certain expenses incurred in connection with the issuance of the DROT 2011 Notes, including the funding of a reserve account required thereby.

The net proceeds received were $64.1 million compared to the $64.5 million face value and the Company recorded the $0.4 million difference as an original issue discount on the securitization notes payable. The Company incurred $2.1 million in placement, structuring, legal and professional fees in connection with this transaction, which will be amortized over the term of the DROT 2011 Notes. Amortization of $0.1 million of debt issuance costs and debt discount related to the DROT 2011 Notes was recorded and is included in interest expense in the accompanying condensed consolidated statement of operations for the nine months ended September 30, 2011.

Tempus Acquisition Loan and Tempus Resorts Acquisition Financing

On November 23, 2010, Tempus Acquisition entered into the Tempus Acquisition Loan with an affiliate of Guggenheim, as the lender, and Guggenheim Corporate Funding, LLC, as administrative agent. The Tempus Acquisition Loan was a revolving loan facility with a maximum principal amount of $8 million, the proceeds of which were used exclusively for the following purposes: (i) to provide Tempus Acquisition, LLC with funds to lend to Tempus Resorts International, Ltd. and certain of its affiliates, pursuant to a debtor-in-possession financing order entered by the United States Bankruptcy Court for the Middle District of Florida (“DIP Financing” or “Tempus Note Receivable”), for general working capital purposes and other lawful purposes as permitted under the agreements governing the DIP Financing; and (ii) to provide $1.5 million for the “Deposit,” as defined and provided in the Agreement for Purchase and Sale of Assets to purchase certain assets of Tempus Resorts International, Ltd. and its affiliates.

The term of the Tempus Acquisition Loan ended on July 1, 2011, when the Tempus Note Receivable was discharged in connection with the Tempus Resorts Acquisition.

On July 1, 2011, the Company completed the Tempus Resorts Acquisition through Mystic Dunes, LLC, a wholly-owned subsidiary of Tempus Acquisition. In order to fund the Tempus Resorts Acquisition, Tempus Acquisition entered into a Loan and Security Agreement with Guggenheim Corporate Funding, LLC, as administrative agent for the lender parties thereto (the “Tempus Guggenheim Loan”). The Tempus Guggenheim Loan is collateralized by all assets of Tempus Acquisition. The Tempus Guggenheim Loan is in an aggregate amount of $41.1 million (which includes a $5.5 million revolving loan), has an interest rate of 18.0% (of which 10.0% is paid currently and the remaining may be paid in cash or accrued and added to the principal amount of the Tempus Guggenheim Loan), and matures on June 30, 2015. An aggregate of $7.5 million of the Tempus Guggenheim Loan was used by Tempus Acquisition to purchase a 10% participating interest in the Tempus Receivables Loan and the remaining proceeds were loaned to Mystic Dunes, LLC pursuant to a Loan and Security Agreement having payment terms identical to the Tempus Guggenheim Loan (the “Mystic Dunes Loan”). The Mystic Dunes Loan is collateralized by all assets of Mystic Dunes, LLC. The proceeds of the Mystic Dunes Loan were used to pay off certain existing indebtedness and closing costs associated with the Tempus Resorts Acquisition.

In connection with the Tempus Resorts Acquisition, a subsidiary of Mystic Dunes, LLC entered into a Loan and Security Agreement with Resort Finance America, LLC (the “Tempus Receivables Loan”). The Tempus Receivables Loan is a receivables credit facility in the amount of $74.5 million, collateralized by mortgages and contracts receivable acquired in the Tempus Resorts Acquisition. The Tempus Receivables Loan has an interest rate which is the higher of (i) one-month LIBOR plus 7.0% and (ii) 10%, adjusted monthly, and matures on July 1, 2015.

 

22


Table of Contents

DIAMOND RESORTS PARENT, LLC AND SUBSIDIARIES

NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - Continued

(Unaudited)

 

Another subsidiary of Mystic Dunes, LLC entered into an Amended and Restated Inventory Loan and Security Agreement with Textron Financial Corporation (the “Tempus Inventory Loan”) in the maximum amount of $4.3 million, collateralized by certain VOI inventory acquired in the Tempus Resorts Acquisition. The Tempus Inventory Loan has an interest rate of three-month LIBOR plus 5.5% (with a floor of 2.0%) and matures on June 30, 2016, subject to extension to June 30, 2018. Hereinafter, the Tempus Guggenheim Loan, the Mystic Dunes Loan, the Tempus Receivables Loan and the Tempus Inventory Loan are sometimes collectively referred to herein as the “Tempus Loans.”

Polo Towers Lines of Credit and Securitization Notes Payable

In connection with the acquisition of Sunterra Corporation in April 2007, a subsidiary formerly owned by Stephen J. Cloobeck assigned revolving lines of credit to Diamond Resorts Parent, LLC. The lines of credit were collateralized by retail contracts receivable and related VOIs. The revolving feature of the lines of credit expired when they were assigned. One of the lines of credit was paid off and terminated on July 30, 2010 upon its final maturity date, and the remaining line of credit was paid off and terminated on January 3, 2011.

Securitized loans that were collateralized by consumer contracts and related VOIs were also assigned in April 2007 by a company controlled by Mr. Cloobeck. These loans were paid in full and terminated on March 4, 2011.

Notes Payable

The Company finances premiums on certain insurance policies under unsecured notes. Certain of the notes, which carried interest rates of 4.0% and 3.7% per annum, matured in January and August 2011, respectively. During the nine months ended September 30, 2011, the Company renewed certain insurance policies and financed $6.1 million in policy premiums under an unsecured note.

 

23


Table of Contents

DIAMOND RESORTS PARENT, LLC AND SUBSIDIARIES

NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - Continued

(Unaudited)

 

The following table presents selected information on the Company’s borrowings as of September 30, 2011 and December 31, 2010 (dollars in thousands):

 

     September 30, 2011     December 31,
2010
 
     Principal
Balance
    Weighted
Average
Interest
Rate
    Maturity     Principal
Balance
 

Senior Secured Notes

   $ 425,000        12.0     8/15/18      $ 425,000   

Original issue discount related to Senior Secured Notes

     (9,672         (10,278

Diamond Resorts Owners Trust Series 2009-1

     93,066        9.5     3/20/26        121,843   

Original issue discount related to Diamond Resorts Owners Trust Series 2009-1

     (704         (899

Tempus Receivables Loan

     68,280        10.0     7/1/15        —     

Diamond Resorts Owners Trust Series 2011-1

     56,285        4.0     3/20/23        —     

Original issue discount related to Diamond Resorts Owners Trust Series 2011-1

     (415         —     

Tempus Guggenheim Loan

     38,361        18.0     6/30/15        —     

ILXA Inventory Loan

     21,762        7.5     8/31/15        18,541   

Quorum Facility

     20,117        7.0     4/30/12        12,942   

2008 Conduit Facility

     14,294        5.5     10/31/11     39,467   

ILXA Receivables Loan

     7,916        10.0     8/31/15        10,292   

Tempus Inventory Loan

     3,798        7.5     6/30/16        —     

Notes payable-insurance policies

     1,422        3.1     Various        1,366   

Notes payable-other

     247        7.2     Various        66   

Tempus Acquisition Loan

     —          N/A        N/A        3,300   

Polo Towers Lines of Credit

     —          N/A        N/A        2,060   

Polo Towers Securitization Notes Payable

     —          N/A        N/A        1,138   
  

 

 

       

 

 

 

Total borrowings

   $ 739,757          $ 624,838   
  

 

 

       

 

 

 

 

* This was subsequently amended to April 12, 2013.

Derivative Instruments

In September 2007, the Company entered into an interest rate swap agreement (the “Credit Suisse Swap”) to manage its exposure to the fluctuation in interest rates. The Company paid interest at a fixed rate of 4.7% and received interest based on one-month LIBOR until the Credit Suisse Swap matured on March 20, 2011. Also in September 2007, the Company paid $0.1 million for an interest rate cap (“2007 Cap”) to further limit its exposure to interest rate increases. The 2007 Cap bore a strike rate of 5.5% and a one-month LIBOR and carried a variable notional amount according to a pre-determined amortization schedule until it was terminated on March 20, 2011 on its scheduled maturity date. The Company paid zero and $0.1 million in cash settlements under the 2008 conduit facility for the three months ended September 30, 2011 and 2010, respectively. The Company paid $0.1 million and $0.3 million in cash settlements under the 2008 conduit facility for the nine months ended September 30, 2011 and 2010, respectively.

In July 2010, the Company took additional measures to limit its exposure to interest rate increases by entering into a second interest rate cap (the “2010 Cap”). The 2010 Cap bears a strike rate of 5.5% and a one-month LIBOR and carries a notional amount of $30 million. The Company paid $0.1 million for the 2010 Cap, which will terminate on July 20, 2013.

In March 2011, the Company entered into another interest rate cap (the “2011 Cap”) to limit its exposure to interest rate increases. The 2011 Cap bears a strike rate of 5.5% and a one-month LIBOR and carries a notional amount of $5 million. The Company paid $0.002 million for the 2011 Cap, which terminated on August 20, 2011.

 

24


Table of Contents

DIAMOND RESORTS PARENT, LLC AND SUBSIDIARIES

NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - Continued

(Unaudited)

 

The swaps and the interest rate caps did not qualify for hedge accounting under ASC 815, “Derivatives and Hedging.” Consequently, the Company recorded zero and $0.1 million for the three months ended September 30, 2011 and 2010, respectively, and $0.1 million and $0.2 million for the nine months ended September 30, 2011 and 2010, respectively, in reduction of interest expense associated with the fair value adjustment of the derivative instruments with a corresponding decrease in derivative liabilities or assets.

As of September 30, 2011, the fair value of the derivative assets and derivative liabilities was zero. The fair value of the derivative assets, which consisted of the 2010 Cap, was calculated to be zero based on the discounted cash flow model. The Company had no derivative liabilities at September 30, 2011 as the Credit Suisse Swap was terminated in March 2011.

Borrowing Restrictions and Limitations

All of the Company’s borrowing under the senior secured notes, securitization notes, and 2008 conduit facility contain various restrictions and limitations that may affect its business and affairs. These include, but are not limited to, restrictions and limitations relating to its ability to incur indebtedness and other obligations, to make investments and acquisitions and to pay dividends. The Company is also required to maintain certain financial ratios and comply with other financial and performance covenants. The failure of the Company to comply with any of these provisions, or to pay its obligations, could result in foreclosure by the lenders of their security interests in the Company’s assets, and could otherwise have a material adverse effect on the Company. The Company was in compliance with all financial covenants as of September 30, 2011.

Capitalized Interest

The interest cost associated with major development and construction projects is capitalized and included in the cost of the project. Interest capitalization ceases once a project is substantially complete or no longer under construction to prepare for its intended use. When no debt is specifically identified as being incurred in connection with a construction project, the Company capitalizes interest on amounts expended on the project at the Company’s weighted average cost of borrowed money. No interest was capitalized during the three and nine months ended September 30, 2011 and 2010.

Note 13—Accrued Liabilities

The Company records estimated amounts for certain accrued liabilities at each period end. Accrued liabilities are obligations to transfer assets or provide services to other entities in the future as a result of past transactions or events. The nature of selected balances included in accrued liabilities of the Company includes:

Accrued marketing expenses—expenses for travel vouchers and certificates used as sales incentives to buyers as well as attraction tickets as tour incentives.

Accrued exchange company fees—estimated liability owed to an exchange company.

Accrued contingent litigation liabilities—estimated settlement costs for existing litigation cases.

Accrued operating lease liabilities—difference between straight-line operating lease expenses and cash payments associated with any equipment, furniture, or facilities leases classified as operating leases.

Accrued call center cost—expenses associated with the out-sourced customer service call center operations.

Accrued construction costs—estimated remaining costs accrued for construction renovation projects.

 

25


Table of Contents

DIAMOND RESORTS PARENT, LLC AND SUBSIDIARIES

NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - Continued

(Unaudited)

 

Accrued liability related to business combinations—estimated liability related to business combinations in accordance with ASC 805. As part of the ILX Acquisition, the Company recorded a $3.7 million estimated liability related to certain parcels of land owned by a third party. Upon the sale of the parcels of land in August 2011, ILXA satisfied this obligation with proceeds obtained from additional borrowings of approximately $4.1 million from the Inventory Loan and Security Agreement entered into with Textron Financial Corporation (the “ILXA Inventory Loan”).

Accrued liabilities consisted of the following as of September 30, 2011 and December 31, 2010 (in thousands):

 

     September 30,
2011
     December 31,
2010
 

Accrued payroll and related

   $ 15,872       $ 14,953   

Accrued interest

     8,098         20,365   

Accrued commissions

     6,143         4,787   

Accrued other taxes

     5,843         3,299   

Accrued marketing expenses

     4,789         5,405   

Accrued exchange company fees

     3,639         1,206   

Accrued contingent litigation liabilities

     2,205         2,642   

Accrued operating lease liabilities

     2,096         2,046   

Accrued insurance

     2,074         2,766   

Accrued professional fees

     1,710         2,648   

Accrued call center costs

     506         1,114   

Accrued construction costs

     440         247   

Other

     3,660         2,311   

Accrued liability related to business combinations

     —           3,744   
  

 

 

    

 

 

 

Total accrued liabilities

   $ 57,075       $ 67,533   
  

 

 

    

 

 

 

Note 14—Deferred Revenues

The Company records deferred revenues for payments received or billed but not earned for various activities.

Deferred maintenance and reserve fee revenue—maintenance fees billed as of January first of each year and earned ratably over the year in the Company’s capacity as the HOA for the two resorts in St. Maarten. In addition, the HOA will periodically bill the owners for capital project assessments to repair and replace the amenities or to reserve the out-of-pocket deductibles for hurricanes and other natural disasters. These assessments are deferred until refurbishment activity occurs, at which time the amounts collected are recognized as a direct reduction to refurbishment expense in consolidated resort operations expense. See Note 5Transactions with Related Parties for further discussion.

Deferred mini-vacations and sampler programs revenue—sold but unused trial Vacation Interests, ranging from three days to one week. This revenue is recognized when the purchaser completes their respective stay at one of the Company’s resorts or the trial period expires, whichever is earlier. Such revenue is recorded as a reduction to Vacation Interest carrying cost in accordance with ASC 978, with the exception of the Company’s European sampler product, which is three years in duration and is treated as Vacation Interest sales revenue.

THE Club deferred revenue—THE Club annual membership fees paid or billed to members and amortized ratably over a one-year period and optional reservation protection fees recognized over an approximate life of the member’s reservation (generally six months on average).

Deferred revenue from an exchange company—in consideration for several agreements entered into with an exchange company in 2008 that provide the Company with call center services and exchange services, the Company received $5 million in consideration for the exclusive right to provide those services to the Company. In accordance with ASC 605-50 — Revenue Recognition — Customer Payments and Incentives, the $5 million will be recognized over the 10-year term of the agreements as a reduction of the costs incurred for the services provided by the exchange company during this time frame.

 

26


Table of Contents

DIAMOND RESORTS PARENT, LLC AND SUBSIDIARIES

NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - Continued

(Unaudited)

 

Deferred revenues consisted of the following as of September 30, 2011 and December 31, 2010 (in thousands):

 

     September 30,
2011
     December 31,
2010
 

Deferred maintenance and reserve fee revenue

   $ 16,617       $ 13,491   

Deferred mini-vacations and sampler program revenue

     16,478         11,465   

THE Club deferred revenue

     8,863         36,535   

Deferred revenue from an exchange company

     2,904         3,246   

Other

     2,103         2,969   
  

 

 

    

 

 

 

Total deferred revenues

   $ 46,965       $ 67,706   
  

 

 

    

 

 

 

Note 15—Income Taxes

The income tax benefit for the three and nine months ended September 30, 2011 and 2010 was determined based on pre-tax book income (loss) (adjusted for book-tax differences) for the three and nine month periods. However, because the Company includes U.S. entities not taxed at the corporate level, non-U.S. disregarded entities, differences in tax rates between the U.S. and foreign jurisdictions, foreign currency and rate change adjustments, and is currently subject to the alternative minimum tax, the Company’s estimated effective tax rate, for the periods presented, differs significantly from the federal statutory rate of 35%.

In 2007, the Company’s wholly-owned subsidiary, Diamond Resorts (Europe) Ltd., filed a claim for refund with the United Kingdom income tax authority in the amount of $10.7 million (£7.4 million) with respect to its income tax returns for the years 1999 through 2004. Prior to 2011, the Company recorded tax benefit of $7.7 million (£5.0 million) for refunds received, plus interest of $0.6 million (£0.4 million). During the three months ended June 30, 2011, the Company recorded tax benefit of $1.6 million (£1.0 million) for an additional tax refund payment received. During the three months ended September 30, 2011, the Company recorded tax benefit of $1.4 million (£0.9 million) for final tax refund payments received, plus interest of $1.4 million (£0.9 million).

Note 16—Commitments and Contingencies

Lease Agreements

The Company conducts a significant portion of its operations from leased facilities, which include regional and global administrative facilities as well as off-premise booths and tour centers near active sales centers. The longest of these obligations extends into 2019. Many of these agreements have renewal options, subject to adjustments for inflation. In most cases, the Company expects that in the normal course of business, such leases will be renewed or replaced by other leases. Typically, these leases call for a minimum lease payment that increases over the life of the agreement by a fixed percentage or an amount based upon the change in a designated index. All of the facilities lease agreements are classified as operating leases.

In addition, the Company leases office and other equipment under both long-term and short-term lease arrangements, which are generally classified as operating leases.

Purchase Obligations

The Company has entered into various purchase obligations relating to sales center remodeling and property amenity improvement projects. The total remaining commitment was $0.3 million as of September 30, 2011.

Litigation and Other

From time to time, the Company or its subsidiaries are subject to certain legal proceedings and claims in the ordinary course of business, including claims or proceedings relating to the Company’s Vacation Interest sales and consumer finance business.

 

27


Table of Contents

DIAMOND RESORTS PARENT, LLC AND SUBSIDIARIES

NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - Continued

(Unaudited)

 

One of the Company’s subsidiaries, FLRX, Inc., is a defendant in a lawsuit originally filed in July 2003, alleging the breach of certain contractual terms relating to the obligations under a stock purchase agreement for the acquisition of FLRX in 1998, as well as certain violations under applicable consumer protection acts. FLRX currently conducts no operations and has no material assets other than an indirect interest in two undeveloped real estate parcels in Mexico. In January 2010, following a jury trial, a Washington state court entered a judgment against FLRX, awarded plaintiffs damages of $30.0 million plus post-judgement interest at a rate of 12% per annum and attorney’s fees of approximately $1.5 million, and ordered specific performance of certain ongoing contractual obligations pursuant to the breach of contract claim.

FLRX appealed the verdict. On November 14, 2011, the Company received notice that the Court of Appeals for the State of Washington affirmed the lower court decision upholding the judgment against FLRX. FLRX is considering a motion for reconsideration to the Court of Appeals and/or a petition for review with the State Supreme Court. Any liability in this matter would not be covered by insurance. Neither Diamond Resorts Corporation nor any of its other subsidiaries are party to this lawsuit. Sunterra was originally named as a defendant in this matter, but it was later dismissed from the case. Depending upon developments in the lawsuit, it is possible that FLRX may at some point determine to file for protection under the Federal Bankruptcy Code. Although the Company believes that it will not have any material liability when this matter is ultimately resolved, there can be no assurance that this will be the case. During the quarter ended September 30, 2011, the Company decreased the estimated litigation accrual by $0.5 million as a result of the exchange rate fluctuations between US Dollar and Mexican Peso. During the quarter ended September 30, 2010, the Company increased the estimated litigation accrual by $0.1 million. At September 30, 2011, the $1.2 million liability represents the write-down of FLRX’s investment in its subsidiaries to zero.

Two separate cases have been filed in St. Maarten against AKGI St. Maarten NV, or AKGI, one of the Company’s subsidiaries, challenging AKGI’s title to seven whole ownership units at the Royal Palm Resort, and alleging the breach of certain agreements that existed prior to AKGI’s acquisition of the resort. AKGI purchased the resort at auction in 1995. Each claimant alleges that, between 1989 and 1991, he purchased certain units from the prior owner of Royal Palm Resort, and that he holds, in perpetuity, legal title to, or a leasehold interest in, the respective units and is entitled to a refund of the purchase price and an annual 12% return on the purchase price (which totaled $1.2 million in one case and $1.3 million in the other case). Due to the nature of the AKGI purchase and the underlying St. Maarten laws, the Company believes that the obligations to the claimants would only be enforceable if the agreement between the claimant and AKGI’s predecessor was either a timeshare agreement or a lease agreement. AKGI has answered that the claimants’ agreements were, in fact, investment contracts, and therefore not enforceable under St. Maarten law. In February 2011, the case that was pending in the highest and final court of appeal was dismissed as to all claims, with the Company having no obligations, financial or otherwise, to claimant. The other case is currently pending in the intermediate court of appeal. A lien has been placed on AKGI’s interest in the Royal Palm Resort while the remaining action is pending.

In 1989, the Predecessor Company paid an advance deposit to acquire buildings/common areas on a resort owned by it in Europe. The seller of the property subsequently raised promissory notes in favor of two other entities (the “Mansilla Companies”) which the Company believes are related to the seller. Having asserted that the seller had breached its obligations by failing to honor the promissory notes, the Mansilla Companies then obtained a charge against the buildings forming the subject matter of the 1989 agreement. In 1994, the Predecessor Company filed two sets of civil proceedings against the seller and the Mansilla Companies opposing the charge based on its belief that the seller had agreed to transfer ownership to the Predecessor Company in accordance with the 1989 sales agreement. The Predecessor Company also commenced criminal proceedings against the owner and officers of the seller. These criminal proceedings concluded without a conviction despite the Predecessor Company’s unequivocal belief that the promissory notes between the seller and the Mansilla companies had been falsified and had not been executed by the seller. The rulings in both cases were affirmed on appeal. Both cases have now been concluded. The Company remains in occupation of the premises, which occupation has not been challenged by the new owners who allegedly acquired the property at auction. The Company intends to acquire the property by adverse possession after the passage of the time as required by law. The property has not been reflected as an asset on the condensed consolidated balance sheets. In 2005, the Company recorded the remaining balance of the purchase price as a legal expense and accrued liability due to the uncertainty of the outcome. The accrued liability balance of $1.0 million and $0.9 million is included in the accompanying condensed consolidated balance sheets as of September 30, 2011 and December 31, 2010, respectively.

The Company has entered into contracts with individual contractors and certain key management employees that specify severance payments upon termination of the contracts.

 

28


Table of Contents

DIAMOND RESORTS PARENT, LLC AND SUBSIDIARIES

NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - Continued

(Unaudited)

 

In 2008, an arbitration demand was filed against the Company for enforcement of a $4.0 million settlement agreement entered into by the Company and a Board of Director’s family member. On October 2, 2009, the arbitrator entered an arbitration award against the Company in the amount of $4.0 million plus interest. On December 8, 2009, a court in District Court, Clark County, Nevada confirmed the arbitration award plus pre-judgment interest and costs. At March 31, 2010, the $4.5 million balance related to this settlement agreement was recorded under due to related parties in the Company’s condensed consolidated balance sheet. On June 10, 2010, the award was paid in full for $4.4 million.

In October 2011, the HOA of one of the Company’s managed resorts levied a $65.8 million water intrusion assessment to the owners of that resort, of which $9.8 million is owed by the Company. The proceeds of this assessment will be used to repair the water intrusion damage at this resort. Since the announcement of the water intrusion assessment, the Company has received a number of complaints from the affected VOI owners regarding the assessment and related disclosures concerning the potential for the assessment, and some of these complaints have threatened litigation, including the pursuit of one or more class action lawsuits against the Company. Because no litigation has been filed regarding the water intrusion assessment to date, we are unable to determine the nature or strength of potential claims or the strength of the Company’s defenses to such claims. See also Note 24 – Subsequent Events.

In addition, the Company is also currently subject to litigation and claims regarding employment, tort, contract, construction, sales taxes and commission disputes, among others. The Company believes that none of these actions, including the actions described above, will have a material adverse effect on its consolidated financial position or results of operations.

Note 17—Fair Value Measurements

ASC 820 defines fair value, establishes a framework for measuring fair value in accordance with accounting principles generally accepted in the United States, and expands disclosures about fair value measurements. ASC 820 defines fair value as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. Financial assets and liabilities carried at fair value are classified and disclosed in one of the following three categories:

 

   

Level 1: Quoted prices for identical instruments in active markets.

 

   

Level 2: Quoted prices for similar instruments in active markets; quoted prices for identical or similar instruments in markets that are not active; and model-derived valuations whose inputs or significant value drivers are observable.

 

   

Level 3: Unobservable inputs used when little or no market data is available.

As of September 30, 2011 and December 31, 2010, the Company’s derivative instruments were the only financial assets and liabilities that were measured at fair value on a recurring basis. See Note 12—Borrowings for further details.

The swap derivative instruments and the cap derivative instruments as of December 31, 2010 were valued internally due to the immateriality of the balances based on cash flow models that discount the future cash flows based on a discount rate that factors in a credit risk premium and the volatility of forward rates. These instruments were classified as Level 3, based on the fact that the credit risk data used for the valuation is not directly observable and cannot be corroborated by observable market data. The Company’s assessment of the significant inputs to the fair value measurement in its entirety requires judgment and considers factors specific to the asset or liability.

 

29


Table of Contents

DIAMOND RESORTS PARENT, LLC AND SUBSIDIARIES

NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - Continued

(Unaudited)

 

The following table presents the effects of the changes in the mark-to-market valuations of the derivative instruments (in thousands):

 

     Derivative
Liabilities
 

Balance at December 31, 2010

   $ 79   

Total change in fair value as a reduction to interest expense

     (79
  

 

 

 

Balance at September 30, 2011

   $ —     
  

 

 

 

At September 30, 2011, the mortgages and contracts receivable had a balance of $297.1 million, net of allowance. The allowance for loan and contract losses against the mortgages and contracts receivable is derived using a static pool analysis to develop historical default percentages to apply to the mortgage and contract population. The Company evaluates other factors such as the credit scores of the individual customers, economic conditions, industry trends, default rates and past due aging reports. The Company believes that this balance approximates the fair value of the mortgages and contracts based on the recent closing of the Company’s securitization transaction on April 27, 2011. See Note 12—Borrowings for further details.

At September 30, 2011, all of the Company’s securitization notes and 2008 conduit facility are classified as Level 2 since they are either recently-completed transactions or measured using other significant observable inputs including the current refinancing activities.

At September 30, 2011, the Quorum Facility, the ILXA Receivables Loan, the ILXA Inventory Loan, the Tempus Guggenheim Loan, the Tempus Receivables Loan and the Tempus Inventory Loan had an aggregate balance of $160.2 million, net of unamortized original issue discount, in the accompanying condensed consolidated balance sheet, which the Company believes approximates their fair value due to the fact that these transactions were recently completed. The DROT 2011 Notes were issued on April 27, 2011, the Quorum Facility was issued in April 2010, the ILXA Receivables Loan and ILXA Inventory Loan were issued in August 2010, and the Tempus Guggenheim Loan, the Tempus Receivables Loan and the Tempus Inventory Loan were issued in July 2011.

At September 30, 2011, the DROT 2011 Notes (net of unamortized original issue discount) had an aggregate balance of $55.9 million. The fair value of the DROT 2011 Notes was determined to be $55.7 million based on a valuation performed by an investment banking firm.

At September 30, 2011, the DROT 2009 Notes (net of unamortized original issue discount) had an aggregate balance of $92.4 million. The fair value of the DROT 2009 Notes was determined to be $99.1 million based on a valuation performed by an investment banking firm.

The borrowings under the senior secured notes are classified as Level 2 as they are actively traded on the open market. At September 30, 2011, the fair value of the senior secured notes was $398.4 million based on its quoted price of 93.8.

The carrying value related to the notes payable balance, excluding the ILXA Inventory Loan, the Tempus Guggenheim Loan and the Tempus Inventory Loan was $1.7 million as of September 30, 2011. The fair value was not calculated based on the fact that the components of the notes payable were either due within one year or were immaterial.

In accordance with ASC 820-10, the Company also applied the provisions of fair value measurement to various non-recurring measurements for the Company’s financial and non-financial assets and liabilities and recorded the impairment charges, which were immaterial for the quarters ended September 30, 2011 and 2010. The Company’s non-financial assets consist of property and equipment, which are recorded at cost, net of depreciation unless impaired, and assets held for sale, which are recorded at the lower of cost or their estimated fair value less costs to sell.

 

30


Table of Contents

DIAMOND RESORTS PARENT, LLC AND SUBSIDIARIES

NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - Continued

(Unaudited)

 

Note 18—Common and Preferred Units

On April 26, 2007, the Company entered into agreements with an institutional investor (“Investor”). Pursuant to the agreements, the Investor contributed an initial capital contribution of $62.4 million to the Company in exchange for 212 common units and 1,000 preferred units.

These agreements also contained a provision to allow the Company, at its discretion, to redeem the preferred units at redemption premiums that vary depending on the redemption date. In addition, these agreements allowed the Investor to require the Company to redeem all or any portion of the preferred units it held under the following circumstances: (1) simultaneously with the Company’s initial public stock offering; (2) at any time after August 13, 2019; (3) upon the acceleration of payment of principal by any lender of senior indebtedness; and (4) in the event of certain uncured breaches of the agreements governing the preferred units. The redemption price varied depending on the event leading to the redemption.

The Company applied the guidance enumerated in ASC 480-10, “Distinguishing Liabilities from Equity,” when determining the classification and measurement of preferred stock. In addition, the Company classified the $62.4 million of conditionally redeemable preferred units as temporary member capital due to the fact that the preferred units contained redemption rights that were either within the control of the holder or subject to redemption upon the occurrence of uncertain events not solely within the Company’s control. Furthermore, the preferred units had a priority return of 17.0% per annum, compounded quarterly, as well as a redemption preference with respect to the common equity securities.

In accordance with ASC 480-10, the Company was required to record the redemption premiums and accrete for the priority returns periodically as it was probable that the preferred units would be redeemed by the Company. Both the redemption premiums and the priority returns were recorded as an increase to accumulated deficits and a corresponding increase to redeemable preferred units in temporary member capital.

On June 17, 2010, the Company and the Investor entered into a redemption agreement whereby the Company redeemed 70.67 common units and 333.33 preferred units for $25 million on the same date and 108.63 common units and 666.67 preferred units for $50 million on August 13, 2010. Upon these redemptions, the recorded value of the equity investment, including the accumulated priority returns and redemption premiums, totaled $111.7 million. The difference between the recorded value and the $75 million that was paid to the Investor was recorded as a credit to the accumulated deficit account in the accompanying condensed consolidated balance sheet.

Also on June 17, 2010, the Company entered into agreements with DRP Holdco, LLC, an investment vehicle managed by an affiliate of Guggenheim Partners, LLC (“Guggenheim”). These agreements provided for Guggenheim to make a $75 million investment in common and preferred units of the Company. An initial investment of $25 million was made on June 17, 2010 and the remaining investment of $50 million was received on August 13, 2010. The proceeds of this investment were used to repurchase the equity securities previously held by the Investor and, therefore, the Company did not retain any net proceeds from these transactions. At December 31, 2010, costs associated with this transaction totaled $2.9 million and have been recorded to the accumulated deficit account in the accompanying condensed consolidated balance sheet.

These agreements also contained a provision to allow the Company, at its discretion, to redeem any of the preferred units at any time after August 13, 2012, for any reason or no reason, at optional redemption premiums ranging from 100% to 103% depending on the redemption date. In addition, Guggenheim may have required the Company to redeem all or any portion of the preferred units it held under the following circumstances: (1) simultaneously with the Company’s initial public stock offering; (2) at any time after August 13, 2019; (3) upon the acceleration of payment of principal by any lender of senior indebtedness; and (4) in the event of certain uncured breaches of the agreements that governed the preferred units. The preferred redemption premiums varied from 100% to 105% depending on the event leading to the redemption.

 

31


Table of Contents

DIAMOND RESORTS PARENT, LLC AND SUBSIDIARIES

NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - Continued

(Unaudited)

 

The Company applied the guidance enumerated in ASC 480-10 when determining the classification and measurement of preferred stock. In addition, the Company classified the $75 million of conditionally redeemable preferred units as temporary member capital due to the fact that the preferred units contained redemption rights that were either within the control of the holder or subject to redemption upon the occurrence of uncertain events not solely within the Company’s control.

Furthermore, the preferred units had a priority return of 17.0% per annum from June 17, 2010 to August 13, 2010 and had a priority return of 16.5% per annum from August 14, 2010 through redemption, compounded quarterly, as well as a liquidation preference with respect to the common equity securities.

In accordance with ASC 480-10, the Company was required to record the redemption premiums and accrete for the priority returns periodically as it was probable that the preferred units would be redeemed by the Company. Both the redemption premiums and the priority returns were recorded as an increase to accumulated deficits and a corresponding increase to redeemable preferred units in temporary member capital.

Prior to any distributions to the common unit holders, the holders of the preferred units were entitled to receive from the Company the product of (a) an amount equal to the sum of (i) such holder’s contribution with respect to the preferred units reduced by any distributions to such holders, and (ii) accrued but unpaid distributions of priority returns, and (b) the relevant redemption premiums based on the date of redemption. Once the sum of any unpaid priority returns and the unreturned contributions with respect to the preferred units was reduced to zero, the preferred units would have been deemed cancelled. The balance, if any, would have been distributed to the common unit holders on a pro rata basis.

On February 18, 2011, DRP entered into various agreements with four new equity investors to issue an aggregate of 25.1 common units and 133.33 preferred units in exchange for $10.1 million. This transaction brought the total number of issued and outstanding common units to 1,115.1 and issued and outstanding preferred units to 1,133.33. The terms of the new equity investor agreements were consistent with the terms included in the Guggenheim agreements discussed above.

Also on February 18, 2011, DRP entered into a warrant purchase agreement to repurchase certain warrants issued by Diamond Resorts Corporation from various holders of the warrants. These warrants were originally issued to holders of DRP’s Second Lien Facility but became detached and transferrable to other parties when the Second Lien Facility was extinguished in August 2010. DRP purchased warrants that were exercisable into approximately 52.4% of the shares of common stock of Diamond Resorts Corporation, in exchange for approximately $10.1 million in cash.

On July 21, 2011, DRP consummated a recapitalization transaction pursuant to which it sold 280.89 common units to certain institutional accredited investors in exchange for $136.5 million. DRP paid approximately $4.5 million in fees in conjunction with the recapitalization transactions. DRP used $108.7 million of the proceeds and issued 26.56 common units to redeem all of the issued and outstanding preferred units (including accrued and unpaid priority returns). In addition, DRP paid $16.4 million to CDP, a related party of the Company, to redeem 34.74 common units previously held by CDP. Immediately after the transaction above, CDP owns approximately 54.3% of the issued and outstanding common units with the remainder owned by various institutional investors. DRP also purchased warrants that are exercisable into approximately 3.3% of common stock of Diamond Resorts Corporation for approximately $6.4 million in cash.

For the nine months ended September 30, 2010, the Company recorded $2.9 million in costs related to the issuance of preferred units, which are recorded under accumulated deficits in the accompanying condensed consolidated balance sheets. For the nine months ended September 30, 2011, the Company recorded $0.1 million in costs related to the issuance of the preferred units, which are recorded under accumulated deficits in the accompanying condensed consolidated balance sheets. In addition, the Company paid $4.5 million in costs related to the issuance of the common units, which are netted against the proceeds received from the issuance of the common units and recorded under member capital in the accompanying condensed consolidated balance sheets.

 

32


Table of Contents

DIAMOND RESORTS PARENT, LLC AND SUBSIDIARIES

NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - Continued

(Unaudited)

 

Note 19—Business Combinations

On August 31, 2010, ILXA acquired a majority of the assets of ILX Resorts, Inc. for an aggregate cash purchase price of $30.7 million with $2.5 million in cash payments and the remainder in borrowings. The ILX Acquisition added ten additional resorts and more than 25,000 owners to the Diamond Resorts family. These assets complement Diamond Resorts’ existing resort network and are expected to increase the Company’s value proposition to its owner base. The ILX Acquisition was financed through the ILXA Inventory Loan and the ILXA Receivables Loan. See Note 12—Borrowings for additional details. In addition, ILXA assumed $4.0 million in liabilities as part of the purchase price based on the final appraisal. The acquisition resulted in no goodwill or gain from business combinations due to the fact the fair value of assets acquired and liabilities assumed equals the purchase price.

The Company accounted for this acquisition under the purchase method in accordance with ASC 805, “Business Combinations” (“ASC 805”). As of December 31, 2010, the acquisition was recorded based on a preliminary appraisal. During the quarter ended March 31, 2011, adjustments were recorded to the respective accounts to reflect the values included in the final appraisal. The following table summarizes the consideration paid and the amounts of the assets acquired and liabilities assumed at the acquisition date based on the preliminary and final appraisals (in thousands):

 

     Based on
Preliminary
Appraisal as
Previously
Reported
     Adjustments
Recorded
During the
Quarter Ended
March 31,
2011
    Based on
Final
Appraisal
 

Consideration:

       

Cash

   $ 30,722       $ —        $ 30,722   
  

 

 

    

 

 

   

 

 

 

Fair value of total consideration transferred

   $ 30,722       $ —        $ 30,722   
  

 

 

    

 

 

   

 

 

 

Recognized amounts of identifiable assets and liabilities assumed as of August 31, 2010:

       

Cash in escrow and restricted cash

   $ 54       $ —        $ 54   

Mortgages and contracts receivable

     9,802         (1,660     8,142   

Prepaid expenses and other assets

     365         (31     334   

Unsold Vacation Interests

     10,100         —          10,100   

Property and equipment

     5,705         1,679        7,384   

Intangible assets

     8,850         (100     8,750   
  

 

 

    

 

 

   

 

 

 

Total assets

     34,876         (112     34,764   

Current liabilities

     4,154         (112     4,042   
  

 

 

    

 

 

   

 

 

 

Total identifiable net assets

   $ 30,722       $ —        $ 30,722   
  

 

 

    

 

 

   

 

 

 

 

33


Table of Contents

DIAMOND RESORTS PARENT, LLC AND SUBSIDIARIES

NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - Continued

(Unaudited)

 

Acquired ILX intangible assets consist of the following (dollar amounts in thousands):

 

     Weighted
Average
Useful Life
in Years
     Based on
Preliminary
Appraisal as
Previously
Reported
     Adjustments
Recorded
During the
Quarter Ended
March 31,
2011
    Based on
Final
Appraisal
 

Member relationships

     10       $ 1,100       $ (100   $ 1,000   

Management contracts

     5         7,120         —          7,120   

Trade name

     5         600         —          600   

Domain name

     5         30         —          30   
     

 

 

    

 

 

   

 

 

 

Total acquired intangible assets

      $ 8,850       $ (100   $ 8,750   
     

 

 

    

 

 

   

 

 

 

The ILX management contracts have automatic renewals for a weighted average term of approximately ten years. The weighted average period before the next renewal or extension is approximately five years.

These notes to the condensed consolidated financial statements do not present supplemental pro forma information to include revenue and earnings of ILX for all periods presented, as the Company deems that it is impracticable to obtain this information. The historical ILX financial statements include segments of operations that were not acquired by the Company. These financial statements co-mingle all activities. As such, management cannot reasonably estimate and carve out the amounts related to the assets acquired and the liabilities assumed by the Company. Additionally, based on the criteria included in ASC 805, the ILX Acquisition is not material in relation to the total assets included on the condensed consolidated balance sheets and the net loss reported on the condensed consolidated statements of operations.

On July 1, 2011, the Company completed the Tempus Resorts Acquisition through Mystic Dunes, LLC, a wholly-owned subsidiary of Tempus Acquisition with $104.9 million in borrowings. The Tempus Resorts Acquisition added two additional resorts and more than 44,000 owners to the Diamond Resorts family. These assets complement Diamond Resorts’ existing resort network and are expected to increase the Company’s value proposition to its owner base.

In order to fund the Tempus Resorts Acquisition, Tempus Acquisition entered into a Loan and Security Agreement with Guggenheim Corporate Funding, LLC, as administrative agent for the lender parties thereto (the “Tempus Guggenheim Loan”). The Tempus Guggenheim Loan is collateralized by all assets of Tempus Acquisition. The Tempus Guggenheim Loan is in an aggregate amount of $41.1 million (which includes a $5.5 million revolving loan), has an interest rate of 18.0% (of which 10.0% is paid currently and the remaining may be paid in cash or accrued and added to the principal amount of the Tempus Guggenheim Loan), and matures on June 30, 2015. An aggregate of $7.5 million of the Tempus Guggenheim Loan was used by Tempus Acquisition to purchase a 10% participating interest in the Loan and Security Agreement with Resort Finance America, LLC (the “Tempus Receivables Loan”) and the remaining proceeds were loaned to Mystic Dunes, LLC pursuant to a Loan and Security Agreement having payment terms identical to the Tempus Guggenheim Loan (the “Mystic Dunes Loan”). The Mystic Dunes Loan is collateralized by all assets of Mystic Dunes, LLC. The proceeds of the Mystic Dunes Loan were used to pay off certain existing indebtedness and closing costs associated with the Tempus Resorts Acquisition.

In connection with the Tempus Resorts Acquisition, a subsidiary of Mystic Dunes, LLC entered into the Tempus Receivables Loan. The Tempus Receivables Loan is a receivables credit facility in the amount of $74.5 million, collateralized by mortgages and contracts receivable acquired in the Tempus Resorts Acquisition. The Tempus Receivables Loan has an interest rate which is the higher of (i) one-month LIBOR plus 7.0% and (ii) 10%, adjusted monthly, and matures on July 1, 2015. Another subsidiary of Mystic Dunes, LLC entered into an Amended and Restated Inventory Loan and Security Agreement with Textron Financial Corporation (the “Tempus Inventory Loan”) in the maximum amount of $4.3 million, collateralized by certain VOI inventory acquired in the Tempus Resorts Acquisition. The Tempus Inventory Loan has an interest rate of three-month LIBOR plus 5.5% (with a floor of 2.0%) and matures on June 30, 2016, subject to extension to June 30, 2018.

 

34


Table of Contents

DIAMOND RESORTS PARENT, LLC AND SUBSIDIARIES

NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - Continued

(Unaudited)

 

Each of Tempus Acquisition, Mystic Dunes, LLC and its wholly-owned subsidiaries are special purpose, unrestricted subsidiaries of the Company. Neither the Company nor any of its other subsidiaries has guaranteed, or is a party to, the Tempus Guggenheim Loan, the Tempus Receivables Loan or the Mystic Dunes Loan.

The Company accounted for this acquisition under the purchase method in accordance with ASC 805, “Business Combinations” (“ASC 805”). As of September 30, 2011, the acquisition was recorded based on a preliminary appraisal; accordingly, provisional amounts have been assigned to the assets acquired and liabilities assumed. Changes to the provisional amounts may be material. The Company expects to make all changes to provisional amounts within one year of the acquisition date.

The following table summarizes the consideration paid and the amounts of the assets acquired and liabilities assumed at the acquisition date based on the preliminary appraisal (in thousands). The Company recorded $34.2 million in gain on bargain purchase from business combinations in accordance with ASC 805-30-25 due to the fact that the assets were purchased as part of a distressed sale as Tempus Resorts International Ltd. had filed for Chapter 11 bankruptcy proceedings in November 2010.

 

     Based on
Preliminary
Appraisal
 

Consideration:

  

Cash

   $ 104,915   
  

 

 

 

Fair value of total consideration transferred

   $ 104,915   
  

 

 

 

Recognized amounts of identifiable assets and liabilities assumed as of July 1, 2011:

  

Cash and cash equivalents acquired

   $ 2,517   

Cash in escrow and restricted cash

     2,912   

Prepaid expenses and other assets

     1,423   

Due from related parties, net

     4   

Other receivables, net

     2,444   

Mortgages and contracts receivable

     70,496   

Unsold Vacation Interests

     22,745   

Property and equipment

     19,544   

Intangible assets

     24,889   
  

 

 

 

Total assets

     146,974   

Liabilities assumed

     7,876   
  

 

 

 

Total identifiable net assets

   $ 139,098   
  

 

 

 

Gain on bargain purchase from business combination

   $ 34,183   
  

 

 

 

 

35


Table of Contents

DIAMOND RESORTS PARENT, LLC AND SUBSIDIARIES

NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - Continued

(Unaudited)

 

Acquired Tempus intangible assets consist of the following (dollar amounts in thousands):

 

     Weighted
Average
Useful Life
in Years
     Based on
Preliminary
Appraisal
 

Management Contract—Mystic Dunes

     15       $ 13,780   

Amenity Fee Agreements

     17.5         8,709   

Member relationships

     3         2,070   

Management Contract—Dunes Village

     15         330   
     

 

 

 

Total acquired intangible assets

      $ 24,889   
     

 

 

 

The Tempus Resorts Acquisition contributed $11.2 million of revenue and $31.8 million of net income, which includes $34.2 million of gain on bargain purchase, from the acquisition date through September 30, 2011. These amounts are included in the condensed consolidated statements of operations for the three and nine months ended September 30, 2011.

The following table presents unaudited consolidated pro forma financial information as if the closing of the Tempus Resorts Acquisition had occurred on January 1, 2010 for purposes of the financial information presented for the three and nine months ended September 30, 2011 and 2010 (in thousands):

 

     Three Months Ended     Nine Months Ended  
     September 30,
2011
     September 30,
2010
    September 30,
2011
    September 30,
2010
 

Revenue

   $ 107,450       $ 109,880      $ 304,702      $ 320,233   

Net income (loss)

   $ 3,421       $ (2,511   $ (2,372   $ (5,172

The historical unaudited consolidated financial information has been adjusted to give effect to pro forma events that are (1) directly attributable to the acquisition, (2) factually supportable, and (3) expected to have a continuing impact on the combined results of the Company and Tempus Acquisition.

The unaudited pro forma results have been adjusted with respect to certain aspects of the Tempus Resorts Acquisition to reflect:

 

   

the consummation of the acquisition;

 

   

changes in assets and liabilities to record their acquisition date fair values and changes in certain expenses resulting therefrom;

 

   

additional indebtedness, including, but not limited to, debt issuance costs and interest expense, incurred in connection with the acquisition;

 

   

the removal of legal and professional fees incurred in connection with the Tempus Resorts Acquisition;

 

   

the removal of Tempus reorganization items relating to the impairment of assets that were not acquired and professional fees related to the bankruptcy proceedings, which do not relate to continuing operations; and

 

   

the removal of the gain on bargain purchase from business combination.

The unaudited pro forma results do not reflect future events that either have occurred or may occur after the Tempus Resorts Acquisition, including, but not limited to, the anticipated realization of ongoing savings from operating synergies in subsequent periods. They also do not give effect to certain one-time charges the Company expects to incur in connection with the acquisitions, including, but not limited to, charges that are expected to achieve ongoing cost savings and synergies.

 

36


Table of Contents

DIAMOND RESORTS PARENT, LLC AND SUBSIDIARIES

NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - Continued

(Unaudited)

 

Note 20—Segment Reporting

The Company presents its results of operations in two segments: (1) Hospitality and Management Services, which includes operations related to the management of resort properties, the Collections and revenue from its operation of THE Club and the provision of other services; and (2) Vacation Interest Sales and Financing, which includes operations relating to the marketing and sales of Vacation Interests, as well as the consumer financing activities related to such sales. While certain line items reflected on the statement of operations fall completely into one of these business segments, other line items relate to revenues or expenses which are applicable to more than one segment. For line items that are applicable to more than one segment, revenues or expenses are allocated by management, which involves significant estimates. Certain expense items (principally corporate interest expense and depreciation and amortization) are not, in management’s view, allocable to either of these business segments as they apply to the entire Company. In addition, general and administrative expenses are not allocated to either of these business segments because historically management has not allocated these expenses for purposes of evaluating the Company’s different operational divisions. Accordingly, these expenses are presented under Corporate and Other.

Management believes that it is impracticable to allocate specific assets and liabilities related to each business segment. In addition, management does not review balance sheets by business segment as part of their evaluation of operating segment performances. Consequently, no balance sheet segment reports have been presented.

 

37


Table of Contents

DIAMOND RESORTS PARENT, LLC AND SUBSIDIARIES

NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - Continued

(Unaudited)

 

Information about the Company’s operations in different business segments is as follows:

CONDENSED CONSOLIDATING STATEMENTS OF OPERATIONS BY BUSINESS SEGMENT

For the three months ended September 30, 2011 and 2010

(In thousands)

 

    Three Months Ended
September 30, 2011
    Three Months Ended
September 30, 2010
 
    Hospitality and
Management
Services
    Vacation
Interest Sales
and Financing
    Corporate
and
Other
    Total     Hospitality and
Management
Services
    Vacation
Interest Sales
and Financing
    Corporate
and
Other
    Total  

Revenues:

               

Vacation Interest sales

  $ —        $ 60,228      $ —        $ 60,228      $ —        $ 56,515      $ —        $ 56,515   

Provision for uncollectible Vacation Interest sales revenue

    —          (4,516     —          (4,516     —          (2,051     —          (2,051
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Vacation Interest, net

    —          55,712        —          55,712        —          54,464        —          54,464   

Management, member and other services

    26,266        3,221        —          29,487        22,959        2,661        —          25,620   

Consolidated resort operations

    7,601        —          —          7,601        6,563        —          —          6,563   

Interest

    —          12,966        1,684        14,650        —          9,839        37        9,876   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total revenues

    33,867        71,899        1,684        107,450        29,522        66,964        37        96,523   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Costs and Expenses:

               

Vacation Interest cost of sales

    —          1,854        —          1,854        —          11,765        —          11,765   

Advertising, sales and marketing

    —          34,488        —          34,488        —          30,321        —          30,321   

Vacation Interest carrying cost, net

    —          4,156        —          4,156        —          6,693        —          6,693   

Management, member and other services

    6,603        562        —          7,165        5,042        280        —          5,322   

Consolidated resort operations

    6,620        —          —          6,620        5,520        —          —          5,520   

Loan portfolio

    290        2,459        —          2,749        255        2,363        —          2,618   

General and administrative

    —          —          21,074        21,074        —          —          18,326        18,326   

Depreciation and amortization

    —          —          3,853        3,853        —          —          3,451        3,451   

Interest

    —          5,649        16,453        22,102        —          4,371        13,085        17,456   

Loss on extinguishment of debt

    —          —          —          —          —          —          1,081        1,081   

Impairments and other write-offs

    7        —          686        693        —          —          9        9   

Gain on disposal of assets

    —          —          (76     (76     —          —          (289     (289

Gain on bargain purchase from business combination

    —          —          (34,183     (34,183     —          —          —          —     
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total costs and expenses

    13,520        49,168        7,807        70,495        10,817        55,793        35,663        102,273   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Income (loss) before benefit for income taxes

    20,347        22,731        (6,123     36,955        18,705        11,171        (35,626     (5,750

Benefit for income taxes

    —          —          (646     (646     —          —          (1,994     (1,994
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net income (loss)

  $ 20,347      $ 22,731      $ (5,477   $ 37,601      $ 18,705      $ 11,171      $ (33,632   $ (3,756
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

38


Table of Contents

DIAMOND RESORTS PARENT, LLC AND SUBSIDIARIES

NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - Continued

(Unaudited)

 

CONDENSED CONSOLIDATING STATEMENTS OF OPERATIONS BY BUSINESS SEGMENT

For the nine months ended September 30, 2011 and 2010

(In thousands)

 

    Nine Months Ended
September 30, 2011
    Nine Months Ended
September 30, 2010
 
    Hospitality and
Management
Services
    Vacation
Interest Sales
and Financing
    Corporate
and
Other
    Total     Hospitality and
Management
Services
    Vacation
Interest Sales
and Financing
    Corporate
and
Other
    Total  

Revenues:

               

Vacation Interest sales

  $ —        $ 154,631      $ —        $ 154,631      $ —        $ 158,833      $ —        $ 158,833   

Provision for uncollectible Vacation Interest sales revenue

    —          (11,259     —          (11,259     —          (2,919     —          (2,919
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Vacation Interest, net

    —          143,372        —          143,372        —          155,914        —          155,914   

Management, member and other services

    81,144        8,184        —          89,328        67,879        8,281        —          76,160   

Consolidated resort operations

    21,789        —          —          21,789        20,057        —          —          20,057   

Interest

    —          31,679        2,601        34,280        —          29,288        75        29,363   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total revenues

    102,933        183,235        2,601        288,769        87,936        193,483        75        281,494   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Costs and Expenses:

               

Vacation Interest cost of sales

    —          (3,760     —          (3,760     —          33,630        —          33,630   

Advertising, sales and marketing

    —          96,121        —          96,121        —          83,585        —          83,585   

Vacation Interest carrying cost, net

    —          20,063        —          20,063        —          20,875        —          20,875   

Management, member and other services

    18,155        1,304        —          19,459        16,224        1,272        —          17,496   

Consolidated resort operations

    19,894        —          —          19,894        18,045        —          —          18,045   

Loan portfolio

    729        7,177        —          7,906        771        7,077        —          7,848   

General and administrative

    —          —          58,797        58,797        —          —          50,218        50,218   

Depreciation and amortization

    —          —          10,165        10,165        —          —          8,899        8,899   

Interest

    —          14,082        46,300        60,382        —          13,907        34,959        48,866   

Loss on extinguishment of debt

    —          —          —          —          —          —          1,081        1,081   

Impairments and other write-offs

    7        —          1,009        1,016        —          —          989        989   

Gain on disposal of assets

    —          —          (448     (448     —          —          (1,049     (1,049

Gain on bargain purchase from business combination

    —          —          (34,183     (34,183     —          —          —          —     
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total costs and expenses

    38,785        134,987        81,640        255,412        35,040        160,346        95,097        290,483   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Income (loss) before benefit for income taxes

    64,148        48,248        (79,039     33,357        52,896        33,137        (95,022     (8,989
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Benefit for income taxes

    —          —          (64     (64     —          —          (569     (569
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net income (loss)

  $ 64,148      $ 48,248      $ (78,975   $ 33,421      $ 52,896      $ 33,137      $ (94,453   $ (8,420
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

39


Table of Contents

DIAMOND RESORTS PARENT, LLC AND SUBSIDIARIES

NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - Continued

(Unaudited)

 

Note 21—Condensed Consolidating Financial Statements

The following condensed consolidating financial statements present, on a supplemental basis, the financial position, results of operations, and statements of cash flow for (1) those subsidiaries of the Company which have been designated “Unrestricted Subsidiaries” for purposes of the 2010 Note Indenture; and (2) the Company and all of its other subsidiaries. As of September 30, 2011 and December 31, 2010, the Unrestricted Subsidiaries were FLRX, Inc. and its subsidiaries, ILX Acquisition and its subsidiaries, and Tempus Acquisition and its subsidiaries. For purposes of the 2010 Note Indenture, the financial position, results of operations, and statements of cash flow of Unrestricted Subsidiaries are excluded from the Company’s financial results to determine whether the Company is in compliance with the financial covenants governing the senior secured notes. Accordingly, management believes that the following presentation is helpful to current and potential investors in the senior secured notes as well as others.

 

40


Table of Contents

DIAMOND RESORTS PARENT, LLC AND SUBSIDIARIES

NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - Continued

(Unaudited)

 

CONDENSED CONSOLIDATING BALANCE SHEET

September 30, 2011 and December 31, 2010

(In thousands)

 

    September 30, 2011
(Unaudited)
    December 31, 2010
(Audited)
 
    Diamond
Resorts
Parent, LLC
and Restricted
Subsidiaries
    Unrestricted
Subsidiaries
    Elimination     Total     Diamond
Resorts
Parent, LLC
and Restricted
Subsidiaries
    Unrestricted
Subsidiaries
    Elimination     Total  
ASSETS                

Cash and cash equivalents

  $ 16,627      $ 2,757      $ —        $ 19,384      $ 27,163      $ 166      $ —        $ 27,329   

Cash in escrow and restricted cash

    31,271        1,154        —          32,425        29,868        180        —          30,048   

Mortgages and contracts receivable, net of allowance of $47,639, $33,547, $0, $81,186, $51,551, $3,600, $0 and $55,151, respectively

    225,361        71,729        (6     297,084        236,846        8,454        (13     245,287   

Due from related parties, net

    24,638        1,248        —          25,886        20,789        223        (54     20,958   

Other receivables, net

    15,891        9,593        (633     24,851        31,650        4,330        —          35,980   

Income tax receivable

    27        356        (356     27        10        —          —          10   

Prepaid expenses and other assets, net

    57,476        6,419        (1,214     62,681        45,260        2,662        (1,674     46,248   

Unsold Vacation Interests, net

    212,957        35,028        (1,540     246,445        180,464        10,100        —          190,564   

Property and equipment, net

    27,106        26,101        —          53,207        23,468        5,629        —          29,097   

Assets held for sale

    5,730        —          —          5,730        9,517        —          —          9,517   

Intangible assets, net

    34,871        31,332        —          66,203        37,411        8,302        —          45,713   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total assets

  $ 651,955      $ 185,717      $ (3,749   $ 833,923      $ 642,446      $ 40,046      $ (1,741   $ 680,751   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 
LIABILITIES AND MEMBER CAPITAL (DEFICIT)                

Accounts payable

  $ 10,553      $ 704      $ —        $ 11,257      $ 7,409      $ 246      $ —        $ 7,655   

Due to related parties, net

    40,386        36,364        (7,378     69,372        29,197        13,724        (6,670     36,251   

Accrued liabilities

    55,195        3,747        (1,867     57,075        62,367        6,853        (1,687     67,533   

Income taxes payable

    3,448        —          (356     3,092        3,936        —          —          3,936   

Deferred revenues

    44,747        2,218        —          46,965        67,706        —          —          67,706   

Senior secured notes, net of original issue discount of $9,672, $0, $0, $9,672, $10,278, $0, $0 and $10,278, respectively

    415,328        —          —          415,328        414,722        —          —          414,722   

Securitization notes and conduit facility, net

    182,645        76,194        —          258,839        176,551        10,292        —          186,843   

Derivative liabilities

    —          —          —          —          79        —          —          79   

Notes payable

    1,485        64,105        —          65,590        1,432        21,841        —          23,273   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total liabilities

    753,787        183,332        (9,601     927,518        763,399        52,956        (8,357     807,998   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Redeemable preferred units

    —          —          —          —          84,502        —          —          84,502   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Member capital

    152,294        9,675        (9,675     152,294        7,335        9,675        (9,675     7,335   

Accumulated deficit

    (236,229     (6,606     14,876        (227,959     (195,044     (22,197     15,903        (201,338

Accumulated other comprehensive loss

    (17,897     (684     651        (17,930     (17,746     (388     388        (17,746
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total member capital (deficit)

    (101,832     2,385        5,852        (93,595     (205,455     (12,910     6,616        (211,749
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total liabilities and member capital (deficit)

  $ 651,955      $ 185,717      $ (3,749   $ 833,923      $ 642,446      $ 40,046      $ (1,741   $ 680,751   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

41


Table of Contents

DIAMOND RESORTS PARENT, LLC AND SUBSIDIARIES

NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - Continued

(Unaudited)

 

CONDENSED CONSOLIDATING STATEMENTS OF OPERATIONS

For the three months ended September 30, 2011 and 2010

(In thousands)

 

    Three Months Ended
September 30, 2011
    Three Months Ended
September 30, 2010
 
    Diamond
Resorts
Parent, LLC
and Restricted
Subsidiaries
    Unrestricted
Subsidiaries
    Elimination     Total     Diamond
Resorts
Parent, LLC
and Restricted
Subsidiaries
    Unrestricted
Subsidiaries
    Elimination     Total  

Revenues:

               

Vacation Interest sales

  $ 57,537      $ 2,691      $ —        $ 60,228      $ 56,515      $ —        $ —        $ 56,515   

Provision for uncollectible Vacation Interest sales revenue

    (4,417     (99     —          (4,516     (2,051     —          —          (2,051
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Vacation Interest, net

    53,120        2,592        —          55,712        54,464        —          —          54,464   

Management, member and other services

    30,476        3,927        (4,916     29,487        25,615        288        (283     25,620   

Consolidated resort operations

    7,228        979        (606     7,601        6,454        109        —          6,563   

Interest

    10,561        4,089        —          14,650        9,544        332        —          9,876   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total revenues

    101,385        11,587        (5,522     107,450        96,077        729        (283     96,523   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Costs and Expenses:

               

Vacation Interest cost of sales

    1,728        126        —          1,854        11,765        —          —          11,765   

Advertising, sales and marketing

    33,350        1,321        (183     34,488        30,290        31        —          30,321   

Vacation Interest carrying cost, net

    3,600        731        (175     4,156        6,868        (175     —          6,693   

Management, member and other services

    7,221        3,246        (3,302     7,165        5,322        283        (283     5,322   

Consolidated resort operations

    5,658        962        —          6,620        5,438        82        —          5,520   

Loan portfolio

    2,501        593        (345     2,749        2,568        50        —          2,618   

General and administrative

    16,480        4,561        33        21,074        16,156        2,170        —          18,326   

Depreciation and amortization

    2,395        1,458        —          3,853        3,277        174        —          3,451   

Interest

    17,054        5,048        —          22,102        16,704        752        —          17,456   

Loss on extinguishment of debt

    —          —          —          —          1,081        —          —          1,081   

Impairments and other write-offs

    681        12        —          693        9        —          —          9   

(Gain) loss on disposal of assets

    (232     156        —          (76     (289     —          —          (289

Gain on bargain purchase from business combination

    —          (34,183     —          (34,183     —          —          —          —     
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total costs and expenses

    90,436        (15,969     (3,972     70,495        99,189        3,367        (283     102,273   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Income (loss) before benefit for income taxes

    10,949        27,556        (1,550     36,955        (3,112     (2,638     —          (5,750

Benefit for income taxes

    (499     (147     —          (646     (1,994     —          —          (1,994
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net income (loss)

  $ 11,448      $ 27,703      $ (1,550   $ 37,601      $ (1,118   $ (2,638   $ —        $ (3,756
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

42


Table of Contents

DIAMOND RESORTS PARENT, LLC AND SUBSIDIARIES

NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - Continued

(Unaudited)

 

CONDENSED CONSOLIDATING STATEMENTS OF OPERATIONS

For the nine months ended September 30, 2011 and 2010

(In thousands)

 

    Nine Months Ended
September 30, 2011
    Nine Months Ended
September 30, 2010
 
    Diamond
Resorts
Parent, LLC
and Restricted
Subsidiaries
    Unrestricted
Subsidiaries
    Elimination     Total     Diamond
Resorts
Parent, LLC
and Restricted
Subsidiaries
    Unrestricted
Subsidiaries
    Elimination     Total  

Revenues:

               

Vacation Interest sales

  $ 149,496      $ 5,134      $ 1      $ 154,631      $ 158,833      $ —        $ —        $ 158,833   

Provision for uncollectible Vacation Interest sales revenue

    (11,088     (171     —          (11,259     (2,919     —          —          (2,919
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Vacation Interest, net

    138,408        4,963        1        143,372        155,914        —          —          155,914   

Management, member and other services

    91,083        5,707        (7,462     89,328        76,155        288        (283     76,160   

Consolidated resort operations

    21,024        1,371        (606     21,789        19,948        109        —          20,057   

Interest

    29,294        4,986        —          34,280        29,029        334        —          29,363   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total revenues

    279,809        17,027        (8,067     288,769        281,046        731        (283     281,494   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Costs and Expenses:

               

Vacation Interest cost of sales

    (3,995     235        —          (3,760     33,630        —          —          33,630   

Advertising, sales and marketing

    93,446        3,032        (357     96,121        83,554        31        —          83,585   

Vacation Interest carrying cost, net

    17,245        3,362        (544     20,063        21,050        (175     —          20,875   

Management, member and other services

    18,383        6,460        (5,384     19,459        17,496        283        (283     17,496   

Consolidated resort operations

    18,440        1,454        —          19,894        17,963        82        —          18,045   

Loan portfolio

    7,508        743        (345     7,906        7,798        50        —          7,848   

General and administrative

    48,278        10,417        102        58,797        47,260        2,958        —          50,218   

Depreciation and amortization

    7,663        2,502        —          10,165        8,725        174        —          8,899   

Interest

    52,918        7,464        —          60,382        48,114        752        —          48,866   

Loss on extinguishment of debt

    —          —          —          —          1,081        —          —          1,081   

Impairments and other write-offs

    994        22        —          1,016        989        —          —          989   

(Gain) loss on disposal of assets

    (732     284        —          (448     (1,049     —          —          (1,049

Gain on bargain purchase from business combination

    —          (34,183     —          (34,183     —          —          —          —     
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total costs and expenses

    260,148        1,792        (6,528     255,412        286,611        4,155        (283     290,483   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Income (loss) before provision (benefit) for income taxes

    19,661        15,235        (1,539     33,357        (5,565     (3,424     —          (8,989

Provision (benefit) for income taxes

    292        (356     —          (64     (569     —          —          (569
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net income (loss)

  $ 19,369      $ 15,591      $ (1,539   $ 33,421      $ (4,996   $ (3,424   $ —        $ (8,420
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

43


Table of Contents

DIAMOND RESORTS PARENT, LLC AND SUBSIDIARIES

NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - Continued

(Unaudited)

 

CONDENSED CONSOLIDATING STATEMENTS OF CASH FLOWS

Nine months ended September 30, 2011 and 2010

(In thousands)

 

    Nine Months Ended
September 30, 2011
    Nine Months Ended
September 30, 2010
 
    Diamond
Resorts
Parent, LLC
and Restricted
Subsidiaries
    Unrestricted
Subsidiaries
    Elimination     Total     Diamond
Resorts
Parent, LLC
and Restricted
Subsidiaries
    Unrestricted
Subsidiaries
    Elimination     Total  

Operating Activities:

               

Net income (loss)

  $ 19,369      $ 15,591      $ (1,539   $ 33,421      $ (4,996   $ (3,424   $      $ (8,420

Adjustments to reconcile net income (loss) to net cash (used in) provided by operating activities:

               

Provision for uncollectible Vacation Interest sales revenue

    11,088        171        —          11,259        2,919        —          —          2,919   

Amortization of capitalized financing costs and original issue discounts

    4,550        194        —          4,744        2,211        —          —          2,211   

Amortization of capitalized loan origination costs and portfolio discount

    1,797        204        —          2,001        1,457        7        —          1,464   

Depreciation and amortization

    7,662        2,503        —          10,165        8,725        174        —          8,899   

Loss on extinguishment of debt

    —          —          —          —          1,081        —          —          1,081   

Impairments and other write-offs

    994        22        —          1,016        989        —          —          989   

(Gain) loss on disposal of assets

    (732     284        —          (448     (1,049     —          —          (1,049

Gain on bargain purchase from business combination

    —          (34,183     —          (34,183     —          —          —          —     

Deferred income taxes

    —          —          —          —          114        —          —          114   

Loss on foreign currency exchange

    13        —          —          13        24        —          —          24   

Gain on mortgage repurchase

    (158     —          —          (158     (171     —          —          (171

Unrealized gain on derivative instruments

    (79     —          —          (79     (237     —          —          (237

Gain on insurance settlement

    (3,535     —          —          (3,535     —          —          —          —     

Changes in operating assets and liabilities excluding acquisitions:

               

Mortgages and contracts receivable

    (1,456     5,186        (7     3,723        10,379        456        (7     10,828   

Due from related parties, net

    (3,560     (943     (54     (4,557     2,890        3,280        46        6,216   

Other receivables, net

    14,976        665        633        16,274        21,113        (351     —          20,762   

Prepaid expenses and other assets, net

    (12,624     (1,082     (498     (14,204     (10,973     (35     —          (11,008

Unsold Vacation Interests, net

    (30,186     (2,183     1,540        (30,829     8,325        —          —          8,325   

Accounts payable

    3,076        84        —          3,160        (1,875     24        —          (1,851

Due to related parties, net

    16,264        19,703        105        36,072        4,882        2,250        (39     7,093   

Accrued liabilities

    (7,333     (3,116     (180     (10,629     7,730        433        —          8,163   

Income taxes payable

    (533     (356     —          (889     2,207        —          —          2,207   

Deferred revenues

    (23,064     (1,690     —          (24,754     (16,970     —          —          (16,970
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net cash (used in) provided by operating activities

    (3,471     1,054        —          (2,417     38,775        2,814        —          41,589   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Investing activities:

               

Property and equipment capital expenditures

    (5,003     (121     —          (5,124     (3,806     (25     —          (3,831

Purchase of assets from ILX Resorts, Inc.

    —          —          —          —          —          (30,722     —          (30,722

Purchase of assets from Tempus Resorts International, net of $0, $2,517, $0, $2,517, $0, $0, $0, $0 cash acquired

    —          (102,398     —          (102,398     —          —          —          —     

Disbursement of Tempus Acquisition note receivable

    —          (3,493     —          (3,493     —          —          —          —     

Proceeds from sale of assets

    1,948        1        —          1,949        1,459        —          —          1,459   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net cash used in investing activities

  $ (3,055   $ (106,011   $ —        $ (109,066   $ (2,347   $ (30,747   $ —        $ (33,094
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

44


Table of Contents

DIAMOND RESORTS PARENT, LLC AND SUBSIDIARIES

NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - Continued

(Unaudited)

CONDENSED CONSOLIDATING STATEMENTS OF CASH FLOWS — Continued

Nine months ended September 30, 2011 and 2010

(In thousands)

 

    Nine Months Ended
September 30, 2011
    Nine Months Ended
September 30, 2010
 
    Diamond
Resorts
Parent, LLC
and Restricted
Subsidiaries
    Unrestricted
Subsidiaries
    Elimination     Total     Diamond
Resorts
Parent, LLC
and Restricted
Subsidiaries
    Unrestricted
Subsidiaries
    Elimination     Total  

Financing activities:

               

Changes in cash in escrow and restricted cash

  $ (1,395   $ 1,938      $ —        $ 543      $ 934      $ (21   $ —        $ 913   

Proceeds from issuance of senior secured notes, net of original issue discount of $0, $0, $0, $0, $10,570, $0, $0, $10,570

    —          —          —          —          414,430        —          —          414,430   

Proceeds from issuance of secured notes and conduit facility

    102,502        78,662        —          181,164        22,043        11,870        —          33,913   

Proceeds from issuance of notes payable

    —          44,678        —          44,678        —          17,513        —          17,513   

Payments on securitization notes and conduit facility

    (96,635     (8,615     —          (105,250     (55,626     (474     —          (56,100

Payments on line of credit agreements

    —          —          —          —          (397,609     —          —          (397,609

Payments on notes payable

    (6,114     (7,544     —          (13,658     (6,521     —          —          (6,521

Payments of debt issuance costs

    (2,844     (1,571     —          (4,415     (18,016     (428     —          (18,444

Proceeds from equity investment

    146,651        —          —          146,651        75,000        —          —          75,000   

Repurchase of a portion of outstanding warrants

    (16,598     —          —          (16,598     —          —          —          —     

Repurchase a portion of outstanding common units

    (16,352     —          —          (16,352     —          —          —          —     

Repurchase of redeemable preferred units

    (108,701     —          —          (108,701     —          —          —          —     

Repurchase of equity previously held by another minority institutional investor

    —          —          —          —          (75,000     —          —          (75,000

Payments of costs related to issuance of common and preferred units

    (4,585     —          —          (4,585     (2,915     —          —          (2,915

Payments for derivative instrument

    —          —          —          —          (71     —          —          (71
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net cash (used in) provided by financing activities

    (4,071     107,548        —          103,477        (43,351     28,460        —          (14,891
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net (decrease) increase in cash and cash equivalents

    (10,597     2,591        —          (8,006     (6,923     527        —          (6,396

Effect of changes in exchange rates on cash and cash equivalents

    61        —          —          61        (49     —          —          (49

Cash and cash equivalents, beginning of period

    27,163        166        —          27,329        17,186        —          —          17,186   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Cash and cash equivalents, end of period

  $ 16,627      $ 2,757      $ —        $ 19,384      $ 10,214      $ 527      $ —        $ 10,741   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:

               

Cash paid for interest

  $ 62,947      $ 4,275      $ —        $ 67,222      $ 40,046      $ 7      $ —        $ 40,053   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Cash paid for taxes, net of cash refunds

  $ 684      $ —        $ —        $ 684      $ (2,917   $ —        $ —        $ (2,917
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

SUPPLEMENTAL SCHEDULE OF NON-CASH INVESTING AND FINANCING ACTIVITIES:

               

Priority returns and redemption premiums (adjustments) on preferred units

  $ 8,412      $ —        $ —        $ 8,412      $ (22,372   $ —        $ —        $ (22,372
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Insurance premiums financed through issuance of note payable

  $ 6,141      $ —        $ —        $ 6,141      $ 6,052      $ —        $ —        $ 6,052   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Assets held for sale reclassified to unsold vacation interests

  $ 2,994      $ —        $ —        $ 2,994      $ —        $ —        $ —        $ —     
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Purchase of assets from Tempus Resorts International and ILX Resorts, Inc., respectively:

               

Fair value of assets acquired

  $ —        $ 146,974      $ —        $ 146,974      $ —        $ 34,626      $ —        $ 34,626   

Goodwill recognized

    —          —          —          —          —          696        —          696   

Gain on bargain purchase recognized

    —          (34,183     —          (34,183     —          —          —          —     

Cash paid

    —          (104,915     —          (104,915     —          (30,722     —          (30,722
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Liabilities assumed

  $ —        $ 7,876      $ —        $ 7,876      $ —        $ 4,600      $ —        $ 4,600   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

45


Table of Contents

DIAMOND RESORTS PARENT, LLC AND SUBSIDIARIES

NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - Continued

(Unaudited)

 

Note 22—Geographic Financial Information

The Company conducts its Hospitality and Management Services and Vacation Interest Sales and Financing operations in two geographic areas: North America and Europe. The Company’s North America operations include the Company’s branded resorts in the continental United States, Hawaii, Mexico and the Caribbean, and the Company’s Europe operations include the Company’s branded resorts in England, Scotland, Ireland, Italy, Spain, Portugal, Austria, Malta and France. The following table reflects total revenue and assets by geographic area for the periods presented (in thousands):

 

     Three months ended      Nine months ended  
     September 30,
2011
     September 30,
2010
     September 30,
2011
     September 30,
2010
 

Revenue

           

North America

   $ 94,468       $ 84,208       $ 255,494       $ 247,905   

Europe

     12,982         12,315         33,275         33,589   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total Revenues

   $ 107,450       $ 96,523       $ 288,769       $ 281,494   
  

 

 

    

 

 

    

 

 

    

 

 

 

 

     As of
September 30,
2011
     As of
December 31,
2010
 

Mortgages and contracts receivable, net

     

North America

   $ 295,763       $ 244,541   

Europe

     1,321         746   
  

 

 

    

 

 

 

Total mortgages and contracts receivable, net

   $ 297,084       $ 245,287   
  

 

 

    

 

 

 

Unsold Vacation Interest, net

     

North America

   $ 223,837       $ 174,642   

Europe

     22,608         15,922   
  

 

 

    

 

 

 

Total unsold Vacation Interest, net

   $ 246,445       $ 190,564   
  

 

 

    

 

 

 

Property and equipment, net

     

North America

   $ 48,393       $ 24,248   

Europe

     4,814         4,849   
  

 

 

    

 

 

 

Total property and equipment, net

   $ 53,207       $ 29,097   
  

 

 

    

 

 

 

Intangible assets, net

     

North America

   $ 61,784       $ 40,926   

Europe

     4,419         4,787   
  

 

 

    

 

 

 

Total intangible assets, net

   $ 66,203       $ 45,713   
  

 

 

    

 

 

 

Total long-term assets, net

     

North America

   $ 629,777       $ 484,357   

Europe

     33,162         26,304   
  

 

 

    

 

 

 

Total long-term assets, net

   $ 662,939       $ 510,661   
  

 

 

    

 

 

 

 

46


Table of Contents

DIAMOND RESORTS PARENT, LLC AND SUBSIDIARIES

NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - Continued

(Unaudited)

 

Note 23—Impairments and other write-offs

During the nine months ended September 30, 2011, the Company wrote down the value of certain assets held for sale in its European operations by $0.6 million to reflect their net realizable value and recorded $0.2 million write-off of costs related to a sales and marketing project that was no longer viable and $0.2 million in impairments of various other assets. During the nine months ended September 30, 2010, the Company recorded a $0.9 million write-down on a receivable related to an HOA management contract that the Company terminated.

Note 24—Subsequent Events

On October 14, 2011, the Company entered into an amended and restated 2008 conduit facility with a maturity date of April 12, 2013. The amendment provides for a $75 million, 18-month facility that is annually renewable for 364-day periods at the election of the lenders, bears interest at either LIBOR or the commercial paper rate (having a floor of 0.50%) plus 4.0%, and has a non-use fee of 0.75%. The advance rates on loans receivable in the portfolio are limited to 75% of the face value of eligible loans.

On October 24, 2011, DPM Acquisition, LLC (“DPM”), an unrestricted subsidiary of the Company, entered into an Asset Purchase Agreement (the “Agreement”) with Pacific Monarch Resorts, Inc., Vacation Interval Realty, Inc., Vacation Marketing Group, Inc., MGV Cabo, LLC, Desarrollo Cabo Azul, S. de R.L. de C.V., and Operadora MGVM S. de R.L. de C.V. (collectively, the “Sellers”), pursuant to which DPM has agreed to purchase certain real estate and timeshare related assets (collectively, the “Assets”), subject to the terms and conditions contained therein. The Sellers are debtors in a Chapter 11 case before the United States Bankruptcy Court for the Central District of California, Santa Ana Division (the “Bankruptcy Court”). The acquisition is subject to the approval of the Bankruptcy Court, the receipt of superior offers and certain other conditions.

Under the terms of the Agreement, DPM has agreed to acquire the Assets from the Sellers for $49.3 million in cash (subject to certain adjustments), plus the assumption of specified liabilities related to the Assets. Assuming approval is obtained from the Bankruptcy Court and all conditions have been satisfied, the Company anticipates closing the acquisition in the first quarter of 2012 if the Company is the successful bidder.

The Company is unable to include any pro forma financial statements in connection with the contemplated Pacific Monarch acquisition as the Company is still in the process of obtaining audited financial statements and an initial valuation report from a third party valuation firm.

In October 2011, the Company was levied a $9.8 million water intrusion assessment related to the intervals and points equivalent owned by the Company at a resort managed by the Company to cover the costs required to repair water intrusion damage. The water intrusion assessment will be recorded as Vacation Interest carrying cost during the quarter ending December 31, 2011. This assessment is payable in annual installments over the next five years.

As more fully described in Note 16, on November 14, 2011, the Company received notice that the Court of Appeals for the State of Washington affirmed the lower court decision upholding the judgment against FLRX. An FLRX is considering a motion for reconsideration to the Court of Appeals and/or a petition for review with the State Supreme Court.

 

47


Table of Contents

ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

This discussion contains forward-looking statements. You can identify these statements by the fact that they do not relate strictly to historical or current facts. We have tried to identify forward-looking statements in this discussion by using words such as “anticipates,” “estimates,” “expects,” “intends,” “plans” and “believes,” and similar expressions or future or conditional verbs such as “will,” “should,” “would,” “may” and “could.” These forward-looking statements include, among others, statements relating to our future financial performance, our business prospects and strategy, anticipated financial position, liquidity and capital needs and other similar matters. These forward-looking statements are based on management’s current expectations and assumptions about future events, which are inherently subject to uncertainties, risks and changes in circumstances that are difficult to predict.

Although we believe that our expectations are based on reasonable assumptions, our actual results may differ materially from those expressed in, or implied by, the forward-looking statements included in this quarterly report as a result of various factors, including, among others:

 

   

adverse trends in economic conditions generally in the vacation ownership, vacation rental and travel industries;

 

   

adverse changes to, or interruptions in, relationships with our affiliates and other third parties, including our hospitality management contracts;

 

   

our ability to maintain a sufficient inventory of vacation ownership interests (“VOI” or “Vacation Interests”) for sale to customers without expending significant capital to develop or acquire additional resort properties;

 

   

our ability to sell, securitize or borrow against the consumer loans that we generate;

 

   

decreased demand from prospective purchasers of VOIs;

 

   

declines or disruptions in the travel industry;

 

   

adverse events or trends in vacation destinations and regions where our resorts are located;

 

   

changes in our senior management;

 

   

our ability to comply with regulations applicable to the vacation ownership industry;

 

   

the effects of our indebtedness and our compliance with the terms thereof;

 

   

our ability to successfully implement our growth strategy; and

 

   

our ability to compete effectively.

Accordingly, you should read this discussion completely and with the understanding that our actual future results may be materially different from what we expect. Forward-looking statements speak only as of the date of this quarterly report. Except as expressly required under federal securities laws and the rules and regulations of the SEC, we do not have any intention, and do not undertake, to update any forward-looking statements to reflect events or circumstances arising after the date of this quarterly report, whether as a result of new information or future events or otherwise. You should not place undue reliance on the forward-looking statements included in this quarterly report or that may be made elsewhere from time to time by us, or on our behalf. All forward-looking statements attributable to us are expressly qualified by these cautionary statements.

You should read the following discussion in conjunction with the following table of our results of operations for the specified periods and our condensed consolidated financial statements and other financial information included elsewhere in this quarterly report. The statements in this discussion regarding market conditions and outlook, our expectations regarding our future performance, liquidity and capital resources and other non-historical

 

48


Table of Contents

statements are subject to numerous risks and uncertainties, including, but not limited to, the risks and uncertainties described above and in the Risk Factors section of this quarterly report and the Prospectus. Our actual results may differ materially from those contained in or implied by any forward-looking statements.

Overview

We are one of the world’s largest companies in the vacation ownership industry, with an ownership base of more than 418,000 families and a network of 214 destinations located in 28 countries throughout the continental United States, Hawaii, Canada, Mexico, the Caribbean, Europe, Asia, Australia and Africa. Our operations consist of three interrelated businesses that provide us with diversified and stable cash flow: (i) hospitality and management services; (ii) marketing and sales of VOIs; and (iii) consumer financing for purchasers of our VOIs. For financial reporting purposes, our business consists of two segments: Hospitality and Management Services, which is composed of our hospitality and management services operations, including our operations related to the management of our resort properties, the Collections and THE Club; and Vacation Interest Sales and Financing, which is composed of our marketing and sales of VOIs and the consumer financing of those interests.

Management is pursuing growth strategies to increase fee-based revenues while remaining consistent with our capital-light business model. A key strategy is the acquisition of complementary resorts and associated management contracts using special-purpose subsidiaries financed on a non-recourse basis. The ILX Acquisition completed in August 2010, the Tempus Resorts Acquisition completed in July 2011, and the acquisition of Pacific Monarch Resorts that is anticipated to close during the first quarter of 2012 (subject to the approval of the Bankruptcy Court) reflect this strategy. The ILX and Tempus acquisitions have provided us with an additional 12 resorts to offer to our member base, additional management contracts, incremental VOI inventory to market and sell, and consumer loan portfolios to manage. In addition, these transactions have added new VOI owners to whom we can market products and services. Both of these transactions were effected through special purpose, unrestricted subsidiaries, and funded by financial partners on a fully non-recourse basis. We believe that this structure enables us to obtain substantial benefits from these acquisitions, without subjecting our historical business or our capital structure to the full risks associated with acquisitions and related leverage. In addition, we have recently entered into agreements with a third-party vacation interest resort operator whereby we provide resort management advisory and sales and marketing services on a fee-for-service basis, without any ownership interest in the operator or capital outlay. We continue to pursue transactions of this nature, although there can be no assurance that we will be successful in identifying and closing such transactions.

In response to the 2008 credit crisis and resulting economic contraction, we implemented a number of steps to reduce our sales pace and accordingly we re-sized our sales and marketing organization to improve efficiencies and to drive consumers toward cash sales. As the credit markets have begun to stabilize, we have taken steps to rebuild and restructure our sales and marketing organization to capture additional revenue opportunities while improving efficiencies and overall member satisfaction while maintaining our high consumer credit standards. These steps included reorganizing the sales and marketing leadership team, revising sales training programs and compensation arrangements, and restructuring sales incentive programs to generate incremental tour flow, increase average sales price per transaction and drive high credit quality financed sales. The impact of these efforts, which began for the most part in late 2010 and early 2011, is not fully reflected in our Vacation Interest sales results, although much of the expense associated with these efforts is already reflected in our cost structure.

Critical Accounting Policies and Use of Estimates

The discussion of our financial condition and results of operations is based upon our condensed consolidated financial statements, which have been prepared in accordance with U.S. GAAP. The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses. On an ongoing basis, we evaluate our estimates and assumptions, including those related to revenue, bad debts and income taxes. These estimates are based on historical experience and on various other assumptions that we believe are reasonable under the circumstances. The results of our analysis form the basis for making assumptions about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions, and the impact of such differences may be material to our condensed consolidated financial statements.

 

49


Table of Contents

Critical accounting policies are those policies that, in management’s view, are most important in the portrayal of our financial condition and results of operations. The methods, estimates and judgments that we use in applying our accounting policies have a significant impact on the results that we report in our financial statements. These critical accounting policies require us to make difficult and subjective judgments, often as a result of the need to make estimates regarding matters that are inherently uncertain. Those critical accounting policies and estimates that require the most significant judgment are discussed further below.

Vacation Interest Sales Revenue Recognition. With respect to our recognition of revenue from VOI sales, we follow the guidelines included in ASC 978, “Real Estate-Time-Sharing Activities.” Under ASC 978, Vacation Interest sales revenue is divided into separate components that include the revenue earned on the sale of the VOI and the revenue earned on the sales incentive given to the customer as motivation to purchase the VOI. Each component is treated as a separate transaction but both are recorded in Vacation Interest sales line of our statement of operations. In order to recognize revenue on the sale of VOIs, ASC 978 requires a demonstration of a buyer’s commitment (generally a cash payment of 10% of the purchase price plus the value of any sales incentives provided). A buyer’s down payment and subsequent mortgage payments are adequate to demonstrate a commitment to pay for the VOI once 10% of the purchase price plus the value of the incentives provided to consummate a VOI transaction has been covered. We recognize sales of VOIs on an accrual basis after (i) a binding sales contract has been executed; (ii) the buyer has adequately demonstrated a commitment to pay for the VOI; (iii) the rescission period required under applicable law has expired; (iv) collectibility of the receivable representing the remainder of the sales price is reasonably assured; and (v) we have completed substantially all of our obligations with respect to any development related to the real estate sold (i.e., construction has been substantially completed and certain minimum project sales levels have been met). If the buyer’s commitment has not met ASC 978 guidelines, the VOI sales revenue and related Vacation Interest cost of sales and direct selling costs are deferred and recognized under the installment method until the buyer’s commitment is satisfied, at which time the full amount of the sale is recognized. The net deferred revenue is included in mortgages and contracts receivable on our balance sheet. Under ASC 978, the provision for uncollectible Vacation Interest sales revenue is recorded as a reduction of Vacation Interest sales revenue.

Vacation Interest Cost of Sales. We record Vacation Interest cost of sales using the relative sales value method in accordance with ASC 978, which requires us to make significant estimates which are subject to significant uncertainty. In determining the appropriate amount of costs using the relative sales value method, we rely on complex, multi-year financial models that incorporate a variety of inputs, most of which are management estimates. These amounts include, but are not limited to, estimated costs to build or acquire any additional VOIs, estimated total revenues expected to be earned on a project, including estimated sales price per point and estimated number of points sold, related estimated provision for uncollectible Vacation Interest sales revenue and sales incentives, and estimated projected future cost and volume of recoveries of VOIs. These models are reviewed on a regular basis, and the relevant estimates used in the models are revised based upon historical results and management’s new estimates. We require a seasoning of pricing strategy changes before such changes fully affect the model which generally occurs over a six month period. In addition, we continue to evaluate our pricing strategy. Any changes in the estimates we use to determine the Vacation Interest cost of sales are recorded in the current period, and these changes can be material. Small changes in any of the numerous assumptions in the model can have a significant financial statement impact, both positively and negatively, as ASC 978 requires a retroactive adjustment reflected in the current period. See Unsold Vacation Interests, net below. Much like depreciation or amortization, for us Vacation Interest cost of sales is essentially a non-cash expense item.

Mortgages and Contracts Receivable and Allowance for Loan and Contract Losses. We account for mortgages (for the financing of intervals) and contracts receivable (for the financing of points) under ASC 310, “Receivables.”

Mortgages and contracts receivable that we originate or acquire are recorded net of (i) deferred loan and contract costs, (ii) the discount or premium on the acquired mortgage pool and (iii) the related allowance for loan and contract losses. Loan and contract origination costs incurred in connection with providing financing for VOIs are capitalized and amortized over the term of the related mortgages or contracts receivable as an adjustment to interest revenue using the effective interest method. Because we currently sell VOIs only in the form of points, we are not currently originating any new mortgages. We record a sales provision for estimated mortgage and contracts receivable losses as a reduction to Vacation Interest sales revenue. This provision is calculated as projected gross

 

50


Table of Contents

losses for originated mortgages and contracts receivable, taking into account estimated VOI recoveries. If actual mortgage and contracts receivable losses differ materially from these estimates, our future results of operations may be adversely impacted.

We apply our historical default percentages based on credit scores of the individual customers to our mortgage and contracts receivable population to analyze the adequacy of the allowance and evaluate other factors such as economic conditions, industry trends, defaults and past due agings. Any adjustments to the allowance for mortgage and contracts receivable loss are also recorded within Vacation Interest sales revenue.

We charge off mortgages and contracts receivable upon the earliest of (i) the initiation of cancellation or foreclosure proceedings or (ii) the customer’s account becoming 180 days delinquent. Once a customer has made six timely payments following the event leading to the charge off, the charge off is reversed. A default in a customer’s initial payment results in a rescission of the sale. All collection and foreclosure costs are expensed as incurred.

The mortgages we acquired on April 27, 2007 in connection with the Sunterra Corporation acquisition, on August 31, 2010 in connection with the ILX Acquisition, and on July 1, 2011 in connection with the Tempus Resorts Acquisition are accounted for separately as an acquired pool of loans. Any discount or premium associated with this pool of loans is amortized using an amortization method that approximates the effective interest method.

Unsold Vacation Interests, Net. Unsold VOIs are valued at the lower of cost or fair market value. The cost of unsold VOIs includes acquisition costs, hard and soft construction costs (which are comprised of architectural and engineering costs incurred during construction), the cost incurred to recover inventory and other carrying costs (including interest, real estate taxes and other costs incurred during the construction period). Costs are expensed to Vacation Interest cost of sales under the relative sales value method described above. In accordance with ASC 978, under the relative sales value method, cost of sales is calculated as a percentage of Vacation Interest sales revenue using a cost-of-sales percentage ratio of total estimated development costs to total estimated Vacation Interest sales revenue, including estimated future revenue and incorporating factors such as changes in prices and the recovery of VOIs generally as a result of maintenance fee and contracts receivable defaults. In accordance with ASC 978-340-25, the selling, marketing and administrative costs associated with any sale, whether the original sale or subsequent resale of recovered inventory, are expensed as incurred.

The costs capitalized for recovered intervals differ based on a variety of factors, including the method of recovery and the timing of the original sale and/or loan origination. Interest, real estate taxes and other carrying costs incurred during the construction period are capitalized and such costs incurred on completed Vacation Interests are expensed.

In accordance with ASC 978, on a quarterly basis, we recalculate the total estimated Vacation Interest sales revenue and total estimated costs. The effects of changes in these estimates are accounted for as a current period adjustment so that the balance sheet at the end of the period of change and the accounting in subsequent periods are as they would have been if the revised estimates had been the original estimates. These adjustments can be material.

For the three months ended September 30, 2011 and September 30, 2010, the changes in these estimates resulted in an increase in unsold Vacation Interests, net and a corresponding decrease in Vacation Interest cost of sales of $8.4 million and $0.3 million, respectively, which were primarily the result of an increase in the estimated sales price per point and a decrease in the average inventory cost per point related to recoveries. This resulted in Vacation Interest cost of sales of $1.9 million for the quarter ended September 30, 2011, compared to $11.8 million for the quarter ended September 30, 2010.

For the nine months ended September 30, 2011 and September 30, 2010, the changes in these estimates resulted in an increase in unsold Vacation Interests, net and a corresponding decrease in Vacation Interest cost of sales of $32.9 million and $1.9 million, respectively, for the same reasons. This resulted in a credit of $3.8 million in Vacation Interest cost of sales for the nine months ended September 30, 2011, compared to a $33.6 million expense for the nine months ended September 30, 2010.

 

51


Table of Contents

Income Taxes. We are subject to income taxes in the United States (including federal and state) and numerous foreign jurisdictions in which we operate. We record income taxes under the asset and liability method, whereby deferred tax assets and liabilities are recognized based on the future tax consequences attributable to temporary differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases, and attributable to operating loss and tax credit carry-forwards. Accounting standards regarding income taxes require a reduction of the carrying amounts of deferred tax assets by a valuation allowance, if based on the available evidence, it is more likely than not that such assets will not be realized. Accordingly, the need to establish valuation allowances for deferred tax assets is assessed periodically based on a more-likely-than-not realization threshold. This assessment considers, among other matters, the nature, frequency and severity of current and cumulative losses, forecasts of future profitability, the duration of statutory carry-forward periods, our experience with operating loss and tax credit carry forwards not expiring unused, and tax planning alternatives.

We recorded a deferred tax asset as a result of net operating losses incurred, and as part of our financial reporting process, we must assess the likelihood that our deferred tax assets can be recovered. During this process, certain relevant criteria are evaluated, including the existence of deferred tax liabilities against which deferred tax assets can be applied, and taxable income in future years. Unless recovery is more likely than not, a reserve in the form of a valuation allowance is established as an offset to the deferred tax asset. As a result of uncertainties regarding our ability to generate sufficient taxable income to utilize our net operating loss carry forwards, we maintain a valuation allowance against the balance of our deferred tax assets.

Accounting standards regarding uncertainty in income taxes provide a two-step approach to recognizing and measuring uncertain tax positions. The first step is to evaluate the tax position for recognition by determining if the weight of available evidence indicates it is more likely than not that the position will be sustained on audit, including resolution of related appeals or litigation processes, if any. The second step is to measure the tax benefit as the largest amount which is more than 50% likely, based solely on the technical merits, of being sustained on examinations. We consider many factors when evaluating and estimating our tax positions and tax benefits, which may require periodic adjustments and which may not accurately anticipate actual outcomes.

Segment Reporting

For financial reporting purposes, we present our results of operations and financial condition in two business segments. The first business segment is Hospitality and Management Services, which includes our operations related to the management of our resort properties, the Collections and revenue from our operation of THE Club and the provision of other services. The second business segment, Vacation Interest Sales and Financing, includes our operations relating to the marketing and sales of our VOIs, as well as our consumer financing activities related to such sales. While certain line items reflected on our statement of operations fall completely into one of these business segments, other line items relate to revenues or expenses which are applicable to both segments. For line items that are applicable to both segments, revenues or expenses are allocated by management as described under “Key Revenue and Expense Items,” which involves significant estimates. Certain expense items (principally corporate interest expense and depreciation and amortization) are not, in management’s view, allocable to either of these business segments as they apply to the entire Company. In addition, general and administrative expenses are not allocated to either of our business segments because historically management has not allocated these expenses for purposes of evaluating our different operational divisions. Accordingly, these expenses are presented under Corporate and Other.

Management believes that it is impracticable to allocate specific assets and liabilities related to each business segment. In addition, management does not review balance sheets by business segment as part of its evaluation of operating segment performances. Consequently, no balance sheet segment reports have been presented.

Key Revenue and Expense Items

Vacation Interest sales revenue, Net. Vacation Interest sales revenue, net, is comprised of Vacation Interest sales, net of a provision for uncollectible Vacation Interest sales revenue. Vacation interest sales consist of revenue from the sale of points, which can be utilized for vacations at any of the resorts in our network for varying lengths of stay, and from the sale of intervals, which provide the right to vacation at a particular resort for a specified length of time, net of the expense associated with certain sales incentives. A variety of sales incentives are routinely provided

 

52


Table of Contents

as sales tools. Sales centers have predetermined budgets for sales incentives and manage the use of incentives accordingly. A provision for uncollectible Vacation Interest sales revenue is recorded upon completion of each financed sale. The provision is calculated based on historical default experience associated with the customer’s FICO score. Additionally, we analyze our allowance for loan and contract losses quarterly and make adjustments based on current trends in consumer loan delinquencies and defaults and other criteria, if necessary. Since October 1, 2007, we have sold VOIs primarily in the form of points. All of our Vacation Interest sales revenue, net, is allocated to our Vacation Interest Sales and Financing business segment.

Management, Member and Other Services Revenue. Management, member and other services revenue includes resort management fees charged to HOAs and Collections that hold our members’ VOIs, as well as revenues from our operation of THE Club and the provision of other services. These revenues are recorded and recognized as follows:

 

   

Management fee revenues are recognized in accordance with the terms of our management contracts. We collect management fees from our HOAs and Collections under our management agreements, which are recognized ratably throughout the year as earned. All of these revenues are allocated to our Hospitality and Management Services business segment. The management fees we earn are included in establishing HOA and Collections operating budgets which, in turn, are used to establish the annual maintenance fees owed directly by each owner of VOIs.

 

   

We charge an annual fee for membership in THE Club, our internal exchange, reservation and membership service organization. In addition to annual dues associated with THE Club, we earn revenue associated with customer conversions into THE Club, which involve the payment of a one-time fee by interval owners who wish to retain their intervals but also participate in THE Club. We also earn revenue through our provision of travel-related services and other affinity programs. All of these revenues are allocated to our Hospitality and Management Services business segment.

 

   

Other services revenue includes (i) collection fees paid by owners when they bring their accounts current after collection efforts have been made by us on behalf of HOAs; (ii) reservation protection plan revenue, which is an optional fee paid by customers when making a reservation to protect their points should they need to cancel their reservation; (iii) closing costs on sales of VOIs; (iv) revenue associated with certain sales incentives given to customers as motivation to purchase a VOI, which is recorded upon recognition of the related VOI sales revenue; (v) late/impound fees assessed on delinquent consumer loans; and (vi) commissions received under the sales and marketing fee-for-service arrangement with a third party. Revenues associated with items (i) and (ii) above are allocated to our Hospitality and Management Services business segment, and revenues associated with items (iii), (iv), (v) and (vi) above are allocated to our Vacation Interest Sales and Financing business segment.

Consolidated Resort Operations Revenue. Consolidated resort operations revenue consists of the following:

 

   

For our properties located in the Caribbean, we provide services traditionally administered by an HOA. Consolidated resort operations revenue includes the maintenance fees billed to owners and the Collections by our St. Maarten HOAs, which are recognized ratably over the year. In addition, these HOAs also bill the owners for capital project assessments to repair and replace the amenities of these resorts, as well as special assessments to reserve the out-of-pocket deductibles for hurricanes and other natural disasters. These assessments are deferred until refurbishment activity occurs, at which time the amounts collected are recognized as a direct reduction to refurbishment expense in consolidated resort operations expense. All operating revenues and expenses associated with these properties are consolidated within our financial statements, except for intercompany transactions, such as maintenance fees for our owned inventory and management fees, which are eliminated.

 

   

Food and beverage revenue at certain resorts whose restaurants we manage directly;

 

   

Greens fees, equipment rental and operation of food services at the golf courses owned and managed by us at certain resorts;

 

53


Table of Contents
   

Revenue from providing cable, telephone, and technology services to HOAs; and

 

   

Other incidental revenues generated at the resorts including, but not limited to, retail and gift shops, spa services, activity fees for arts and crafts, sport equipment rental, and safe rental.

Interest Revenue. Our interest revenue consists primarily of interest earned on consumer loans. Interest earned on consumer loans is accrued based on the contractual provisions of the loan documents. Interest accruals on consumer loans are suspended at the earliest of (i) a first payment default; (ii) the initiation of cancellation or foreclosure proceedings; or (iii) the customer’s account becoming 180 days delinquent. If payments are received while a consumer loan is considered delinquent, interest is recognized on a cash basis. Interest accrual resumes once a customer has made six timely payments on the loan. All interest revenue is allocated to our Vacation Interest Sales and Financing business segment, with the exception of interest revenue earned on bank account balances, which is reported in Corporate and Other.

Vacation Interest Cost of Sales. At the time we record related Vacation Interest sales revenue, we record Vacation Interest cost of sales. See “— Critical Accounting Policies and Use of Estimates — Vacation Interest Cost of Sales” for further explanation of the determination of this expense. All of these costs are allocated to our Vacation Interest Sales and Financing business segment.

Advertising, Sales and Marketing Costs. Advertising, sales and marketing costs are expensed as incurred, except for costs directly related to VOI sales that are not eligible for revenue recognition under ASC 978, as described under “Critical Accounting Policies and Use of Estimates — Vacation Interest Sales Revenue Recognition,” which are deferred along with related revenue until the buyer’s commitment requirements are satisfied. Advertising, sales and marketing costs are allocated to our Vacation Interest Sales and Financing business segment.

Vacation Interest Carrying Cost, Net. We are responsible for paying HOA annual maintenance fees and reserves on our unsold VOIs. Vacation interest carrying cost, net, includes amounts paid for delinquent maintenance fees related to VOIs acquired pursuant to our inventory recovery agreements, except for amounts that are capitalized to unsold Vacation Interests, net. In addition, we historically entered into subsidy agreements to fund negative cash flows of certain HOAs. These subsidy agreements were discontinued as of December 31, 2008. All subsidy-related costs were expensed as incurred.

To offset our Vacation Interest carrying cost, we rent VOIs controlled by us to third parties on a short-term basis. We also generate revenue on sales of sampler programs and mini-vacations, which allow prospective owners to sample a resort property. This revenue and the associated expenses are deferred until the vacation is used by the customer or the expiration date, whichever is earlier. Revenue from resort rentals, sampler programs and mini-vacations is recognized as a reduction to Vacation Interest carrying cost, with the exception of our European sampler product, which is three years in duration and is treated as Vacation Interest sales revenue. Vacation interest carrying cost, net, is allocated to our Vacation Interest Sales and Financing business segment.

Management, Member and Other Services Expense. Currently, substantially all direct expenses related to the provision of services to the HOAs (other than for our Caribbean resorts, for which we provide services traditionally administered by an HOA) and the Collections are recovered through our management agreements, and consequently are not recorded as expenses. We pass through to the HOAs certain overhead charges incurred to operate the resorts. In accordance with guidance included in ASC 605-45, “Revenue Recognition — Principal Agent Considerations” (“ASC 605-45”) reimbursements from the HOAs relating to pass-through costs are recorded net of the related expenses.

Expenses associated with our operation of THE Club include costs incurred for the third-party call center, annual membership fees paid to a third-party exchange company on behalf of each member of THE Club and administrative expenses. In addition, we also incur selling costs associated with customer conversions into THE Club. These expenses are allocated to our Hospitality and Management Services business segment.

 

54


Table of Contents

Other services expenses include certain sales incentives given to customers as motivation to purchase a VOI and costs incurred under the sales and marketing fee-for-service arrangement with a third party. These incentives are expensed as the related Vacation Interest sales revenue is recognized. These expenses are allocated to our Vacation Interest Sales and Financing business segment.

Consolidated Resort Operations Expense. With respect to the Caribbean resorts, we record expenses associated with housekeeping, front desk, maintenance, landscaping and other similar activities, which are recovered by the maintenance fees recorded in consolidated resort operations revenue. In addition, consolidated resort operations expense includes the costs related to food and beverage operations at certain resorts whose restaurants we manage directly. Similarly, the expenses of operating the golf courses and retail and gift shops are included in consolidated resort operations expense.

Loan Portfolio Expense. Loan portfolio expense includes payroll and administrative costs of our finance operations, loan servicing fees paid to third parties and credit card processing fees. These costs are expensed as incurred with the exception of mortgages and contract receivable origination costs, which are capitalized and amortized over the term of the related mortgages and contracts receivable as an adjustment to interest revenue using the effective interest method in accordance with guidelines issued under ASC 310, “Receivables.” This expense is allocated to our Vacation Interest Sales and Financing business segment.

General and Administrative Expense. General and administrative expense includes payroll and benefits, legal, audit and other professional services, travel costs, system-related costs and corporate facility expense. This expense is reported under Corporate and Other.

Depreciation and Amortization. Depreciation and amortization is not allocated to our business segments, but rather is reported in Corporate and Other.

Interest Expense. Interest expense is comprised of corporate-level indebtedness, which is reported in Corporate and Other, and interest expense related to our securitizations and consumer loan financings, which are allocated to our Vacation Interest Sales and Financing business segment.

Factors That May Affect Our Future Financial Presentation

We intend to pursue opportunities to grow fee-based revenue in the following three areas: (i) assuming the management of resorts from operators facing financial distress; (ii) managing the sales and marketing of VOIs and consumer loans from these operators or financial institutions; and (iii) servicing the consumer loan portfolios. We intend to structure these opportunities in a manner consistent with our capital-light business model, including through the acquisition of assets by special purpose entities. Examples of this strategy are our completed acquisition of ILX and Tempus and our contemplated acquisition of Pacific Monarch Resorts. Both the ILX and Tempus transactions were structured such that we now hold certain of ILX’s and Tempus’ assets and have assumed related ILX and Tempus liabilities through special purpose entities. Each of the respective lenders of the ILX and Tempus indebtedness assumed by the respective special purpose entity has recourse only to those ILX or Tempus assets that were acquired. Although the Company and its consolidated subsidiaries have not assumed the indebtedness of any of the ILX or the Tempus special purpose entities, each such entity is deemed an unrestricted subsidiary for purposes of the indenture governing the notes, U.S. GAAP requires that we consolidate such non- recourse liabilities on our financial statements for financial reporting purposes. We intend to pursue other transactions that may use similar special purpose entities in similar structures, and these entities may also be required to be consolidated on our financial statements. In that circumstance, our future condensed consolidated financial statements may reflect substantially higher levels of debt and interest expense than our historical consolidated financial statements included elsewhere in this quarterly report. See Note 21—Condensed Consolidating Financial Statements included elsewhere in this quarterly report for additional information.

In addition, on July 8, 2011, we became a SEC reporting company and are subject to certain SEC regulations, including various provisions of the Sarbanes-Oxley Act of 2002. Our compliance with these regulations has required us to incur additional legal, accounting and information technology expense related to the enhancement of accounting and internal control systems. We have also been required to hire additional employees to ensure that we have appropriate staffing for ongoing compliance with these requirements.

 

55


Table of Contents

Presentation of Certain Financial Metrics

We define Adjusted EBITDA as our net income (loss) before provision (benefit) for income taxes, plus: (i) corporate interest expense; (ii) depreciation and amortization; (iii) Vacation Interest cost of sales; (iv) loss on extinguishment of debt; (v) impairments and other noncash write-offs; (vi) gain or loss on the disposal of assets; (vii) gain on bargain purchase from business combinations; (viii) amortization of loan origination costs; and (ix) amortization of portfolio discount; less non-cash revenue outside the ordinary course of business. Adjusted EBITDA is a non-U.S. GAAP financial measure and should not be considered as an alternative to net income, operating income or any other measure of financial performance calculated and presented in accordance with U.S. GAAP.

We believe Adjusted EBITDA is useful to investors in evaluating our operating performance for the following reasons:

 

   

it and similar non-U.S. GAAP measures are widely used by investors and securities analysts to measure a company’s operating performance without regard to items that can vary substantially from company to company depending upon financing and accounting methods, book values of assets, capital structures and the methods by which assets were acquired;

 

   

by comparing Adjusted EBITDA in different historical periods, we can evaluate our operating results without the additional variations of interest income (expense), income tax provision (benefit), depreciation and amortization expense and the Vacation Interest cost of sales expense; and

 

   

several of the financial covenants governing the senior secured notes and 2008 conduit facility, including the limitation on our ability to incur additional indebtedness, are determined by reference to our EBITDA as defined in the senior secured notes, which definition approximates Adjusted EBITDA as presented here.

Our management uses Adjusted EBITDA: (i) as a measure of our operating performance, because it does not include the impact of items that we do not consider indicative of our core operating performance; (ii) for planning purposes, including the preparation of our annual operating budget; (iii) to allocate resources to enhance the financial performance of our business; and (iv) to evaluate the effectiveness of our business strategies.

The following table presents a reconciliation of Adjusted EBITDA to net income (loss) before benefit for income taxes:

 

     Three Months Ended September 30,     Nine Months Ended September 30,  
     2011     2010     2011     2010  
     ($ in thousands)     ($ in thousands)  

Income (loss) before benefit for income taxes

   $ 36,955      $ (5,750   $ 33,357      $ (8,989

Plus: Corporate interest expense(a)

     16,453        13,085        46,300        34,960   

Depreciation and amortization(b)

     3,853        3,451        10,165        8,899   

Vacation interest cost of sales(c)

     1,854        11,765        (3,760     33,630   

Loss on extinguishment of debt(b)

     —          1,081        —          1,081   

Impairments and other write-offs(b)

     693        9        1,016        989   

Gain on the disposal of assets(b)

     (76     (289     (448     (1,049

Gain on bargain purchase from business combinations(b)

     (34,183     —          (34,183     —     

Amortization of loan origination costs(b)

     718        889        2,026        2,567   

Amortization of portfolio discount(b)

     138        (113     (25     (355
  

 

 

   

 

 

   

 

 

   

 

 

 

Adjusted EBITDA - Consolidated(d)

   $ 26,405      $ 24,128      $ 54,448      $ 71,733   
  

 

 

   

 

 

   

 

 

   

 

 

 

Adjusted EBITDA - Diamond Resorts Parent, LLC and Restricted Subsidiaries(d)

     29,667        25,937        66,787        74,328   

Adjusted EBITDA - Unrestricted Subsidiaries(d)

     (1,712     (1,809     (10,800     (2,595

Adjusted EBITDA - Intercompany elimination(d)

     (1,550     —          (1,539     —     

 

(a) Excludes interest expense related to non-recourse indebtedness incurred by our special purpose vehicles that is secured by our VOI consumer loans.

 

56


Table of Contents
(b) These items represent non-cash charges/gains.
(c) We record Vacation Interest cost of sales using the relative sales value method in accordance with ASC 978, which requires us to make significant estimates which are subject to significant uncertainty. In determining the appropriate amount of costs using the relative sales value method, we rely on complex, multi-year financial models that incorporate a variety of estimated inputs. These models are reviewed on a regular basis, and the relevant estimates used in the models are revised based upon historical results and management’s new estimates. Small changes in any of the numerous assumptions in the model can have a significant financial statement impact as ASC 978 requires a retroactive adjustment back to the time of the Sunterra Corporation acquisition in the current period. Much like depreciation or amortization, for us, Vacation Interest cost of sales is essentially a non-cash expense item.
(d) For purposes of certain covenants governing the senior secured notes, our financial performance, including Adjusted EBITDA, is measured with reference to us and our Restricted Subsidiaries, and the performance of Unrestricted Subsidiaries is not considered. Therefore, we believe that this presentation of Adjusted EBITDA provides helpful information to investors in the senior secured notes.

We understand that, although measures similar to Adjusted EBITDA are frequently used by investors and securities analysts in their evaluation of companies, it has limitations as an analytical tool, and you should not consider it in isolation or as a substitute for analysis of our results of operations as reported under U.S. GAAP. Some of these limitations are:

 

   

Adjusted EBITDA does not reflect our cash expenditures or future requirements for capital expenditures or VOI inventory;

 

   

Adjusted EBITDA does not reflect changes in, or cash requirements for, our working capital needs;

 

   

Adjusted EBITDA does not reflect cash requirements for income taxes;

 

   

Adjusted EBITDA does not reflect interest expense for our corporate indebtedness;

 

   

Although depreciation and amortization are non-cash charges, the assets being depreciated or amortized will often have to be replaced in the future, and Adjusted EBITDA does not reflect any cash requirements for these replacements;

 

   

Although Vacation Interest cost of sales is also a non-cash item, we may in the future be required to develop or acquire new resort properties to replenish VOI inventory, and Adjusted EBITDA does not reflect any cash requirements for these expenditures; and

 

   

Other companies in our industry may calculate Adjusted EBITDA differently than we do, limiting its usefulness as a comparative measure.

To properly and prudently evaluate our business, we encourage you to review our U.S. GAAP financial statements included elsewhere in this quarterly report, and not to rely on any single financial measure to evaluate our business.

 

57


Table of Contents

Results of Operations

The following table sets forth our results of operations for the specified periods.

Comparison of the Three Months Ended September 30, 2011 to the Three Months Ended September 30, 2010

(In thousands)

 

    Three Months Ended
September 30, 2011
    Three Months Ended
September 30, 2010
 
    Hospitality and
Management
Services
    Vacation
Interest Sales
and Financing
    Corporate
and
Other
    Total     Hospitality and
Management
Services
    Vacation
Interest Sales
and Financing
    Corporate
and
Other
    Total  

Revenues:

               

Vacation Interest sales

  $ —        $ 60,228      $ —        $ 60,228      $ —        $ 56,515      $ —        $ 56,515   

Provision for uncollectible Vacation Interest sales revenue

    —          (4,516     —          (4,516     —          (2,051     —          (2,051
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Vacation Interest, net

    —          55,712        —          55,712        —          54,464        —          54,464   

Management, member and other services

    26,266        3,221        —          29,487        22,959        2,661        —          25,620   

Consolidated resort operations

    7,601        —          —          7,601        6,563        —          —          6,563   

Interest

    —          12,966        1,684        14,650        —          9,839        37        9,876   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total revenues

    33,867        71,899        1,684        107,450        29,522        66,964        37        96,523   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Costs and Expenses:

               

Vacation Interest cost of sales

    —          1,854        —          1,854        —          11,765        —          11,765   

Advertising, sales and marketing

    —          34,488        —          34,488        —          30,321        —          30,321   

Vacation Interest carrying cost, net

    —          4,156        —          4,156        —          6,693        —          6,693   

Management, member and other services

    6,603        562        —          7,165        5,042        280        —          5,322   

Consolidated resort operations

    6,620        —          —          6,620        5,520        —          —          5,520   

Loan portfolio

    290        2,459        —          2,749        255        2,363        —          2,618   

General and administrative

    —          —          21,074        21,074        —          —          18,326        18,326   

Depreciation and amortization

    —          —          3,853        3,853        —          —          3,451        3,451   

Interest

    —          5,649        16,453        22,102        —          4,371        13,085        17,456   

Loss on extinguishment of debt

    —          —          —          —          —          —          1,081        1,081   

Impairments and other write-offs

    7        —          686        693        —          —          9        9   

Gain on disposal of assets

    —          —          (76     (76     —          —          (289     (289

Gain on bargain purchase from business combination

    —          —          (34,183     (34,183     —          —          —          —     
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total costs and expenses

    13,520        49,168        7,807        70,495        10,817        55,793        35,663        102,273   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Income (loss) before benefit for income taxes

    20,347        22,731        (6,123     36,955        18,705        11,171        (35,626     (5,750

Benefit for income taxes

    —          —          (646     (646     —          —          (1,994     (1,994
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net income (loss)

  $ 20,347      $ 22,731      $ (5,477   $ 37,601      $ 18,705      $ 11,171      $ (33,632   $ (3,756
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Adjusted EBITDA - Diamond Resorts Parent, LLC and Restricted Subsidiaries

        $ 29,667            $ 25,937   

Adjusted EBITDA - Unrestricted Subsidiaries

          (1,712           (1,809

Adjusted EBITDA -
Intercompany Elimination

          (1,550           —     
       

 

 

         

 

 

 

Adjusted EBITDA - Consolidated

        $ 26,405            $ 24,128   
       

 

 

         

 

 

 

 

58


Table of Contents

Revenues

Total revenues increased by $11.0 million, or 11.3%, to $107.5 million for the three months ended September 30, 2011 from $96.5 million for the three months ended September 30, 2010. Total revenues in our Hospitality and Management Services segment increased $4.4 million, or 14.7%, to $33.9 million for the three months ended September 30, 2011 from $29.5 million for the three months ended September 30, 2010, due to higher management, member and other services revenue and consolidated resort operations revenue. Total revenues in our Vacation Interest Sales and Financing segment increased $4.9 million, or 7.4%, to $71.9 million for the three months ended September 30, 2011 from $67.0 million for the three months ended September 30, 2010. The increase was mostly attributable to the increase in Vacation Interest, net and interest revenue. Revenues in our corporate and other segment increased $1.6 million, or 4,451.4%, to $1.7 million for the three months ended September 30, 2011 from $0.04 million for the three months ended September 30, 2010.

Vacation Interest, Net. Vacation interest, net, in our Vacation Interest Sales and Financing segment increased $1.2 million, or 2.3%, to $55.7 million for the three months ended September 30, 2011 from $54.5 million for the three months ended September 30, 2010. The increase in Vacation Interest, net was attributable to a $3.7 million increase in Vacation Interest sales revenue, offset by a $2.4 million increase in our provision for uncollectible Vacation Interest sales revenue.

The $3.7 million increase in Vacation Interest sales revenue was primarily due to a higher average VOI sale price per transaction partially offset by a decline in the number of Vacation Interest transactions and closing percentage. Vacation Interest sales revenue was also boosted by the revenue contribution from our ILX sales center, which commenced in March 2011, and our Tempus sales center, which commenced in July 2011. Our total number of tours increased to 40,299 for the three months ended September 30, 2011 from 36,459 for the three months ended September 30, 2010, primarily as a result of our expansion of certain marketing programs. The tour conversion programs we have implemented have not yet achieved target efficiency levels as we are completing changes to our training platform and sales personnel. We closed a total of 5,845 VOI sales transactions during the three months ended September 30, 2011, compared to 6,076 transactions during the three months ended September 30, 2010. Our closing percentage (which represents the percentage of VOI sales closed relative to the total number of sales presentations at our sales centers during the period presented) decreased to 14.5% in the three months ended September 30, 2011 from 16.7% in the three months ended September 30, 2010. These decreases were due to reduced sales efficiencies at certain sales centers, continued sales resistance of our consumers due to ongoing economic uncertainty and an increase in marketing programs designed to attract new customers which was expected to reduce our closing percentage. Our average VOI sale price per transaction increased to $10,623 for the three months ended September 30, 2011 from $9,370 for the three months ended September 30, 2010 due to the focus of selling larger point packages and an increase to our pricing model.

As a percentage of gross Vacation Interest sales revenue, sales incentives were 1.5% for the three months ended September 30, 2011, compared to 1.7% for the three months ended September 30, 2010. This decrease was primarily due to a reduction of certain sales incentives given in our European operations.

Provision for uncollectible Vacation Interest sales revenue increased $2.4 million, or 120.2%, to $4.5 million for the three months ended September 30, 2011 from $2.1 million for the three months ended September 30, 2010. This increase was mainly due to changes in estimates based on the current performance of our consumer loan receivable portfolio, the increase in Vacation Interest sales revenue and an increase in the percentage of financed sales. Provision for uncollectible Vacation Interest sales revenue as a percentage of Vacation Interest sales revenue increased to 7.5% for the three months ended September 30, 2011 from 3.6% for the three months ended September 30, 2010. The provision for uncollectible Vacation Interest sales revenue as a percentage of Vacation Interest sales revenue for the three months ended September 30, 2011 follows our typical trending. The provision for uncollectible Vacation Interest sales revenue as a percentage of Vacation Interest sales revenue for the three months ended September 30, 2010 was unusually low due to changes in estimates during that period.

Management, Member and Other Services. Total management, member and other services revenue increased $3.9 million, or 15.1%, to $29.5 million for the three months ended September 30, 2011 from $25.6 million for the three months ended September 30, 2010.

Management, member and other services revenue in our Hospitality and Management Services segment increased $3.3 million, or 14.4%, to $26.3 million for the three months ended September 30, 2011 from $23.0 million for the three months ended September 30, 2010. Management fees increased as a result of increases in

 

59


Table of Contents

operating costs at the resort level, which generated higher management fee revenue under our cost-plus management agreements as well as the addition of managed properties from the ILX Acquisition and the Tempus Resorts Acquisition. In addition, we entered into a sales and marketing fee-for-service arrangement with a third party, which began to generate commission revenue during the second quarter of 2011.

Management, member and other services revenue in our Vacation Interest Sales and Financing segment increased $0.5 million, or 21.0%, to $3.2 million for the three months ended September 30, 2011 from $2.7 million for the three months ended September 30, 2010. Non-cash incentives increased $0.2 million, or 138.9%, to $0.4 million for the three months ended September 30, 2011 from $0.2 million for the three months ended September 30, 2010. As a percentage of Vacation Interest sales revenue, non-cash incentives were 0.7% for the three months ended September 30, 2011, compared to 0.3% for the three months ended September 30, 2010.

Consolidated Resort Operations. Consolidated resort operations revenue, which is recorded in our Hospitality and Management Services segment, increased $1.0 million, or 15.8%, to $7.6 million for the three months ended September 30, 2011 from $6.6 million for the three months ended September 30, 2010. The increase was primarily due to the addition of the ILX and the Tempus resorts and increased maintenance fee revenue in our St. Maarten resorts to recover prior year fund deficits.

Interest Revenue. Interest revenue increased $4.8 million, or 48.3%, to $14.7 million for the three months ended September 30, 2011 from $9.9 million for the three months ended September 30, 2010. This increase was primarily due to the addition of portfolios acquired as part of the ILX Acquisition and the Tempus Resorts Acquisition and interest earned on an income tax refund recorded in our European operations during the three months ended September 30, 2011.

Costs and Expenses

Total costs and expenses decreased $31.8 million, or 31.1%, to $70.5 million for the three months ended September 30, 2011 from $102.3 million for the three months ended September 30, 2010. Excluding gain on bargain purchase from business combination (as discussed below), total costs and expenses increased $2.4 million, or 2.4%, to $104.7 million for the three months ended September 30, 2011 from $102.3 million for the three months ended September 30, 2010.

Vacation Interest Cost of Sales. Vacation interest cost of sales related to our Vacation Interest Sales and Financing segment decreased $9.9 million, or 84.2%, to $1.9 million for the three months ended September 30, 2011 from $11.8 million for the three months ended September 30, 2010. This decrease was mainly due to a reduction of $8.4 million under the relative sales value model recorded during the three months ended September 30, 2011 as compared to a reduction of $0.3 million recorded during the three months ended September 30, 2010. The reduction under the relative sales value model was primarily attributable to an increase in projected sales price per point resulting from our revised pricing strategy that was implemented in late 2010, which permanently eliminated certain incentive programs, and a decrease in the average inventory cost per point related to recoveries. Projected sales price per point is one of the multiple estimates used in the model discussed in “Critical Accounting Policies and Use of Estimates—Vacation Interest Cost of Sales.” Vacation Interest cost of sales as a percentage of Vacation Interest sales revenue was 3.1% for the three months ended September 30, 2011, compared to 20.8% for the three months ended September 30, 2010.

Advertising, Sales and Marketing. Advertising, sales and marketing (ASM) costs increased $4.2 million, or 13.7%, to $34.5 million for the three months ended September 30, 2011 from $30.3 million for the three months ended September 30, 2010. As a percentage of Vacation Interest sales revenue, ASM costs were 57.3% for the three months ended September 30, 2011, compared to 53.7% for the three months ended September 30, 2010. The increase of such costs as a percentage of Vacation Interest sales revenue was due primarily to higher support personnel costs, direct marketing costs incurred to generate additional tour flow, and revisions to sales commission and other compensation structures.

Vacation Interest Carrying Cost, Net. Net Vacation Interest carrying cost decreased $2.5 million, or 37.9%, to $4.2 million for the three months ended September 30, 2011 from $6.7 million for the three months ended September 30, 2010, primarily due to an increase in rental revenue, which reduces carrying costs, resulting from the

 

60


Table of Contents

ILX Acquisition and the Tempus Resorts Acquisition and more occupied room nights on a same-store basis. This was partially offset by an increase in maintenance fees related to the ILX Acquisition and the Tempus Resorts Acquisition and a higher level of developer-owned inventory due to maintenance fee and loan defaults on a same-store basis.

Management, Member and Other Services Expense. Management, member and other services expense as a percentage of management, member and other services revenue increased to 24.3% for the three months ended September 30, 2011 from 20.8% for the three months ended September 30, 2010. The increase was primarily due to costs incurred under a sales and marketing fee-for-service arrangement with a third party, which began during the second quarter of 2011, partially offset by an increase in the allocation of certain resort management expenses to the HOAs that we manage.

Consolidated Resort Operations Expense. Consolidated resort operations expense as a percentage of consolidated resort operations revenue increased to 87.1% the three months ended September 30, 2011 from 84.1% for the three months ended September 30, 2010. The increase is primarily due to the addition of ILX and Tempus resort-level operations.

Loan Portfolio Expense. Loan portfolio expense increased $0.1 million, or 5.0%, to $2.7 million for the three months ended September 30, 2011 from $2.6 million for the three months ended September 30, 2010.

General and Administrative Expense. General and administrative expense increased $2.8 million, or 15.0%, to $21.1 million for the three months ended September 30, 2011 from $18.3 million for the three months ended September 30, 2010. This increase was primarily attributable to higher payroll and related expense and legal and professional fees associated with enhancements in internal controls and preparations for our becoming subject to SEC reporting obligations due to the registration of the senior secured notes. In addition, we incurred legal and professional fees related to the Tempus transaction and certain pending acquisitions in the three months ended September 30, 2011 and hired additional staff after the ILX and Tempus Resorts acquisitions were completed in August 2010 and July 2011, respectively, and incurred various office-related expenses associated with the additional staff. These increases were partially offset by an increase in allocations of certain hospitality-related corporate general and administrative expenses to the HOAs that we manage, thereby reducing our corporate-level general and administrative expense.

Depreciation and Amortization. Depreciation and amortization increased $0.4 million, or 11.6%, to $3.9 million for the three months ended September 30, 2011 from $3.5 million for the three months ended September 30, 2010. This increase was primarily attributable to the depreciation and amortization associated with the ILX and Tempus assets acquired in August 2010 and July 2011, respectively, partially offset by a reduction in the amortization of the intangible assets acquired in connection with the Sunterra Corporation acquisition. We recorded significantly higher amortization expense associated with these assets in earlier years in accordance with the accelerated amortization schedule established at the time of the Sunterra Corporation acquisition.

Interest Expense. Interest expense increased $4.6 million, or 26.6%, to $22.1 million for the three months ended September 30, 2011 from $17.5 million for the three months ended September 30, 2010. Non-cash interest expense for the three months ended September 30, 2011 was higher compared to the three months ended September 30, 2010. Higher debt issuance cost amortization and original issue discount amortization for the three months ended September 30, 2011 resulting from the issuance of the senior secured notes in August 2010, DROT 2011 in April 2011 and additional loans assumed in connection with the Tempus Resorts Acquisition in July 2011 was partially offset by the elimination of paid-in-kind interest on our second lien facility due to the extinguishment of the second lien facility. After removing these non-cash interest items, interest expense totaled $19.9 million for the three months ended September 30, 2011, and $15.9 million for the three months ended September 30, 2010. This increase was primarily related to the higher interest rates on the outstanding debt balances resulting from our issuance of the senior secured notes and loans issued in connection with the ILX Acquisition in August 2010 and the Tempus Resorts Acquisition in July 2011 as compared to the first and second lien facilities.

Loss on Extinguishment of Debt. Loss on extinguishment of debt, which is recorded in Corporate and Other, was zero for the three months ended September 30, 2011 compared to $1.1 million the three months ended September 30, 2010. On August 13, 2010, we completed our offering of $425 million of our senior secured notes. The proceeds from the senior secured notes were used primarily to repay all of the outstanding indebtedness under

 

61


Table of Contents

our existing revolving line of credit and first and second lien facilities. The write-off of the capitalized debt issuance costs related to these credit facilities resulted in a $1.1 million loss on extinguishment of debt for the three months ended September 30, 2010.

Impairments and Other Write-offs. Impairments and other write-offs increased $0.7 million to $0.7 million for the three months ended September 30, 2011 from $0.01 million for the three months ended September 30, 2010. During the three months ended September 30, 2011, we wrote down the value of certain assets held for sale in our European operations by $0.6 million to reflect their net realizable value.

Gain on bargain purchase from business combination. Gain on bargain purchase from business combination was $34.2 million for the three months ended September 30, 2011 as the fair value of the assets acquired in the Tempus Resorts Acquisition net of the liabilities assumed exceeds the purchase price. The assets were purchased as part of a distressed sale as Tempus Resorts International Ltd. had filed for Chapter 11 bankruptcy proceedings in November 2010.

 

62


Table of Contents

Comparison of the Nine Months Ended September 30, 2011 to the Nine Months Ended September 30, 2010

(In thousands)

 

    Nine Months Ended
September 30, 2011
    Nine Months Ended
September 30, 2010
 
    Hospitality and
Management
Services
    Vacation
Interest Sales
and Financing
    Corporate
and
Other
    Total     Hospitality and
Management
Services
    Vacation
Interest Sales
and Financing
    Corporate
and
Other
    Total  

Revenues:

               

Vacation Interest sales

  $ —        $ 154,631      $ —        $ 154,631      $ —        $ 158,833      $ —        $ 158,833   

Provision for uncollectible Vacation Interest sales revenue

    —          (11,259     —          (11,259     —          (2,919     —          (2,919
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Vacation Interest, net

    —          143,372        —          143,372        —          155,914        —          155,914   

Management, member and other services

    81,144        8,184        —          89,328        67,879        8,281        —          76,160   

Consolidated resort operations

    21,789        —          —          21,789        20,057        —          —          20,057   

Interest

    —          31,679        2,601        34,280        —          29,288        75        29,363   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total revenues

    102,933        183,235        2,601        288,769        87,936        193,483        75        281,494   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Costs and Expenses:

               

Vacation Interest cost of sales

    —          (3,760     —          (3,760     —          33,630        —          33,630   

Advertising, sales and marketing

    —          96,121        —          96,121        —          83,585        —          83,585   

Vacation Interest carrying cost, net

    —          20,063        —          20,063        —          20,875        —          20,875   

Management, member and other services

    18,155        1,304        —          19,459        16,224        1,272        —          17,496   

Consolidated resort operations

    19,894        —          —          19,894        18,045        —          —          18,045   

Loan portfolio

    729        7,177        —          7,906        771        7,077        —          7,848   

General and administrative

    —          —          58,797        58,797        —          —          50,218        50,218   

Depreciation and amortization

    —          —          10,165        10,165        —          —          8,899        8,899   

Interest

    —          14,082        46,300        60,382        —          13,907        34,959        48,866   

Loss on extinguishment of debt

    —          —          —          —          —          —          1,081        1,081   

Impairments and other write-offs

    7        —          1,009        1,016        —          —          989        989   

Gain on disposal of assets

    —          —          (448     (448     —          —          (1,049     (1,049

Gain on bargain purchase from business combination

    —          —          (34,183     (34,183     —          —          —          —     
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total costs and expenses

    38,785        134,987        81,640        255,412        35,040        160,346        95,097        290,483   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Income (loss) before benefit for income taxes

    64,148        48,248        (79,039     33,357        52,896        33,137        (95,022     (8,989

Benefit for income taxes

    —          —          (64     (64     —          —          (569     (569
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net income (loss)

  $ 64,148      $ 48,248      $ (78,975   $ 33,421      $ 52,896      $ 33,137      $ (94,453   $ (8,420
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Adjusted EBITDA - Diamond Resorts Parent, LLC and Restricted Subsidiaries

        $ 66,787            $ 74,328   

Adjusted EBITDA - Unrestricted Subsidiaries

          (10,800           (2,595

Adjusted EBITDA - Intercompany Elimination

          (1,539           —     
       

 

 

         

 

 

 

Adjusted EBITDA - Consolidated

        $ 54,448            $ 71,733   
       

 

 

         

 

 

 

 

63


Table of Contents

Revenues

Total revenues increased by $7.3 million, or 2.6%, to $288.8 million for the nine months ended September 30, 2011 from $281.5 million for the nine months ended September 30, 2010. Total revenues in our Hospitality and Management Services segment increased $15.0 million, or 17.1%, to $102.9 million for the nine months ended September 30, 2011 from $87.9 million for the nine months ended September 30, 2010, primarily due to higher management, member and other services revenue and consolidated resort operations revenue. Revenues in our corporate and other segment increased $2.5 million, or 3,368.0%, to $2.6 million for the nine months ended September 30, 2011 from $0.1 million for the nine months ended September 30, 2010. Total revenues in our Vacation Interest Sales and Financing segment decreased $10.3 million, or 5.3%, to $183.2 million for the nine months ended September 30, 2011 from $193.5 million for the nine months ended September 30, 2010. The decrease was mostly attributable to the decline in Vacation Interest, net, partially offset by the increase in the interest revenue.

Vacation Interest, Net. Vacation interest, net, in our Vacation Interest Sales and Financing segment decreased $12.5 million, or 8.0%, to $143.4 million for the nine months ended September 30, 2011 from $155.9 million for the nine months ended September 30, 2010. The decrease in Vacation Interest, net was attributable to a $4.2 million decrease in Vacation Interest sales revenue, and an $8.3 million increase in our provision for uncollectible Vacation Interest sales revenue.

The $4.2 million decline in Vacation Interest sales revenue was primarily due to a decline in the number of Vacation Interest transactions and closing percentage, partially offset by an increase in our average VOI sale price per transaction and a decrease in sales incentives. The decrease in Vacation Interest sales revenue was partially offset by the revenue contribution from our ILX sales center, which commenced in March 2011, and our Tempus sales center, which commenced in July 2011. Our total number of tours increased to 107,152 for the nine months ended September 30, 2011 from 96,611 for the nine months ended September 30, 2010, primarily as a result of our expansion of certain marketing programs. The tour conversion programs we have implemented have not yet achieved target efficiency levels as we are completing changes to our training platform and sales personnel. We closed a total of 15,255 VOI sales transactions during the nine months ended September 30, 2011, compared to 16,801 transactions during the nine months ended September 30, 2010. Our closing percentage (which represents the percentage of VOI sales closed relative to the total number of sales presentations at our sales centers during the period presented) decreased to 14.2% in the nine months ended September 30, 2011 from 17.4% in the nine months ended September 30, 2010. These decreases were due to reduced sales efficiencies at certain sales centers, continued sales resistance of our consumers due to ongoing economic uncertainty and an increase in marketing programs designed to attract new customers which was expected to reduce our closing percentage. Our average VOI sale price per transaction increased to $10,383 for the nine months ended September 30, 2011 from $9,544 for the nine months ended September 30, 2010 due to the focus of selling larger point packages and an increase to our pricing model.

As a percentage of gross Vacation Interest sales revenue, sales incentives were 1.5% for the nine months ended September 30, 2011, compared to 1.9% for the nine months ended September 30, 2010. This decrease was primarily due to a reduction of certain sales incentives given in our European operations.

Provision for uncollectible Vacation Interest sales revenue increased $8.4 million, or 285.7%, to $11.3 million for the nine months ended September 30, 2011 from $2.9 million for the nine months ended September 30, 2010. This increase was mostly due to changes in estimates based on the current performance of our consumer loan receivable portfolio, the increase in Vacation Interest sales revenue and an increase in the percentage of financed sales. Provision for uncollectible Vacation Interest sales revenue as a percentage of Vacation Interest sales revenue increased to 7.3% for the nine months ended September 30, 2011 from 1.8% for the nine months ended September 30, 2010. The provision for uncollectible Vacation Interest sales revenue as a percentage of Vacation Interest sales revenue for the nine months ended September 30, 2011 follows our typical trending. The provision for uncollectible Vacation Interest sales revenue as a percentage of Vacation Interest sales revenue for the nine months ended September 30, 2010 was unusually low due to changes in estimates during that period.

Management, Member and Other Services. Total management, member and other services revenue increased $13.1 million, or 17.3%, to $89.3 million for the nine months ended September 30, 2011 from $76.2 million for the nine months ended September 30, 2010.

 

64


Table of Contents

Management, member and other services revenue in our Hospitality and Management Services segment increased $13.2 million, or 19.5%, to $81.1 million for the nine months ended September 30, 2011 from $67.9 million for the nine months ended September 30, 2010. During the quarter ended March 31, 2011, we recorded $5.2 million in insurance proceeds received related to the replacement of assets that were destroyed due to a severe flood in 2008 at one of our resorts. In addition, management fees increased as a result of increases in operating costs at the resort level, which generated higher management fee revenue under our cost-plus management agreements as well as the addition of managed properties from the ILX Acquisition and the Tempus Resorts Acquisition. We also experienced higher club revenues due to a higher member count in THE Club as well as increased membership dues in the nine months ended September 30, 2011 compared to the nine months ended September 30, 2010. Furthermore, we entered into a sales and marketing fee-for-service arrangement with a third party, which began to generate commission revenue during the second quarter of 2011.

Management, member and other services revenue in our Vacation Interest Sales and Financing segment decreased $0.1 million, or 1.2%, to $8.2 million for the nine months ended September 30, 2011 from $8.3 million for the nine months ended September 30, 2010.

Consolidated Resort Operations. Consolidated resort operations revenue, which is recorded in our Hospitality and Management Services segment, increased $1.7 million, or 8.6%, to $21.8 million for the nine months ended September 30, 2011 from $20.1 million for the nine months ended September 30, 2010. The increase was primarily due to the addition of the ILX and the Tempus resorts and increased maintenance fee revenue in our St. Maarten resorts to recover prior year fund deficits.

Interest Revenue. Interest revenue increased $4.9 million, or 16.7%, to $34.3 million for the nine months ended September 30, 2011 from $29.4 million for the nine months ended September 30, 2010. This increase was primarily due to the addition of portfolios acquired as part of the ILX and Tempus acquisitions and interest earned on an income tax refund recorded in our European operations during the nine months ended September 30, 2011, partially offset by lower interest revenue due to a reduction in our loan portfolios.

Costs and Expenses

Total costs and expenses decreased $35.1 million, or 12.1%, to $255.4 million for the nine months ended September 30, 2011 from $290.5 million for the nine months ended September 30, 2010. Excluding gain on bargain purchase from business combination (as discussed below), total costs and expenses decreased $0.9 million, or 0.3%, to $289.6 million for the nine months ended September 30, 2011 from $290.5 million for the nine months ended September 30, 2010.

Vacation Interest Cost of Sales. Vacation interest cost of sales related to our Vacation Interest Sales and Financing segment decreased $37.4 million, or 111.2%, to a $3.8 million credit for the nine months ended September 30, 2011 from $33.6 million expense for the nine months ended September 30, 2010. This decrease was mainly due to a reduction of $32.9 million under the relative sales value model recorded during the nine months ended September 30, 2011 as compared to a reduction of $1.9 million recorded during the nine months ended September 30, 2010. The reduction under the relative sales value model was primarily attributable to an increase in projected sales price per point resulting from our revised pricing strategy that was implemented in late 2010, which permanently eliminated certain incentive programs, and a decrease in the average inventory cost per point related to recoveries. Projected sales price per point is one of the multiple estimates used in the model discussed in “Critical Accounting Policies and Use of Estimates—Vacation Interest Cost of Sales.”

In addition, the decline in the volume of VOI sales for the nine months ended September 30, 2011 relative to the nine months ended September 30, 2010 contributed to the decrease in Vacation Interest cost of sales. Vacation Interest cost of sales as a percentage of Vacation Interest sales revenue was (2.4)% for the nine months ended September 30, 2011, compared to 21.7% for the nine months ended September 30, 2010.

Advertising, Sales and Marketing. Advertising, sales and marketing (ASM) costs increased $12.5 million, or 15.0%, to $96.1 million for the nine months ended September 30, 2011 from $83.6 million for the nine months ended September 30, 2010. As a percentage of Vacation Interest sales revenue, ASM costs were 62.2% for the nine months ended September 30, 2011, compared to 54.1% for the nine months ended September 30, 2010. The increase of such costs as a percentage of Vacation Interest sales revenue was due primarily to higher support personnel costs, direct marketing costs incurred to generate additional tour flow, and revisions to sales commission and other compensation structures.

 

65


Table of Contents

Vacation Interest Carrying Cost, Net. Net Vacation Interest carrying cost decreased $0.8 million, or 3.9%, to $20.1 million for the nine months ended September 30, 2011 from $20.9 million for the nine months ended September 30, 2010, primarily due to an increase in rental revenue, which reduces carrying costs, resulting from the ILX Acquisition and the Tempus Resorts Acquisition and more occupied room nights on a same-store basis. This was partially offset by an increase in maintenance fees related to the ILX Acquisition and the Tempus Resorts Acquisition and a higher level of developer-owned inventory due to maintenance fee and loan defaults on a same-store basis.

Management, Member and Other Services Expense. Management, member and other services expense as a percentage of management, member and other services revenue decreased to 21.8% for the nine months ended September 30, 2011 from 23.0% for the nine months ended September 30, 2010. The decrease was primarily due to an increase in the allocation of certain resort management expenses to the HOAs that we manage, thereby reducing our management, member and other services expense.

Consolidated Resort Operations Expense. Consolidated resort operations expense as a percentage of consolidated resort operations revenue increased to 91.3% for the nine months ended September 30, 2011 from 90.0% for the nine months ended September 30, 2010. The increase is primarily due to the addition of ILX and Tempus resort-level operations.

Loan Portfolio Expense. Loan portfolio expense increased $0.1 million, or 0.7%, to $7.9 million for the nine months ended September 30, 2011 from $7.8 million for the nine months ended September 30, 2010.

General and Administrative Expense. General and administrative expense increased $8.6 million, or 17.1%, to $58.8 million for the nine months ended September 30, 2011 from $50.2 million for the nine months ended September 30, 2010. This increase was primarily attributable to higher payroll and related expense and legal and professional fees associated with enhancements in internal controls and preparations for our becoming subject to SEC reporting obligations due to the registration of the senior secured notes. In addition, we incurred legal and professional fees related to the Tempus transaction and certain pending acquisitions in the nine months ended September 30, 2011 and hired additional staff after the ILX Acquisition and the Tempus Resorts Acquisition were completed in August 2010 and July 2011, respectively, and incurred various office-related expenses associated with the additional staff. These increases were partially offset by an increase in allocations of certain hospitality-related corporate general and administrative expenses to the HOAs that we manage, thereby reducing our corporate-level general and administrative expense.

Depreciation and Amortization. Depreciation and amortization increased $1.3 million, or 14.2%, to $10.2 million for the nine months ended September 30, 2011 from $8.9 million for the nine months ended September 30, 2010. This increase was primarily attributable to the depreciation and amortization associated with the ILX and Tempus assets acquired in August 2010 and July 2011, respectively, partially offset by a reduction in the amortization of the intangible assets acquired in connection with the Sunterra Corporation acquisition. We recorded significantly higher amortization expense associated with these assets in earlier years in accordance with the accelerated amortization schedule established at the time of the Sunterra Corporation acquisition.

Interest Expense. Interest expense increased $11.5 million, or 23.6%, to $60.4 million for the nine months ended September 30, 2011 from $48.9 million for the nine months ended September 30, 2010. Non-cash interest expense was higher for the nine months ended September 30, 2011 compared to the nine months ended September 30, 2010. Higher debt issuance cost amortization and original issue discount amortization for the nine months ended September 30, 2011 resulting from the issuance of the senior secured notes in August 2010, DROT 2011 in April 2011 and additional loans assumed in connection with the Tempus Resorts Acquisition in July 2011 was partially

 

66


Table of Contents

offset by the elimination of paid-in-kind interest on our second lien facility due to the extinguishment of the second lien facility. After removing these non-cash interest items, interest expense totaled $55.0 million for the nine months ended September 30, 2011, and $44.0 million for the nine months ended September 30, 2010. This increase was primarily related to the higher interest rates on the outstanding debt balances resulting from our issuance of the senior secured notes and loans issued in connection with the ILX Acquisition in August 2010 and the Tempus Resorts Acquisition in July 2011 as compared to the first and second lien facilities.

Loss on Extinguishment of Debt. Loss on extinguishment of debt, which is recorded in Corporate and Other, was zero for the nine months ended September 30, 2011 compared to $1.1 million the nine months ended September 30, 2010. On August 13, 2010, we completed our offering of $425 million of our senior secured notes. The proceeds from the senior secured notes were used primarily to repay all of the outstanding indebtedness under our existing revolving line of credit and first and second lien facilities. The write-off of the capitalized debt issuance costs related to these credit facilities resulted in a $1.1 million loss on extinguishment of debt for the nine months ended September 30, 2010.

Impairments and Other Write-offs. Impairments and other write-offs was $1.0 million for both the nine months ended September 30, 2011 and the nine months ended September 30, 2010.

Gain on bargain purchase from business combination. Gain on bargain purchase from business combination was $34.2 million for the nine months ended September 30, 2011 as the fair value of the assets acquired in the Tempus Resorts Acquisition net of the liabilities assumed exceeds the purchase price. The assets were purchased as part of a distressed sale as Tempus Resorts International Ltd. had filed for Chapter 11 bankruptcy proceedings in November 2010.

Liquidity and Capital Resources

Overview. Historically, our business has depended on the availability of credit to finance the consumer loans we have provided to our customers for the purchase of their VOIs. Typically, these loans have required a minimum cash down payment of 10% of the purchase price at the time of sale. However, selling, marketing and administrative expenses attributable to VOI sales are primarily cash expenses and often exceed the buyer’s minimum down payment requirement. Accordingly, the availability of financing facilities for the sale or pledge of these receivables to generate liquidity is a critical factor in our ability to meet our short and long-term cash needs. We have historically relied upon our ability to sell receivables in the securitization market in order to generate liquidity and create capacity on our conduit facilities.

Additionally, the terms of the consumer loans we seek to finance are generally longer than the facilities through which we seek to finance such loans. While the term of our consumer loans is typically ten years, our conduit facilities typically have a term of 364 days. If we are unable to refinance conduit borrowings in the term securitization markets, we are required to refinance our conduit facilities on an annual basis in order to provide adequate liquidity for our consumer finance business.

While the securitization market has been limited since 2008, we completed a $182 million securitization in October 2009 that was composed of A and BBB+ rated notes backed by vacation ownership loans. The proceeds of the securitization were used to pay down our conduit facilities. In addition, on April 27, 2011, we completed a second securitization transaction and issued the Diamond Resorts Owners Trust Series 2011-1 Timeshare Loan Backed Notes, Series 2011-1 (the “DROT 2011 Notes”) with a face value of $64.5 million.

On October 14, 2011, we entered into an amended and restated 2008 conduit facility that extended the maturity date of the facility to April 12, 2013. The amendment provides for a $75 million, 18-month facility that is annually renewable for 364-day periods at the election of the lenders. The advance rates on loans receivable in the portfolio are limited to 75% of the face value of eligible loans.

Although we completed these securitizations and conduit transactions, we may not be successful in completing similar transactions in the future and, if we are unable to continue to participate in securitization transactions on acceptable terms, our liquidity and cash flows would be materially and adversely affected.

We require access to the capital markets in order to fund our operations and may, in the implementation of our growth strategy, become more reliant on third-party financing. There can be no assurances that any such financing will be available to allow us to implement our growth strategy and sustain and improve our results of operations.

 

67


Table of Contents

We spent $1.5 million and $10.3 million to purchase VOI inventory during the nine months ended September 30, 2011 and 2010, respectively. Construction of inventory during the nine months ended September 30, 2011 and 2010 was $0.7 million and $0.3 million, respectively, related to a minor build-out of our Italian property.

We had $19.4 million and $27.3 million in cash and cash equivalents at September 30, 2011 and December 31, 2010, respectively. Our primary sources of liquidity have historically come from cash from operations and borrowings. We believe there will be sufficient existing cash resources and cash flow from operations, in addition to refinancing activities, to meet the anticipated debt maturities and other cash requirements during 2011. If cash flows from operations are less than expected, we would need to curtail our sales and marketing operations or raise additional capital.

In October 2011, we were levied a $9.8 million water intrusion assessment related to the intervals and points equivalent that we own at a resort that we manage to cover the costs required to repair water intrusion damage. The water intrusion assessment will be recorded as Vacation Interest carrying cost during the quarter ending December 31, 2011. This assessment is payable in annual installments over the next five years, and we expect to fund these payments from operating cash flows.

On July 21, 2011, DRP consummated a recapitalization transaction pursuant to which it sold 280.89 common units to certain institutional accredited investors in exchange for $136.5 million. DRP paid approximately $4.5 million in fees in conjunction with the recapitalization transactions. DRP used $108.7 million of the proceeds and issued 26.56 common units to redeem all of the issued and outstanding preferred units (including accrued and unpaid priority returns). In addition, DRP paid $16.4 million to CDP, a related party of the Company, to redeem 34.74 common units previously held by CDP. Immediately after the transaction above, CDP owns approximately 54.3% of the issued and outstanding common units with the remainder owned by various institutional investors. DRP also purchased warrants that are exercisable into approximately 3.3% of common stock of Diamond Resorts Corporation for approximately $6.4 million in cash.

Cash Flow From Operating Activities. During the nine months ended September 30, 2011, net cash used in operating activities was $2.4 million and was the result of a net income of $33.4 million, non-cash revenues and expenses totaling $(9.2) million and other changes in operating assets and liabilities of $(26.6) million. The significant non-cash revenues and expenses included (i) $10.2 million in depreciation and amortization, (ii) $11.3 million in the provision for uncollectible Vacation Interest sales revenue, (iii) $4.7 million in amortization of capitalized financing costs and original issue discounts, (iv) $2.0 million in amortization of capitalized loan origination costs and portfolio discount, (v) $1.0 million in impairments and other write-offs, offset by (vi) gain from disposal of assets of $0.4 million, (vii) $34.2 million in gain on bargain purchase from business combination related to the Tempus Resorts Acquisition and (viii) $3.5 million of insurance proceeds received related to the replacement of assets that were destroyed due to a severe flood in 2008 at one of our resorts, which represents proceeds received in prior years but recognized as revenue in the nine months ended September 30, 2011.

During the nine months ended September 30, 2010, net cash provided by operating activities was $41.6 million and was the result of a net loss of $8.4 million, non-cash expenses totaling $16.2 million and other changes in operating assets and liabilities of $33.8 million. The significant non-cash expenses included (i) $8.9 million in depreciation and amortization, (ii) $2.9 million in the provision for uncollectible vacation interest sales revenue, (iii) $2.2 million in amortization of capitalized deferred loan and contract origination costs, (iv) $1.5 million in amortization of capitalized financing costs, and (v) $1.1 million loss on extinguishment of debt, (vi) $1.0 million in impairments and other write-offs, offset by (vii) $1.0 million in gain on disposal of assets and (viii) $0.2 million in unrealized gain on derivative instruments.

Cash Flow From Investing Activities. During the nine months ended September 30, 2011, net cash used in investing activities was $109.1 million, comprised of (i) $5.1 million used to purchase furniture, fixtures, computer software and equipment, including $1.1 million for the replacement of assets that were destroyed due to a severe flood in 2008 for which insurance proceeds were received, (ii) $102.4 million used in connection with the Tempus Resorts Acquisition (net of $2.5 million of cash acquired), (iii) $3.5 million issuance of Tempus Note Receivable, offset by (iv) $2.0 million in proceeds from the sale of assets in our European operations.

 

68


Table of Contents

During the nine months ended September 30, 2010, net cash used in investing activities was $33.1 million, comprised of $30.7 million used in connection with the ILX Acquisition, $3.8 million used to purchase furniture, fixtures, computer software and equipment, offset by $1.5 million in proceeds from the sale of assets in our European operations.

Cash Flow From Financing Activities. During the nine months ended September 30, 2011, net cash provided by financing activities was $103.5 million. Cash provided by financing activities consisted of (i) $181.2 million from the issuance of debt under our securitization notes and conduit facility, (ii) $44.7 million in notes payable, (iii) $146.7 million in equity investment received from new investors, and (iv) a $0.5 million decrease in cash in escrow and restricted cash. These amounts were offset by cash used in financing activities consisting of (i) $105.3 million on our securitizations and conduit facility, (ii) $13.7 million on notes payable, (iii) $4.4 million of debt issuance costs, (iv) $16.6 million to purchase a portion of our outstanding stock warrants, (v) $16.4 million to repurchase a portion of common units, (vi) $108.7 million to redeem all previously-issued preferred units, and (vii) $4.6 million in costs related to preferred and common units issued.

During the nine months ended September 30, 2010, net cash used in financing activities was $14.9 million. Cash used in financing activities consisted of net payments of (i) $397.6 million on our first lien, second lien and revolving credit facility, (ii) $56.1 million on our securitizations and 2008 conduit facility, (iii) $6.5 million on notes payable, (iv) $18.4 million of debt issuance costs, (v) $75.0 million to repurchase equity previously held by another minority institutional investor, and (vi) $2.9 million in payments related to the 2010 equity recapitalization. These amounts were offset by cash generated from financing activities of (i) $414.4 million from our issuance of the senior secured notes, (ii) $33.9 million from the issuance of debt under our securitization notes and conduit facility, (iii) $17.5 million of issuance of other long-term debt, (iv) $75.0 million in equity investment from new investors, and (v) $0.9 million due to a decrease in cash in escrow and restricted cash.

Senior Secured Notes. On August 13, 2010, we completed the issuance of $425 million of principal amount of outstanding senior secured notes. The outstanding senior secured notes carry an interest rate of 12.0% and were issued with an original issue discount of 2.5%, or $10.6 million. Interest payments will be made in arrears on February 15 and August 15 of each year, commencing February 15, 2011. The proceeds from the outstanding senior secured notes were used primarily to repay all of the outstanding indebtedness under our existing revolving line of credit and first and second lien facilities.

First and Second Lien Facilities. On April 26, 2007, we entered into our first lien facility and second lien facility. Our first lien facility included a $250.0 million term loan and a $25.0 million revolving line of credit, with maturity dates of April 26, 2012 and April 26, 2011, respectively, and was secured by our capital and assets. The second lien facility, which was secured by the same assets as our first lien facility but on a second lien basis, had a maturity date of April 26, 2013.

On August 13, 2010, we used the net proceeds from our sale of the outstanding senior secured notes and other general-purpose funds to repay the $395.7 million of then-outstanding indebtedness under our revolving line of credit and first and second lien facilities.

Conduit Facilities, 2009 Securitization and 2011 Securitization. On November 3, 2008, we entered into agreements for our 2008 conduit facility, pursuant to which we issued secured VOI receivable backed variable funding notes designated Diamond Resorts Issuer 2008 LLC, Variable Funding Notes (the “2008 Funding Notes”), in an aggregate principal amount not to exceed $215.4 million, which was decreased to $200.0 million, $73.4 million, and $64.6 million on March 27, 2009, October 15, 2009, and August 31, 2010, respectively. On October 14, 2011, we entered into an amended and restated 2008 conduit facility that extended the maturity date of the facility to April 12, 2013. The amendment provides for a $75 million, 18-month facility that is annually renewable for 364-day periods at the election of the lenders, bears interest at either LIBOR or the commercial paper rate (having a floor of 0.50%) plus 4.0%, and has a non-use fee of 0.75%. The advance rates on loans receivable in the portfolio are limited to 75% of the face value of eligible loans.

The 2008 conduit facility is subject to covenants including the maintenance of specific financial ratios. The financial ratio covenants consist of a minimum consolidated interest coverage ratio of at least 1.5 to 1.0 as of the measurement date and a maximum consolidated leverage ratio not to exceed 5.5 to 1.0 on each measurement date.

 

69


Table of Contents

The consolidated interest coverage ratio is calculated by dividing Consolidated EBITDA (as defined in the credit agreement) by Consolidated Interest Expense (as defined in the credit agreement), both as measured on a trailing 12 month basis preceding the measurement date. As of September 30, 2011, our interest coverage ratio was 1.76. The consolidated leverage ratio is calculated by dividing Total Funded Debt (as defined in the credit agreement) minus unrestricted cash and cash equivalents as of the measurement date by Consolidated EBITDA as measured on a trailing 12 month basis preceding the measurement date. As of September 30, 2011, our leverage ratio was 4.84. Covenants in the 2008 conduit facility also include limitations on liquidity. The total liquidity covenant stipulates that our aggregate unrestricted cash and cash equivalents as of the measurement date must exceed $10 million through December 31, 2010 and must exceed $15 million as of the measurement dates from January 1, 2011 through the Commitment Expiration Date. As of September 30, 2011, our unrestricted cash and cash equivalents under the Restricted Subsidiaries was $16.6 million. As of September 30, 2011, we were in compliance with all of these covenants.

On October 15, 2009, we completed our 2009 securitization transaction and issued two consumer loan backed notes designated as Diamond Resorts Owners Trust Series 2009-1 Class A (the “DROT 2009 Class A Notes”), and Series 2009-1 Class B, (the “DROT 2009 Class B Notes” and together with the DROT 2009 Class A Notes, the “DROT 2009 Notes”). The Class A notes carry an interest rate of 9.3% and had an initial face value of $169.2 million. The Class B notes carry an interest rate of 12.0% and had an initial face value of $12.8 million. The DROT 2009 Notes have a maturity date of March 20, 2026. The net proceeds received were $181.1 million compared to the $182.0 million face value and we recorded the $0.9 million difference as an original issue discount on the securitization notes payable. Also on October 15, 2009, we used the proceeds from the DROT 2009 Notes to pay off in full the $35.4 million outstanding principal balance under our 2007 conduit facility and to pay down the $148.9 million outstanding principal balance under our 2008 conduit facility, along with requisite accrued interest and fees associated with both conduit facilities.

On April 27, 2011, we completed a securitization transaction and issued the DROT 2011 Notes with a face value of $64.5 million. The DROT 2011 Notes mature March 20, 2023 and have an interest rate of 4.0%. The net proceeds were used to pay off in full the $36.4 million outstanding principal balance under our 2008 conduit facility, to pay down approximately $7 million of the Quorum Facility, to pay requisite accrued interest and fees associated with both facilities, and to pay certain expenses incurred in connection with the issuance of the DROT 2011 Notes, including the funding of a reserve account required thereby. During the period from April 28 to September 30, 2011, we borrowed $14.3 million, net of repayments, under the 2008 Conduit Facility.

Polo Towers Lines of Credit and Securitization Notes Payable. In connection with the acquisition of Sunterra Corporation in April 2007, a subsidiary formerly owned by Stephen J. Cloobeck assigned revolving lines of credit to Diamond Resorts Parent, LLC. The lines of credit were collateralized by retail contracts receivable and related VOIs. The revolving feature of the lines of credit expired when they were assigned. One of the lines of credit was paid off and terminated on July 30, 2010 upon its final maturity date, and the remaining line of credit was paid off and terminated January 3, 2011.

Securitized loans that were collateralized by consumer contracts and related VOIs were also assigned in April 2007 by a company controlled by Mr. Cloobeck. These loans were paid in full and terminated on March 4, 2011.

Quorum Facility. Our subsidiary DRI Quorum entered into a Loan Sale and Security Agreement (the “LSSA”), dated as of April 30, 2010 with Quorum Federal Credit Union (“Quorum”), as purchaser. The LSSA and related documents provide for an aggregate minimum $40 million loan sale facility and joint marketing venture (the “Quorum Facility”) where DRI Quorum may sell eligible consumer loans and in-transit loans to Quorum on a non-recourse, permanent basis, provided that the underlying consumer obligor is a Quorum credit union member. The joint marketing venture has a minimum term of two years and the LSSA provides for a purchase period of two years. The purchase price payment and the program purchase fee are each determined at the time that the loan is sold to Quorum. At September 30, 2011, the weighted average purchase price payment was 88.3% of the obligor loan amount and the weighted average program purchase fee was 7.0%. To the extent excess funds remain after payment of the sold loans at Quorum’s purchase price, such excess funds shall be remitted to us as a deferred purchase price payment. This transaction did not qualify as a loan sale under U.S. GAAP.

 

70


Table of Contents

Tempus Acquisition Loan and Tempus Resorts Acquisition Financing. On November 23, 2010, Tempus Acquisition, one of our wholly-owned subsidiaries, entered into the Tempus Acquisition Loan with an affiliate of Guggenheim, as the lender, and Guggenheim Corporate Funding, LLC, as administrative agent. The Tempus Acquisition Loan was a revolving loan facility with a maximum principal amount of $8 million, the proceeds of which were used exclusively for the following purposes: (i) to provide Tempus Acquisition, LLC with funds to lend to Tempus Resorts International, Ltd. and certain of its affiliates, pursuant to a debtor-in-possession financing order entered by the United States Bankruptcy Court for the Middle District of Florida (“DIP Financing” or “Tempus Note Receivable”), for general working capital purposes and other lawful purposes as permitted under the agreements governing the DIP Financing; and (ii) to provide $1.5 million for the “Deposit,” as defined and provided in the Agreement for Purchase and Sale of Assets to purchase certain assets of Tempus Resorts International, Ltd. and its affiliates.

The term of the Tempus Acquisition Loan ended on July 1, 2011, when the Tempus Note Receivable was discharged in connection with the acquisition of certain assets of Tempus Resorts International, Ltd. and certain of its affiliates (the “Tempus Resorts Acquisition”).

On July 1, 2011, we completed the Tempus Resorts Acquisition through Mystic Dunes, LLC, a wholly-owned subsidiary of Tempus Acquisition. In order to fund the Tempus Resorts Acquisition, Tempus Acquisition entered into a Loan and Security Agreement with Guggenheim Corporate Funding, LLC, as administrative agent for the lender parties thereto (the “Tempus Guggenheim Loan”). The Tempus Guggenheim Loan is collateralized by all assets of Tempus Acquisition. The Tempus Guggenheim Loan is in an aggregate amount of $41.1 million (which includes a $5.5 million revolving loan), has an interest rate of 18.0% (of which 10.0% is paid currently and the remaining may be paid in cash or accrued and added to the principal amount of the Tempus Guggenheim Loan), and matures on June 30, 2015. An aggregate of $7.5 million of the Tempus Guggenheim Loan was used by Tempus Acquisition to purchase a 10% participating interest in the Tempus Receivables Loan and the remaining proceeds were loaned to Mystic Dunes, LLC pursuant to a Loan and Security Agreement having payment terms identical to the Tempus Guggenheim Loan (the “Mystic Dunes Loan”). The Mystic Dunes Loan is collateralized by all assets of Mystic Dunes, LLC. The proceeds of the Mystic Dunes Loan were used to pay off certain existing indebtedness and closing costs associated with the Tempus Resorts Acquisition.

In connection with the Tempus Resorts Acquisition, a subsidiary of Mystic Dunes, LLC entered into a Loan and Security Agreement with Resort Finance America, LLC (the “Tempus Receivables Loan”). The Tempus Receivables Loan is a receivables credit facility in the amount of $74.5 million, collateralized by mortgages and contracts receivable acquired in the Tempus Resorts Acquisition. The Tempus Receivables Loan has an interest rate which is the higher of (i) one-month LIBOR plus 7.0% and (ii) 10%, adjusted monthly, and matures on July 1, 2015.

Another subsidiary of Mystic Dunes, LLC entered into an Amended and Restated Inventory Loan and Security Agreement with Textron Financial Corporation (the “Tempus Inventory Loan”) in the maximum amount of $4.3 million, collateralized by certain VOI inventory acquired in the Tempus Resorts Acquisition. The Tempus Inventory Loan has an interest rate of three-month LIBOR plus 5.5% (with a floor of 2.0%) and matures on June 30, 2016, subject to extension to June 30, 2018. Hereinafter, the Tempus Guggenheim Loan, the Mystic Dunes Loan, the Tempus Receivables Loan and the Tempus Inventory Loan are sometimes collectively referred to herein as the “Tempus Loans.”

Each of Tempus Acquisition, Mystic Dunes, LLC and its wholly-owned subsidiaries are special purpose, unrestricted subsidiaries.

ILXA Receivables Loan and Inventory Loan. On August 31, 2010, we completed the ILX acquisition through our wholly-owned subsidiary, ILXA. In connection with the ILX acquisition, ILXA entered into an Inventory Loan and Security Agreement (“ILXA Inventory Loan”) and a Receivables Loan and Security Agreement (“ILXA Receivables Loan”) with Textron Financial Corporation. The ILXA Inventory Loan is a non-revolving credit facility in the maximum principal amount of $23.0 million with an interest rate of 7.5%. The ILXA Receivables Loan is a receivables facility with an initial principal amount of $11.9 million with an interest rate of 10% and is collateralized by mortgages and contracts receivable of ILXA. Both loans mature on August 31, 2015. The proceeds from these loans were used to fund the ILX acquisition. Each of ILXA and its wholly-owned subsidiaries are special purpose subsidiaries and unrestricted subsidiaries.

 

71


Table of Contents

Notes Payable. We finance premiums on certain insurance policies under unsecured notes. These unsecured notes will mature in December 2011 and January 2012, and carry an interest rate of 3.1% per annum.

The following table presents selected information on our borrowings as of September 30, 2011 and December 31, 2010 (dollars in thousands):

 

     September 30, 2011     December 31,
2010
 
     Principal
Balance
    Weighted
Average
Interest
Rate
    Maturity     Principal
Balance
 

Senior Secured Notes

   $ 425,000        12.0     8/15/18      $ 425,000   

Original issue discount related to Senior Secured Notes

     (9,672         (10,278

Diamond Resorts Owners Trust Series 2009-1

     93,066        9.5     3/20/26        121,843   

Original issue discount related to Diamond Resorts Owners Trust Series 2009-1

     (704         (899

Tempus Receivables Loan

     68,280        10.0     7/1/15        —     

Diamond Resorts Owners Trust Series 2011-1

     56,285        4.0     3/20/23        —     

Original issue discount related to Diamond Resorts Owners Trust Series 2011-1

     (415         —     

Tempus Guggenheim Loan

     38,361        18.0     6/30/15        —     

ILXA Inventory Loan

     21,762        7.5     8/31/15        18,541   

Quorum Facility

     20,117        7.0     4/30/12        12,942   

2008 Conduit Facility

     14,294        5.5     10/31/11     39,467   

ILXA Receivables Loan

     7,916        10.0     8/31/15        10,292   

Tempus Inventory Loan

     3,798        7.5     6/30/16        —     

Notes payable-insurance policies

     1,422        3.1     Various        1,366   

Notes payable-other

     247        7.2     Various        66   

Tempus Acquisition Loan

     —          N/A        N/A        3,300   

Polo Towers Lines of Credit

     —          N/A        N/A        2,060   

Polo Towers Securitization Notes Payable

     —          N/A        N/A        1,138   
  

 

 

       

 

 

 

Total borrowings

   $ 739,757          $ 624,838   
  

 

 

       

 

 

 

 

* This was subsequently amended to April 12, 2013.

Future Capital Requirements. A substantial amount of our indebtedness is non-recourse, including the DROT 2011-1 Notes, the DROT 2009 Notes, the 2008 conduit facility, the Quorum Facility, the ILXA Receivables Loan, the ILXA Inventory Loan and the Tempus Loans. Our securitizations represent debt that is securitized through bankruptcy-remote special purpose entities, the creditors of which have no recourse to us for principal and interest. The funds received from the obligors of our consumer loans are directly used to pay the principal and interest due on the securitization notes. Over the next twelve months, we expect that our cash flows from operations and the borrowings under the conduit facility and under the Quorum Facility will be available to cover the interest payments due under the senior secured notes and fund our operating expenses and other obligations. The 2008 conduit facility was paid in full on April 27, 2011 with the proceeds of the DROT 2011 Notes; however, between April 27, 2011 and September 30, 2011, we borrowed approximately $14.3 million, net of repayments, under the 2008 conduit facility. The 2008 conduit facility is scheduled to mature on April 26, 2013.

 

72


Table of Contents

Our future capital requirements will depend on many factors, including the growth of our consumer financing activities and the expansion of our hospitality management operations. Our ability to secure short-term and long-term financing in the future will depend on a variety of factors, including our future profitability, the performance of our consumer loan receivable portfolio, our relative levels of debt and equity and the overall condition of the credit and securitization markets. If we are unable to secure short-term and long-term financing in the future, our liquidity and cash flows would be materially and adversely affected and we may be required to curtail our sales and marketing operations.

Deferred Taxes. At December 31, 2010, we had available approximately $223.8 million of unused federal net operating loss carry-forwards, $204.6 million of unused state net operating loss carry-forwards, and $100.4 million of foreign net operating loss carry-forwards with expiration dates from 2011 through 2029 (except for certain foreign net operating loss carry-forwards that do not expire) that may be applied against future taxable income, subject to certain limitations.

Even with the limitation, $69.2 million of federal net operating loss is currently available for unlimited use and an additional $13.5 million becomes available each year. Similarly, use of the state net operating loss carry forward is also available. Although our future cash tax liabilities cannot be entirely eliminated through the application of these net operating loss carry-forwards due to a 90% statutorily imposed limitation on offsetting U.S. alternative minimum taxable income with net operating loss carry-forwards, we believe that the availability of these net operating loss carry-forwards to offset future taxable income will result in minimal cash tax obligations in future periods.

Off-Balance Sheet Financing Arrangements. As of September 30, 2011, we did not have any off-balance sheet financing arrangements.

Contractual Obligations. Certain contractual obligations are summarized in the Prospectus. As of September 30, 2011, there had been no material changes outside the ordinary course of our business in contractual obligations since December 31, 2010.

New Accounting Pronouncements

In January 2010, the FASB issued Accounting Standards Update (“ASU”) No. 2010-06, Improving Disclosures about Fair Value Measurements, which, among other things, amends ASC 820, “Fair Value Measurements and Disclosures” to require entities to separately present purchases, sales, issuances and settlements in their reconciliation of Level 3 fair value measurements (i.e., to present such items on a gross basis rather than on a net basis), and which clarifies existing disclosure requirements provided by ASC 820 regarding the level of disaggregation and the inputs and valuation techniques used to measure fair value for measurements that fall within either Level 2 or Level 3 of the fair value hierarchy. ASU No. 2010-06 is effective for interim and annual periods beginning after December 15, 2009, except for disclosures about purchases, sales, issuances and settlements in the roll forward of activity in Level 3 fair value measurements which are effective for fiscal years beginning after December 15, 2010 and for interim periods within those fiscal years. We adopted ASU No. 2010-06 on January 1, 2011. The adoption did not have a material impact on our condensed consolidated financial statements or our disclosures, as we did not have any transfers between Level 1 and Level 2 fair value measurements and did not have material classes of assets and liabilities that required additional disclosure.

In December 2010, the FASB issued ASU 2010-28, Intangibles—Goodwill and Other (Topic 350): When to Perform Step 2 of the Goodwill Impairment Test for Reporting Units with Zero or Negative Carrying Amounts. The amendments in this update modify Step 1 of the goodwill impairment test for reporting units with zero or negative carrying amounts. For those reporting units, an entity is required to perform Step 2 of the goodwill impairment test if it is more likely than not that a goodwill impairment exists. For SEC reporting companies, the amendments in this update are effective for fiscal years, and interim periods within those years, beginning after December 15, 2010. Early adoption is not permitted. We adopted ASU 2010-28 as of January 1, 2011, which did not have a material impact on our financial statements.

 

73


Table of Contents

In December 2010, the FASB issued ASU 2010-29, Business Combinations (Topic 805): Disclosure of Supplementary Pro Forma Information for Business Combinations. The amendments in this update specify that if a SEC reporting company presents comparative financial statements, the entity should disclose revenue and earnings of the combined entity as though the business combination(s) that occurred during the current year had occurred as of the beginning of the comparable prior annual reporting period only. The amendments also expand the supplemental pro forma disclosures to include a description of the nature and amount of material, nonrecurring pro forma adjustments directly attributable to the business combination included in the reported pro forma revenue and earnings. The amendments affect any SEC reporting company as defined by Topic 805 that enters into business combinations that are material on an individual or aggregate basis. The amendments in this update are effective prospectively for business combinations for which the acquisition date is on or after the beginning of the first annual reporting period beginning on or after December 15, 2010. Early adoption is permitted. We adopted ASU 2010-29 for all business combinations for which the acquisition date is on or after January 1, 2011. The adoption of this update primarily resulted in increased disclosures.

In April 2011, the FASB issued ASU 2011-02, Receivables (Topic 310): A Creditor’s Determination of Whether a Restructuring Is a Troubled Debt Restructuring. The amendments in this update provide additional guidance to assist creditors in determining whether a restructuring of a receivable meets the criteria to be considered a troubled debt restructuring. The amendments in this update are effective for the first interim or annual period beginning on or after June 15, 2011, and should be applied retrospectively to the beginning of the annual period of adoption. As a result of applying these amendments, an entity may identify receivables that are newly considered impaired. For purposes of measuring impairment of those receivables, an entity should apply the amendments prospectively for the first interim or annual period beginning on or after June 15, 2011. We adopted ASU 2011-02 as of our interim period ended June 30, 2011. The adoption of this update did not have a material impact on our financial statements.

In May 2011, the FASB issued ASU 2011-04, Fair Value Measurement (Topic 820): Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and IFRSs. The amendments in this update generally represent clarifications of Topic 820, but also include some instances where a particular principle or requirement for measuring fair value or disclosing information about fair value measurements has changed. This update results in common principles and requirements for measuring fair value and for disclosing information about fair value measurements in accordance with U.S. GAAP and IFRSs. The amendments in this update are to be applied prospectively. For SEC reporting companies, the amendments are effective during interim and annual periods beginning after December 15, 2011. We will adopt ASU 2011-04 as of our interim period ending March 31, 2012. We believe that the adoption of this update will not have a material impact on our financial statements.

In June 2011, the FASB issued ASU 2011-05, Comprehensive Income (Topic 220): Presentation of Comprehensive Income. Under the amendments to Topic 220, Comprehensive Income, in this update, an entity has the option to present the total of comprehensive income, the components of net income, and the components of other comprehensive income either in a single continuous statement of comprehensive income or in two separate but consecutive statements. In both choices, an entity is required to present each component of net income along with total net income, each component of other comprehensive income along with a total for other comprehensive income, and a total amount for comprehensive income. This update eliminates the option to present the components of other comprehensive income as part of the statement of changes in member capital. The amendments in this update do not change the items that must be reported in other comprehensive income or when an item of other comprehensive income must be reclassified to net income. The amendments in this update should be applied retrospectively. For SEC reporting companies, the amendments are effective for fiscal years, and interim periods within those years, beginning after December 15, 2011. Early adoption is permitted, because compliance with the amendments is already permitted. The amendments do not require any transition disclosures. We will adopt ASU 2011-05 as of our interim period ending March 31, 2012. We believe that the adoption of this update will primarily result in increased disclosures.

In September 2011, the FASB issued ASU 2011-08, Intangibles—Goodwill and Other (Topic 350): Testing Goodwill for Impairment. The objective of this update is to simplify how entities test goodwill for impairment. The amendments in the update permit an entity to first assess qualitative factors to determine whether it is more likely than not that the fair value of a reporting unit is less than its carrying amount as a basis for determining whether it is necessary to perform the two-step goodwill impairment test described in Topic 350. The more-likely-than-not threshold is defined as having a likelihood of more than 50 percent. The amendments are effective for annual and interim goodwill impairment tests performed for fiscal years beginning after December 15, 2011. We will adopt ASU 2011-08 as of January 1, 2012. We believe that the adoption of this update will not have a material impact on our financial statements.

 

74


Table of Contents
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Inflation. Inflation and changing prices have not had a material impact on our revenues, income (loss) from operations, and net income (loss) during any of our three most recent fiscal years. However, to the extent inflationary trends affect short-term interest rates, a portion of our debt service costs may be affected as well as the rates we charge on our consumer loans.

Interest Rate Risk. Historically, we have been exposed to interest rate risk through our variable rate indebtedness, including our first and second lien facilities, lines of credit and conduit facilities discussed above, which we have attempted to manage through the use of derivative financial instruments. For example, we are required to hedge 90% of the outstanding note balance under our 2008 conduit facility. We do not hold or issue financial instruments for trading purposes and do not enter into derivative transactions that would be considered speculative positions. Our derivative financial instruments currently consist of an interest rate swap and two caps, which do not qualify for hedge accounting. Interest differentials resulting from these agreements are recorded on an accrual basis as an adjustment to interest expense. To manage exposure to counterparty credit risk in interest rate swaps and caps, we enter into agreements with highly rated institutions that can be expected to fully perform under the terms of such agreements.

To the extent we assume variable rate indebtedness in the future, any increase in interest rates beyond amounts covered under any corresponding derivative financial instruments, particularly if sustained, could have an adverse effect on our results of operations, cash flows and financial position. We cannot assure you that any hedging transactions we enter into will adequately mitigate the adverse effects of interest rate increases or that counterparties under these agreements will fulfill their obligations.

Additionally, we derive net interest income from our consumer financing activities to the extent the interest rates we charge our customers who finance their purchases of VOIs exceed the variable interest rates we pay to our lenders. Because our mortgages and contracts receivable bear interest at fixed rates, future increases in interest rates may result in a decline in our net interest income.

Foreign Currency Translation Risk. We receive a portion of our revenues from our European resorts, the operations of which are primarily conducted in Euros and British pounds. Because our financial results are reported in U.S. dollars, fluctuations in the value of the Euro and British pound against the U.S. dollar have had and will continue to have an effect, which may be significant, on our reported financial results. A decline in the value of the Euro or British pound against the U.S. dollar will tend to reduce our reported revenues and expenses, while an increase in the value of the Euro or British pound against the U.S. dollar will tend to increase our reported revenues and expenses. Variations in exchange rates can significantly affect the comparability of our financial results between financial periods.

 

ITEM 4. CONTROLS AND PROCEDURES

Disclosure Controls and Procedures. We carried out an evaluation, under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer, of the effectiveness of our disclosure controls and procedures (as such term is defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended (the “Exchange Act”)) as of the end of the period covered by this report. Based on such evaluation, our Chief Executive Officer and Chief Financial Officer have concluded that, as of the end of such period, our disclosure controls and procedures were effective and provided reasonable assurance that information required to be disclosed by us in the reports that we file or submit under the Exchange Act is recorded, processed, summarized and reported accurately and within the time frames specified in the SEC’s rules and forms and accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, as appropriate to allow timely decisions regarding required disclosure.

There were no changes in our internal controls over financial reporting (as such term is defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) during the quarter ended September 30, 2011 that materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

 

75


Table of Contents

PART II – OTHER INFORMATION

 

ITEM 1. LEGAL PROCEEDINGS

From time to time, the Company or its subsidiaries is subject to certain legal proceedings and claims in the ordinary course of business, including claims or proceedings relating to the Company’s Vacation Interest sales and consumer finance business. In addition, the Company is also currently subject to litigation and claims regarding employment, tort, contract, construction, sales taxes and commission disputes, among others. The Company believes that none of these actions will have a material adverse effect on its consolidated financial condition or results of operations. See Note 16—Commitments and Contingencies for further detail on certain legal proceedings.

 

ITEM 1A. RISK FACTORS

There have been no material changes from risk factors previously disclosed in “Risk Factors” in our prospectus filed with the SEC pursuant to Rule 424(b) of the Securities Act of 1933 on July 8, 2011.

 

ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS.

None.

 

ITEM 3. DEFAULTS UPON SENIOR SECURITIES.

None

 

ITEM 4. REMOVED AND RESERVED.

 

ITEM 5. OTHER INFORMATION.

None.

 

ITEM 6. EXHIBITS.

 

Exhibit

  

Description

31.1    Certification of Chief Executive Officer pursuant to Rule 13a-14(a) under the Securities Exchange Act of 1934, as amended
31.2    Certification of Chief Financial Officer pursuant to Rule 13a-14(a) under the Securities Exchange Act of 1934, as amended
32.1    Certification of Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
32.2    Certification of Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
101*    The following materials from Diamond Resorts Corporation’s Quarterly Report on Form 10-Q for the quarter ended September 30, 2011, formatted in XBRL (Extensible Business Reporting Language): (i) the Condensed Consolidated Balance Sheets, (ii) the Condensed Consolidated Statements of Operations, (iii) the Condensed Consolidated Statements of Member Capital (Deficit) and Comprehensive Income (Loss), (iv) the Condensed Consolidated Statements of Cash Flows, and (v) Notes to the Condensed Consolidated Financial Statements, furnished herewith.

 

* IN ACCORDANCE WITH THE TEMPORARY HARDSHIP EXEMPTION PROVIDED BY RULE 201 OF REGULATION S-T, THE DATE BY WHICH THE INTERACTIVE DATA FILE IS REQUIRED TO BE SUBMITTED HAS BEEN EXTENDED BY SIX BUSINESS DAYS

 

76


Table of Contents

SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

 

    DIAMOND RESORTS CORPORATION
Date:   November 14, 2011     By:   /S/ STEPHEN J. CLOOBECK
       

Stephen J. Cloobeck

Chairman of the Board and Chief Executive Officer

(Principal Executive Officer)

Date:   November 14, 2011     By:   /S/ DAVID F. PALMER
       

David F. Palmer

President and Chief Financial Officer

(Principal Financial Officer)

INDEX TO EXHIBITS

 

Exhibit

  

Description

31.1    Certification of Chief Executive Officer pursuant to Rule 13a-14(a) under the Securities Exchange Act of 1934, as amended
31.2    Certification of Chief Financial Officer pursuant to Rule 13a-14(a) under the Securities Exchange Act of 1934, as amended
32.1    Certification of Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
32.2    Certification of Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
101*    The following materials from Diamond Resorts Corporation’s Quarterly Report on Form 10-Q for the quarter ended September 30, 2011, formatted in XBRL (Extensible Business Reporting Language): (i) the Condensed Consolidated Balance Sheets, (ii) the Condensed Consolidated Statements of Operations, (iii) the Condensed Consolidated Statements of Member Capital (Deficit) and Comprehensive Income (Loss), (iv) the Condensed Consolidated Statements of Cash Flows, and (v) Notes to the Condensed Consolidated Financial Statements, furnished herewith.

 

* IN ACCORDANCE WITH THE TEMPORARY HARDSHIP EXEMPTION PROVIDED BY RULE 201 OF REGULATION S-T, THE DATE BY WHICH THE INTERACTIVE DATA FILE IS REQUIRED TO BE SUBMITTED HAS BEEN EXTENDED BY SIX BUSINESS DAYS

 

77