David Palmer - President and Chief Executive Officer
Alan Bentley - Executive Vice President and Chief Financial Officer
Robert LaFleur - Cantor Fitzgerald
Diamond Resorts International, Inc. (DRII) Q3 2013 Earnings Call October 31, 2013 10:00 AM ET
Welcome to the Diamond Resorts International conference call discussing the results from the quarter ended September 30, 2013. Hosting the call today from the Diamond Resorts International are Mr. David Palmer, Chief Executive Officer and President, and Mr. Alan Bentley, Executive Vice President and CFO.
This call may contain forward-looking statements as defined in the Private Securities Litigation Reform Act of 1995, including statements about the company's expected future financial performance. These statements may be affected by many factors including those listed in the company's SEC filings and in today's earnings release. As a result, the company's actual results may differ materially from the results we discuss or project today. We will not publicly update any forward-looking statements, whether as a result of new information, future events, or any other reason.
We will also discuss non-GAAP financial measures today. We reconcile each non-GAAP measure to the most comparable GAAP measure in an exhibit to today's earnings release. I will now turn the call over to David Palmer.
Thank you and good morning everybody. It's great to be speaking with all of you and discussing a record quarter. We will make some general comments and then we will turn the call over to Al Bentley to review our financial performance. We will then open up the call for your questions.
For those of you who are new to our story, we are a leading global hospitality company that completed our IPO in July. We are paid a fee to operate 92 vacation resorts with a little over half in North America and the rest in Europe. We do not own these resorts, we manage them. We also sell vacation ownership points that provide access to over 300 resorts, which includes our 92 managed resorts plus over 200 affiliate resorts that we do not manage. Currently, we have approximately 0.5 million owner families within our network.
There are three aspects of our unique business model that are important to note. It has at its core evergreen cost plus management fees that provides predictable growth. It's capital light with minimal development CapEx required and it has an inventory capture model that maximizes profitability by providing low cost inventory on a flow basis to our statistically driven sales platform, thereby helping fuel formulaic, profitable sales growth.
Now turning to our third quarter. We are very pleased with our record performance. We continue to experience stable, predictable growth from our hospitality and management services segment. We saw year-over-year growth in all drivers of this business. Growth in our same-store management revenue, the addition of management contracts through our recently completed acquisitions, and continued growth in our club operations. We were particularly excited about the performance of our vacation interest sales segment where we saw improvement in all three principal drivers. Tours, which were up 8.3%. Closing percentage which came in at 14.7%, up 0.1 percentage point year-over-year and up 1.2 percentage points sequentially over Q2. And our average transaction size which came in at $16,881, up 36% from last year and 5.4% sequentially over Q2.
It was gratifying to see both of our efficiency drivers, which is our closing percentage and average transaction size, improve during the quarter. We attribute this performance not only to our continued superior execution by our team, but to the impact of integrating hospitality programs into more aspects of our sales process. The impact of this efficiency which reflected in our advertising, sales and marketing expense. Excluding an IPO related non-cash charge, our advertising, sales and marketing expense as a percentage of vacation interest sales revenue declined 5 percentage points from the third quarter of 2012.
As this quarter's results show, we continue to enjoy the benefits of our scalable infrastructure, our ability to leverage our G&A and administrative expenses. Before I turn the call over to Al, I would like to highlight our adjusted EBITDA for the third quarter. On a consolidated basis it increased 86.5% to $60.4 million. This numbers underscores the success of our business and the advantages of our integrated hospitality platform. As you will see from our press release, we are providing guidance for our key financial metrics for the rest of 2013.
Adjusted EBITDA is an important liquidity measure and a key tool for how we evaluate and manage our business. The guidance we are providing today includes the major building blocks of this key measure of our business. I will now turn the call over to Al who will review our financial results before opening the call up to questions and answers.
Thank you, David. I want to first review the quarter ended September 30, 2013 versus the same period for 2012. I would like to start out with just some general comments in regards to the companies that are included during which periods of time during the acquisitions that we have made.
First, the consolidated financial statement includes the results of operations for our restricted and non-restricted entity and guarantor and non-guarantor subsidiaries as those terms were defined under our senior secured note indentures. Second, the results of operations, financial position and cash flows for Pacific Monarch Resorts are included in the third quarter of both periods. Third, as concurrent with our IPO on July 24, 2013, we completed the acquisition of various assets of the PMR services companies. Accordingly, the third quarter 2013 financial statements included the results, financial position and cash flows of the PMR service companies from the acquisition date.
Further, concurrent with the IPO, we acquired all of the outstanding shares of Island One. Prior to the closing Island One, we provided sales and marketing services and HOA management oversight services to Island One. Our financial statements for 2012 through July 24, 2013, include revenue and expenses relating to the Island One management oversight agreement. From July 25 through September 30, 2013, Island One has been fully consolidated into our financial statement and the marketing and HOA management oversight agreements were terminated.
In the review of P&L for 2013 versus 2012, our total revenues were $191.6 million for the three months ended September 30, 2013, which was in increase of $48.9 million or 34.3% over the same period in 2012. Revenues in our hospitality and management services segment increased to $44.2 million and increased approximately $4.8 million, which is 12.1% over the Q3 2012 amount of $39.4 million. Management and member services revenue increased as a result of increases in operating cost at the resort level which generated higher management fees revenue under our cost plus management agreement. Two is the addition of the Island One managed property and three is increased club revenue.
Our higher club revenue is primarily driven by an increase in annual club fees, a higher number of club members and higher collection rates. Our total club members were 183,110 and 154,987 as of September 30, 2013 and 2012 respectively. The total revenues in our VOI and financing segments were $147.1 million for the quarter, an increase of $44.1 million or approximately 42.8% from the comparable period of the prior year. VOI sales revenues increased $40.4 million or 48.5% from the prior year. Interest income and other revenue increased $3.7 million or 18.9% from the comparable period of the prior year. The VOI sales revenue increased as a result of one, we had increased tour flow from existing stores and the Island One acquisition.
We did close two underperforming PMR sales centers during the quarter which will enable us to increase sales efficiencies in the future. Two, our total tours increased 4,348 or 8.3% to 56,822 as a result of same store sales increased as well as the addition of Island One sales center in Q3 2013. The third item is an increase in the number of transactions closed of 695 to 8342. Our closing percentages for the month ended September 30 -- pardon me, for the three months ended September 30, 2013 was 14.7% versus 14.6% for the comparable period of the prior year.
And number four is our average transaction price has increased by approximately $4,467 or 36% in the same of the prior year to $16,881. The increase in average transaction price is primarily due to a change in our selling strategy that focuses on selling larger points packages and the success of the sales and marketing initiatives implemented in furtherance of this strategy. From a cost and expenses perspective, our advertising, sales and marketing cost as a percentage of vacation interest sales revenue were 51.4% for the three months ended September 30, 2013, compared to 55.3% for the three months ended September 30, 2012.
Our advertising, sales and marketing expense includes a charge of $2 million for stock-based compensation related to options grant made at the time of the IPO. Without this non-cash charge, advertising, sales and marketing as a percentage of gross vacation interest sales revenue would have been 50%, a decrease of 5.3 percentage points from the prior year. This decrease of such cost as a percentage of vacation interest sales revenue was primarily due to improved absorption of fixed costs through the increased sales efficiency.
Our vacation interest carry cost increased by approximately $2 million for the same period in the prior year, and our general and administrative expenses for the quarter included a non-cash charge of $35.4 million related to the IPO. Excluding this charge, general and administrative expenses would have decreased $2.3 million or 8.1% to $25.7 million for the three-months ended September 30, 2013 from $28 million for the three months ended September 30, 2012. This decrease was due to lower legal and professional expenses after the integration of the Pacific Monarch Resorts acquisition, as well as higher allocation of our expenses to the HOA and the collection. And that was partially offset by higher payable expenses to support operations acquired in connection with the Island One acquisition and the PMR service companies acquisition.
The $35.4 million non-cash charge included in general and administrative expenses, relates to stock-based compensation recognized in the three months ended September 30, 2013 due to the issuance of 6.4 million stock options by Diamond in connection with the IPO. Giving effect to this charge, general and administrative expenses as reported were $61.1 million for the three months ended September 30, 2013.
The pretax loss for the quarter included those non-cash items that netted to $49.1 million related to the IPO and related transactions. Excluding these items, the pretax income would have increased $26.4 million to $50.2 for the three months ended September 30, 2013 from a pretax loss of $11.3 million for the three months ended September 30, 2012. The non-cash items related to stock compensation of $38.5 million, an early extinguishment of debt of $13.4 million, offset in part by a gain on bargain purchase of $2.8 million, each recognized in the three months in September 30, 2013.
Giving effect to these items, the pretax loss was $34 million for the three months ended September 30, 2013. Approximately 90% of the non-cash stock compensation charge relates to pre-IPO LLC interests which were converted into full vested options at the time of the IPO. The net loss increased $14.7 million to $26.3 million for the three months ended September 30, 2013, from $11.6 million for the three months ended September 30, 2012. As a result of the increases in revenues, reduced ASM percentage, and maintaining of consistent G&A, adjusted EBITDA on a consolidated basis increased 86.9% over the prior year to $60.4 million, an increase of $28.1 million from the prior year level of $32.3 million.
Adjusted EBITDA for the company and its restricted subsidiary increased $21.8 million to $60.6 million. Now from a balance sheet and liquidity overview. Our total assets increased by approximately $239.2 million from December 31, 2012, primarily as a result of the Island One and PMR service companies acquisition. Unrestricted cash and cash equivalents as of September 30, 2013 was $29.9 million. During the quarter on a consolidated basis, we had a net decrease in cash of approximately $11 million. Further, net cash used in operations was approximately $13 million. The primary use of net cash from operations relates to the increase in our mortgages and contracts receivables portfolio of $43.8 million which will be included in future securitization transactions.
During the quarter we also generated cash from the IPO proceeds of approximately $205 million net of the issuance cost. Usage of the IPO proceeds includes a repayment of acquisition debt, including interest and fees of approximately $112.2 million. Acquisition of the PMR service company of $47.8 million, repayment of approximately $50.6 million of our senior secured notes, and the repurchase of warrants of $10.3 million.
As a result of the repayment of debt from the IPO proceeds, we anticipate net interest savings of approximately $25 million per annum. Also during the third quarter of 2013, we used $4.6 million to acquire inventory pursuant to our inventory recovery agreement and construction progress which relates primarily to development of lobby and other common areas in our Cabo Azul resort, which we acquired in the PMR acquisition. Further, we used cash of $4.3 million in capital expenditures and received $1.7 million from the proceeds from the sale of assets.
We were in compliance with all of our debt covenants at September 30, 2013. David, that completes the review of the financials and I would like to turn it back to the operator for any questions that may be asked.
(Operator Instructions) Your first question comes from the line of Joel Simkins of Credit Suisse.
It's actually Ben on for Joel. First, congratulation on the quarter. In the past you have highlighted the fact you are pushing your average transaction price in your VOI sales business, even though this may push down your closing percentage. However, it's kind of the second quarter in a row that you have put up a stronger than expected number on this front. Can you talk about what's driving this? And then I have one more this time.
Sure. Thanks, Ben. You can see the innovation around our customer journey is really taking hold in the last two quarters. As we continue to infuse hospitality experiences in the overall sales process, we are having extraordinary results. We talked in the road show about a couple of key programs. Our Diamond Dream Holiday Program, our Perfectly Cut Event program, our VIP check-in program. Those all continue to scale nicely across the enterprise. We continue to have good results around both average transaction and also driving the overall closing percentage. So we are very pleased this quarter. You can see its not typical in the industry if you will see a quarter where you have rising average transaction and rising closing percentages. So we are very pleased we are able to do that. Again, driven principally around innovation around the hospitality experience.
Got it, thank you. And then just one more. Can you give us a breakout of the new versus existing customers in the quarter in terms of sales?
We can give you the breakout of what, the sales that were contributed from Island One. But we don’t track the new versus existing customers other than to say, right now we are tracking still a little over 60% of our sales are to existing customers. A little under that to new customers. So we continue to hold that. So for the quarter, the mix was about the same. A little bit more probably internal. As I said, over the next two years really the effort will be on the new customer acquisitions. So our mix is pretty much stable this year, so that the average increase in transaction that you are seeing is really a merchandise driven increase on average transaction.
Your next question comes from the line of Bob LaFleur of Cantor Fitzgerald.
Robert LaFleur - Cantor Fitzgerald
Two questions on different topics. Al, could you just give us a little more detail on the impact of Island One and sort of where the different puts and takes were last quarter or last year versus where they are now that you have acquired the whole thing and are consolidating it?
Bob, as you know we are operating a management agreement, oversight agreement for them all throughout 2012 and 2013. That was in place until we completed the acquisition which occurred in July of 2013. That revenue then of course was reported in our management revenue for those periods up to the acquisition date. After the acquisition date, we began of course consolidating that in total. The revenue from Island One, the sales numbers were about $3 million from July 24 through the end of the period.
Robert LaFleur - Cantor Fitzgerald
Can you give us a sense of order of magnitude of what the fee contribution from that was, like on a full-year basis last year?
Yeah, for the Island One it was about $1.5 million in the 2012 numbers.
Robert LaFleur - Cantor Fitzgerald
Okay, so pretty small. And the other question I have is related to the financing business. There is a comment in the press release about sort of a higher propensity to finance in the quarter, and you have talked publicly about your desire to sort of hold that financing business steady because it facilitates the amount of people who don't have loans which facilitates your inventory recovery program. Is there any change there or was that just a quarter-to-quarter fluctuation?
We continue to, as you know, provide financing. We changed our strategy some time ago about shifting a number of people we provide financing for. We are still running at this point of time for the quarter in the high 70% of the percent financed. So a little bit higher this quarter than what we have experienced in the previous quarters.
Robert LaFleur - Cantor Fitzgerald
Do you expect to sort of continue at that level or do you expect it to revert back to the 70% on a run rate basis?
Hey, Robert, it's David. One of the things that we have been doing this quarter is I think the most -- we have said to the market we want to make sure we are prepared on an annual basis to have a securitization product available for our institutional securitization investors. So we are trying to make sure we have proper portfolio available for securitization. So right in this quarter, somewhere in the 70% plus range is something we are very comfortable right now. I don’t think you will see us push aggressively much beyond the range where we are currently. But we did step it up a little bit this quarter to make sure we had the proper portfolio for securitization.
Robert LaFleur - Cantor Fitzgerald
And the ideal size for a securitization is 200, is that the right number?
Well, it's clearly a good size. It's a proper a liquidity profile with $200 million. We have been able to be successful with securitizations around the $100 million mark. We would like to be in the market with deals that run $150 million. If we can get to $200 million that would be great. I think you would have to have a little bit better execution but we try -- our target is to bring out about $150 million per year.
(Operator Instructions) Your next question comes from the line of [Adam Joseph] of [Westin Partners].
Congratulations, guys on a great quarter. David, you had made a mention previously that there were some innovations and some experiments that, if my notes are correct, you were working on as it related to the sales side. Are there any updates on that?
Well, I think what you see in the quarter is a continued evolution of that process. We started experimentation back about two years ago by infusing a number of hospitality programs in our sales process and really dissecting the entire customer journey along that process. So we have been able -- we are probably in our third generation right now. And so the first two generations actually have been totally institutionalized and spread across the enterprise, both here and in Europe. We still are continuing to innovate and so I would say it's really more of an evolution of that process where we bring it to additional segments of our tour channel. So if you think about, we have seven or eight different principal tour segments. What we are trying to do is on a case by case basis look at what aspects of each one of those tour channels we can bring a certain degree of hospitality to in order to impact either average transaction across the business or ideally like we did in this quarter, both of those.
So it's really an evolution. I wouldn't say that there was a new radical product that was introduced in the third quarter, but we continue to develop aspects of that same program which is based around wrapping the customer in a more event driven environment or recreate a very specific memory for them. So it's really an evolution than it is anything new that came out during the quarter.
Okay. And staying on that topic, so you have reduced by two sales centers down to 47 now. How should we think about that moving forward? I mean are there going to be, like two phases of that that we can assume from a modeling standpoint as you grow you could potentially add more but in quarters where you don't grow the sales centers would stay the same? How do we think about that number, especially as it relates to the average transaction prices and the transaction closed percentages?
We are very disciplined about evaluating our tour flow. If we see that there is a particular channel that’s not working for, we will actually cut that channel out. The two sales centers that were closed were sales centers that we acquired during the PMR acquisition. We gave them a year plus to evaluate the efficacy of those channels. Those were actually different types of sales centers for us. They were called evening showcases. They don’t like that market. We had a different product that we actually substituted that was much better. The efficacy was substantially superior. So we decided to close those down in the quarter.
So I think that was more of a onetime type of an event where we actually evaluated a particular sales channel as opposed to really -- we don’t like to bring up and down sales centers on a quarterly basis. So I think that this current sales center that you see is actually a pretty stable number going forward.
Okay. And then, finally, do you break out -- you had mentioned that 60% of the transactions are to existing customers. Of that 60%, do you break out that average transaction price to those existing?
We don’t do that publicly. I think we did it during the road show presentation. We did announce obviously the average transaction to people who currently own with us is lower than those who are becoming new members and we gave that number. I will state it again publicly, the average transaction for people who own with us is more in the kind of $12,000 range, and those who don’t own with us is $18,000 or so range. So what we are seeing is across the board with, particularly with the Diamond Dream Holiday program, we were able to drive average transaction higher in both of those segments and that’s what you saw is happening during the quarter. So we are very very pleased that holiday product innovation and the market innovation led to increases in average transaction to both of those elements.
(Operator Instructions) At this time there are no further questions. I will now turn the call over to David Palmer for any additional or closing remarks.
Thank you, operator and thank you all. In closing, we are excited about what the future holds for this business. So we are confident that as we have an opportunity to discuss Diamond Resorts with many of you in the weeks and months ahead, you will share our enthusiasm. Thank you for joining us today. Have a good day and safe travels everybody. Thank you.
Thank you for participating in today's conference call. You many now disconnect.
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