Drive Shack Inc.
Q1 2016 Earnings Call Transcript

Published: 10 May 2016

[Operator:]

Good morning. My name is Kyle, and I will be your conference operator today. At this time, I would like to welcome everyone to the Newcastle Fourth Quarter 2016 Earnings Conference Call. All lines have been placed on mute to prevent any background noise. After the speakers’ remarks there will be a question-and-answer session. [Operator Instructions] Thank you. [Ms. Yoon] you may begin your conference.

[Unidentified Company Representative:]

Thank you, Kyle and good morning, everyone. I'd like to welcome you today to Newcastle's first quarter 2016 earnings call. Joining me here today are Wes Edens, the Chairman of our Board of Directors; Ken Riis, our Chief Executive Officer; Justine Cheng, our Chief Financial Officer; Eun Nam, our Chief Accounting Officer and Sarah Watterson, Managing Director, who Heads the [indiscernible] business. We've posted an Investor Presentation on our website, which we encourage you to download if you have not already done so. Before I turn the call over to Wes, I'd like to point out that certain statements made today will be forward-looking statements. The statements by their nature are uncertain and may differ materially from actual results. We encourage you to review the disclaimers in our press release and investor presentation regarding forward-looking statements and to review the risk factors contained in our annual and quarterly reports filed with the SEC. And now, I'd like to turn the call over to Wes.

[Wes Edens:]

Great. Thanks, and welcome, everyone. Just a couple of opening remarks before I turn over to Ken and Sarah. The task of simplifying the business and transforming it from the hybrid where we have a debt business, the legacy business and the golf business and our new growth initiatives have been the golf business continues at a pretty rapid pace. The first quarter, we deconsolidated our last material CDO, CLO that was opened in a large one-time gain and greatly simplify the balance sheet. So the earnings for the quarter $3 million license per share. AFFO of $81 million, a $1.21, so a large one-time gain and as important or more importantly, it greatly does simplify the balance sheet. So it's all now very, very clear and we view indeed. Earnings were a little bit down year-over-year in the Golf business really just due to seasonality. We're still quite positive and optimistic about what the year holds for us there and Sarah will talk about that for a second. On Page 3 we have the highlights for the quarter. Debt business generated $11 million net of investment income that represents about a $16 million return on our estimated $275 million of invested equity. In March, we monetized $11 million of CDO Class IMM-2 at $0.93 at par, so $10 million in net proceeds. In April we sold a mezzanine loan at par, another $8 million in proceeds. So again we continue to deconsolidate and simplify the balance sheet. Our expectation is that the debt business will largely be gone by the end of the year. There is still a lot of work to do here and its obviously still only May, but we’re optimistic about that. Performance in the Golf business was actually quite solid. We had weather challenges at El Niño. Sarah will talk about that in the middle in just a few minutes, but the core business is -- we expect to have a good year. And then our business initiative where we're spending a lot of our time on the growth side, but again I'll leave it to Sarah to talk about that, but we're quite optimistic about what the year is going to hold for us there. So with that let me turn to over Ken. Ken?

[Ken Riis:]

Thanks Wes. I’m on Page 4 of the presentations. The real estate debt business continues to perform very well generating a mid teens return on invested equity and along with that, we continue to look for ways to optimize recoveries and harvest the capital invested in this business. In the quarter, we sold our remaining economic equity interest in CDO 6, resulting in the deconsolidation of its assets and liabilities from our balance sheet. As Wes mentioned, the deconsolidation generated $82 million gain and simplified our balance sheet by eliminating $81 million of negative equities. Year-to-date our sales activity resulted in $80 million of principle recovery and since the first quarter 2015, we have reduced the debt portfolio by approximately $400 million recovering a $110 million. Today we own $640 million of assets, $277 million of non-agency loans and securities unencumbered on our balance sheet and $360 million of agency securities. So going forward, we expect to recover the $230 million to $280 million from this portfolio and target to do that over the next 12 months to 24 months. So now, I’ll hand it over to Sarah to talk about Golf business.

[Sarah Watterson:]

Thanks Ken. I’m on Page 5 everyone. So the 85 courses across 13 states our Golf portfolio is one of the largest operators of golf properties in the U.S. Our business is diversified across public and private courses as well as only leased and managed courses. Furthermore our portfolio is optimally situated with 75% of these courses in top 20 MSAs. This will come into play later. We ended the first quarter with 15,000 private club members of which 9,000 were full golf members. We also have 26,000 players club members. Over the last year, Management focused diligently on growing these very sticky revenue streams. Since 1Q 2015, we added 325 full golf members each paying $6,000 of average annual deals and added 18,000 players club members each paying about $400 of average annual dues. Since yearend alone, we added 75 full golf members and 7,000 players club members. Our constant focus on growing these and other revenue streams match with very well situated portfolio and continued expense management will propel the growth of this business. Turning to Page 6, while the first quarter is our least significant quarter of the year we achieved solid results despite challenging weather conditions on the West Coast and in Florida as a result of El Niño. We earned $2.4 million of adjusted EBITDA, which was in line with what we expected in our budget. It was really Management's focus on the growth revenue stream I mentioned on a previous page to help prepare the business for these adverse weather conditions and mitigated the effect of El Niño. In this quarter alone, the growth achieved in those areas resulted in the $2 million revenue boost versus 1Q 2015. So with El Niño behind us and many programs in place take advantage of the next two peak quarters, we are exactly where we need to be to deliver $32 million to $36 million of adjusted EBITDA in 2016. Moving to Page 7 on the innovative golf side, we continue to be very excited about the prospect of Drive Shack and working along with TaylorMade to develop Drive Shack. For those of you who might be unfamiliar with the business, Drive Shack is the golf-like experience that combines food and beverage with a technologically enhanced driving range game. On the bottom left hand side, we show an example using a typical golf range versus Drive Shack range. A typical all season golf range might get 25,000 to 100,000 golfers per year who spent on average $10 or less per visit. However when food, beverage and entertainment are introduced, we believe that universe of visitors grows to 375,000 plus, includes top and renowned golfers and the revenue per visit grows to $40 to $50 plus. It’s for this reason and others that we believe these facilities compliment our traditional course very nicely. We continue to aim to have three to five sites under development by yearend and hope to scale the business rapidly once we’ve established our proof of concept. Each site is expected to cost approximately $15 million to $20 million to build and we hope to apply financing near all our portion of the sites. With each site expected to earn about $5 million of annual site EBITDA, the unlevered return could be north of 25%. I think it’s also important to look at the future of the traditional golf business plus the innovative golf business together. As I mentioned previously, our traditional golf business is expected to grow 10% this year, at the midpoint of our $34 million adjusted EBITDA range. Beyond 2016 we believe this business has room to grow to achieve 95% stabilized private occupancy from our current 82% today and increased round in green fees on the public side. This is the reason we are excited about our golf business. We have an existing business that can grow at 10% per year coupled with a Drive Shack opportunity that can fuel outside growth. If we're able to build 7 to 10 Drive Shack sites and they achieve our targeted results, we would have in essence spent a modest amount of capital that double the earnings or existing golf business today. With that, we look forward to keeping you updated on this progress that we're making and I’ll turn it back to Wes for conclusion.

[Wes Edens:]

Great, well good side quarter, good start to the year for us. We’re excited about the prospectus for the golf business and our growth initiatives there and we're also excited to put to rest the debt business, which has been a very productive and slow grind for us to get back to recovery, but we feel very, very good about it. So with that, we'll pause now and ask -- open up for questions. Operator?

[Operator:]

[Operator Instructions] Your first question comes from the line of Matthew Howlett from UBS. Your line is open.

[Matthew Howlett:]

Just on the seasonality golf, either the $0.05, can you just -- last year I think you were $0.12 core. I know there was some heavier rainfall in California, but you see seasonality but it was lower year-over-year. Can you just it's -- what do you expect on a run rate basis? I said because obviously people are looking at the $0.12 dividend.

[Sarah Watterson:]

Yeah, I think quarter-over-quarter the seasonality in the Golf business was really driven by just weather. I think if you look year-over-year, the $0.12 to either $0.05 today was really driven by the shift in the business from the CDOs to the golf business where we bought back a lot of the debt in the golf business. As we mentioned on one of the earlier page, we’re working to refinance this golf portfolio and so once we close that financing we'll expect to redeploy those proceeds and hopefully that should grow back to that $0.12 plus number.

[Matthew Howlett:]

Okay. Got you. So of course you get the natural pick up in the EBITDA you kept your EBITDA guidance, you get the natural pick-up in the second and third quarter that drives the $32 million to $36 million.

[Sarah Watterson:]

And we took into effect that we knew there was going to be an El Niño and so we factored that into our first quarter budget. So we're really on track to meet our numbers for the year in golf.

[Matthew Howlett:]

Got you and then I want to drill down on the financing options. You talked about the 120 to 140, what are the uses of those proceeds given it’s going to take a while for these Drive Shack to get in and I’ll get back to the Drive Shack in a second, but what are the exact usage of those prices, either buy more courses, you're going to buy back stock?

[Wes Edens:]

Yeah, I think the answer is yes, there is a lot of things we talked to the Board about. So I think when the financing closes we'll have surplus liquidity. We are looking at a number of things on the core golf business that wanted to take that was interesting. We obviously could buy back shares just through simple dividend. So, we think we'll be more than adequately capitalized given what our growth plans. So that gives a lot of flexibility and it’s too early to make determination of what to do, but we feel good about -- what the position we've put us in and know to figure it out at the Board in the second quarter.

[Matthew Howlett:]

Okay. You said that, that, Wes, you said by June you’re going to get that leverage on and I’m assuming you’re going to pay down the $70 million of short term debt and you'll free up $50 million of cash on top of the other cash you have to do something with.

[Wes Edens:]

That’s exactly right and so the financing is not closed until its close. We feel pretty good about at this point and very late stages. So we’re hoping that they get closed here in the next few weeks.

[Matthew Howlett:]

Got it. And then just the last thing about Drive Shack, sorry if I missed this, but when do you -- when can we start modeling that in terms of taking in and so having some impact of the P&L and then you're going to put financing on the Top Golf to -- what’s the capital structure look like on the building of these sites.

[Wes Edens:]

I think the first couple we probably will capitalize entirely with equity. I think that, getting the first one out the ground is the hardest one. We've spend a tremendous amount of time and effort to get into a place where we feel good about what the prospects for us now. As Sarah said, the goal is to have three to five building permits in hand by the end of the year that would put us sometime in the second half of next year where we actually have an opening and actually revenues from it but so it will be probably a little over a year before they would be tangible or economics from it coming out. But we'll have a lot of progress between now and then on the building side. There is a number of different sites. We think that there are 100s of potential sites in the U.S. We think there is a big international component to this business. It all starts from getting first couple up and running and that’s what we're very focused on right now, but by the end of the year I am quite confident we'll have building permits in hand and we'll be constructing that in a couple of days, so.

[Matthew Howlett:]

Yeah, and so some of them are going to go on the courses and your courses some will go outside of that and then Wes, we're not all familiar Top Golf. We know that's the biggest player out there. Is this a complement to it? Can you go where they are, Top Golf is private?

[Wes Edens:]

I think that, certain of the market look it's -- there is lots of movie theaters in different cities. It's not like one movie theater determines that we can't put another theater there and so I think that there is certainly is room in these markets for a number of entrances. That said, Top Golf is clearly the market leader in this right now. They've been doing this for long time but they've still got a couple of dozen sites. So relative to the United States and relative to the world I think they're are pretty underpenetrated right now. So we feel like there is a lot of opportunities. The first couple of sites we got we're excited about, we do think that the Golf Course business is highly complementary to us. It gives us a great deal of brand awareness. We go into these markets given the size of our golf business and I think a number of golf courses are very good candidates to be conversion candidates. So, we'll provide more detail obviously as we have, but I think that even by the summer we'll have some pretty good direction in terms of where the first couple of these are and we can provide you guys some model information about what we think it should mean to us. But I think as Sarah said, just by building a handful of these things, we think we can relatively double the earnings of the Golf business. So it turns golf into a good steady business for us and this is something that we could grow actually quite rapidly. That’s the goal.

[Matthew Howlett:]

Yeah, and when you double, you talk -- is it the 3 to 5 or the 5 to 10 on the additional to…

[Wes Edens:]

5 to 10 should be enough to kind double the EBITDA of the business which is -- that’s material obviously.

[Matthew Howlett:]

And this is going to be funded with internal capital?

[Wes Edens:]

It is and we have the capital to deal it with this transformation of the debt business. We've been planning for this obviously, but it's good to see it come to pass, but I think we're going to continue to get liquidity on the debt portfolio that will give us actually a surplus capital. So, back to your original question that gives us some good food for thought as a board to try and figure out what to do with the capital and it depends on it actually throwing whatever else, but it's a good position to be in.

[Matthew Howlett:]

Yeah, that’s great, perfect. Thanks Wes, I appreciate it.

[Wes Edens:]

You bet.

[Operator:]

Thank you. [Operator Instructions] Your next question comes from Douglas Harter from Credit Suisse. Your line is open.

[Josh Bolton:]

Hey guys this is actual Josh Bolton filling in for Doug. Just one quick question about monetizing the debt portfolio, anything you guys are seeing today, that you could update us about some factors you're looking at, that could bring you possibly to the front or to the early part or the latter part of that 12 to 24 month range? Thanks.

[Wes Edens:]

Well the portfolio is generating pretty good return for us right now. But the loans that we have, the [19 months] we have in our balance sheet are fairly chunky and what we're doing there is we will strategically sell a couple of them, but we could also, we expect them to pay down over time also. So they're little bit less liquid then the portfolio we owned a year ago, but we do think that they're unencumbered on our balance sheet. So we have a lot of flexibility with it. We can maybe finance some of it or experience some pay down and sell along the way. So, we have a lot of flexibility with the portfolio and the bulk of our recoveries coming from the non agency side of the portfolio and that’s what we look to all the time in terms of what's the best way to monetize it on a timely basis and use the capital for reinvestment.

[Josh Bolton:]

Great. Thanks for those details.

[Wes Edens:]

Yeah.

[Operator:]

There are no further questions at this time.

[Ken Riis:]

Terrific. Great. Well thanks everyone for dialing in. Look forward to talking to you next quarter. Thank you.

[Operator:]

This concludes today's conference call. You may now disconnect.