Diamond Resorts International's Second Quarter Earnings Reversal Is Worrisome

Diamond Resorts International's (DRII) first-quarter 2016 earnings release headline on May 4 was titled, "Company Posts 11th Consecutive Quarter of Record Performance."

Then in June came the announcement that Apollo Global Management would acquire timeshare company Diamond Resorts. After a delay in second-quarter earnings reporting due to accounting issues at Diamond Resorts, the company's unexpected downturn in net income coming so soon after the acquisition announcement raises questions for investors as well as some law firms. 

Almost immediately after the acquisition announcement, a flurry of law firms sought to investigate whether there was a breach of fiduciary duty and other violations of state law in connection with the sale of the company.

The concern was that Apollo Global Management was shortchanging investors by underpaying for Diamond Resorts at $30.25 a share. The stock traded as high as $35 a share last year.

Management had options for 5 million shares or 6% of the company struck at $12.56 that expired in July. 

Diamond Resorts went public in July 2013 at $14 a share. By last year, the company was seeking ways to maximize shareholder value in response to pressure from major stakeholders concerned with its poor stock performance. 

Apollo Global Management paid about $2.2 billion all cash for the company at a 25% premium. The acquisition was completed on Sept. 2.

Diamond Resorts' second-quarter earnings release was delayed after the company's independent registered public accounting firm BDO USA said that the company may not have correctly applied the relative sales value inventory valuation model when preparing its consolidated financial statements for 2014 and subsequent periods.

After the correction, the change resulted in a decrease in net income of $5.6 million for 2015 and a $1.3 million decrease for the first quarter, in each case from amounts originally reported, according to the second-quarter release.

Significantly, second-quarter net income decreased $10.1 million or 28.5% to $25.5 million year over year, compared with a first quarter increase of $8.4% or 32.6% to $34.4 million, prior to the restatement.

What effect will this have on future earnings if the change in the inventory valuation model is permanent, in that it isn't a one-time charge?

Investors won't know because as a private company, Diamond Resorts will no longer be providing guidance. Surely analysts would have adjusted their price targets given such dismal performance.

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