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As filed with the Securities and Exchange Commission on May 6, 2010
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One) | ||
ý | QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 | |
For the quarterly period ended March 31, 2010 | ||
or | ||
o | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 | |
For the transition period from to |
Commission File No. 1-34062
INTERVAL LEISURE GROUP, INC.
(Exact name of registrant as specified in its charter)
Delaware (State or other jurisdiction of incorporation or organization) | 26-2590997 (I.R.S. Employer Identification No.) | |
6262 Sunset Drive, Miami, FL (Address of Registrant's principal executive offices) | 33143 (Zip Code) |
(305) 666-1861
(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 ý No o
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 o No o
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 definition of "accelerated filer," "large accelerated filer" and "smaller reporting company" in Rule 12b-2 of the Exchange Act. (Check one):
Large accelerated filer o | Accelerated filer ý | Non-accelerated filer o (Do not check if a smaller reporting company) | Smaller reporting company o |
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes o No ý
As of May 3, 2010, 56,877,276 shares of the registrant's common stock were outstanding.
Item 1. Consolidated Financial Statements
INTERVAL LEISURE GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
(In thousands, except per share data)
(Unaudited)
| Three Months Ended March 31, | |||||||
---|---|---|---|---|---|---|---|---|
| 2010 | 2009 | ||||||
Revenue | $ | 113,838 | $ | 112,926 | ||||
Cost of sales | 34,181 | 33,775 | ||||||
Gross profit | 79,657 | 79,151 | ||||||
Selling and marketing expense | 13,531 | 13,118 | ||||||
General and administrative expense | 22,290 | 21,425 | ||||||
Amortization expense of intangibles | 6,575 | 6,476 | ||||||
Depreciation expense | 2,448 | 2,163 | ||||||
Operating income | 34,813 | 35,969 | ||||||
Other income (expense): | ||||||||
Interest income | 78 | 389 | ||||||
Interest expense | (9,014 | ) | (9,465 | ) | ||||
Other income (expense), net | (734 | ) | 1,410 | |||||
Total other expense, net | (9,670 | ) | (7,666 | ) | ||||
Earnings before income taxes and noncontrolling interest | 25,143 | 28,303 | ||||||
Income tax provision | (9,730 | ) | (11,467 | ) | ||||
Net income | 15,413 | 16,836 | ||||||
Net income attributable to noncontrolling interest | — | (2 | ) | |||||
Net income attributable to common stockholders | $ | 15,413 | $ | 16,834 | ||||
Earnings per share attributable to common stockholders: | ||||||||
Basic | $ | 0.27 | $ | 0.30 | ||||
Diluted | $ | 0.27 | $ | 0.30 | ||||
Weighted average number of common stock outstanding: | ||||||||
Basic | 56,627 | 56,331 | ||||||
Diluted | 57,436 | 56,571 |
The accompanying Notes to Consolidated Financial Statements are an integral part of these statements.
2
INTERVAL LEISURE GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(In thousands, except share and per share data)
| March 31, 2010 | December 31, 2009 | ||||||
---|---|---|---|---|---|---|---|---|
| (Unaudited) | | ||||||
ASSETS | ||||||||
Cash and cash equivalents | $ | 177,085 | $ | 160,014 | ||||
Restricted cash and cash equivalents | 4,641 | 5,243 | ||||||
Accounts receivable, net of allowance of $230 and $431, respectively | 37,370 | 24,219 | ||||||
Deferred income taxes | 20,144 | 20,052 | ||||||
Deferred membership costs | 14,707 | 14,433 | ||||||
Prepaid income taxes | — | 5,221 | ||||||
Prepaid expenses and other current assets | 21,529 | 17,566 | ||||||
Total current assets | 275,476 | 246,748 | ||||||
Property and equipment, net | 45,535 | 44,400 | ||||||
Goodwill | 479,867 | 479,867 | ||||||
Intangible assets, net | 132,749 | 139,324 | ||||||
Deferred membership costs | 21,184 | 21,411 | ||||||
Deferred income taxes | 5,820 | 6,162 | ||||||
Other non-current assets | 27,277 | 20,669 | ||||||
TOTAL ASSETS | $ | 987,908 | $ | 958,581 | ||||
LIABILITIES AND EQUITY | ||||||||
LIABILITIES: | ||||||||
Accounts payable, trade | $ | 15,162 | $ | 11,672 | ||||
Deferred revenue | 108,319 | 96,541 | ||||||
Income taxes payable | 2,592 | — | ||||||
Interest payable | 2,623 | 9,748 | ||||||
Accrued compensation and benefits | 12,126 | 15,283 | ||||||
Member deposits | 9,944 | 9,521 | ||||||
Accrued expenses and other current liabilities | 36,044 | 31,522 | ||||||
Total current liabilities | 186,810 | 174,287 | ||||||
Long-term debt, net of current portion | 385,840 | 395,290 | ||||||
Other long-term liabilities | 11,133 | 1,746 | ||||||
Deferred revenue | 134,748 | 134,236 | ||||||
Deferred income taxes | 76,735 | 76,224 | ||||||
Total liabilities | 795,266 | 781,783 | ||||||
Redeemable noncontrolling interest | 422 | 422 | ||||||
Commitments and contingencies | ||||||||
STOCKHOLDERS' EQUITY: | ||||||||
Preferred stock $.01 par value; authorized 25,000,000 shares, of which 100,000 shares are designated Series A Junior Participating Preferred Stock, none issued and outstanding | — | — | ||||||
Common stock $.01 par value; authorized 300,000,000 shares, 56,870,037 and 56,543,016 issued and outstanding shares, respectively | 569 | 565 | ||||||
Additional paid-in capital | 156,993 | 156,260 | ||||||
Retained earnings | 45,200 | 29,787 | ||||||
Accumulated other comprehensive loss | (10,542 | ) | (10,236 | ) | ||||
Total stockholders' equity | 192,220 | 176,376 | ||||||
TOTAL LIABILITIES AND EQUITY | $ | 987,908 | $ | 958,581 | ||||
The accompanying Notes to Consolidated Financial Statements are an integral part of these statements.
3
INTERVAL LEISURE GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY
(Unaudited)
| | Common Stock | | | Accumulated Other Comprehensive Loss | |||||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| Total Stockholders' Equity | Additional Paid-in Capital | Retained Earnings | |||||||||||||||||
| Amount | Shares | ||||||||||||||||||
| (In thousands, except share data) | |||||||||||||||||||
Balance as of December 31, 2009 | $ | 176,376 | $ | 565 | 56,543,016 | $ | 156,260 | $ | 29,787 | $ | (10,236 | ) | ||||||||
Comprehensive income: | ||||||||||||||||||||
Net income attributable to common stockholders | 15,413 | — | — | — | 15,413 | — | ||||||||||||||
Foreign currency translation losses | (306 | ) | — | — | — | — | (306 | ) | ||||||||||||
Comprehensive income | 15,107 | |||||||||||||||||||
Non-cash compensation expense | 2,494 | — | — | 2,494 | — | — | ||||||||||||||
Issuance of common stock upon exercise of stock options | 173 | — | 23,113 | 173 | — | — | ||||||||||||||
Release of common stock in escrow upon exercise of IAC warrants | 249 | — | — | 249 | — | — | ||||||||||||||
Issuance of common stock upon vesting of restricted stock units, net of withholding taxes | (2,155 | ) | 4 | 303,908 | (2,159 | ) | — | — | ||||||||||||
Deferred stock compensation expense | (24 | ) | — | — | (24 | ) | — | — | ||||||||||||
Balance as of March 31, 2010 | $ | 192,220 | $ | 569 | 56,870,037 | $ | 156,993 | $ | 45,200 | $ | (10,542 | ) | ||||||||
The accompanying Notes to Consolidated Financial Statements are an integral part of this statement.
4
INTERVAL LEISURE GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
| Three Months Ended March 31, | |||||||
---|---|---|---|---|---|---|---|---|
| 2010 | 2009 | ||||||
| (In thousands) | |||||||
Cash flows from operating activities: | ||||||||
Net income | $ | 15,413 | $ | 16,836 | ||||
Adjustments to reconcile net income to net cash provided by operating activities: | ||||||||
Amortization expense of intangibles | 6,575 | 6,476 | ||||||
Amortization of debt issuance costs | 666 | 697 | ||||||
Depreciation expense | 2,448 | 2,163 | ||||||
Accretion of original issue discount | 550 | 484 | ||||||
Non-cash compensation expense | 2,494 | 1,945 | ||||||
Deferred income taxes | 448 | 9,480 | ||||||
Excess tax benefits from stock-based awards | (921 | ) | — | |||||
Changes in assets and liabilities: | ||||||||
Accounts receivable | (13,319 | ) | (14,816 | ) | ||||
Prepaid expenses and other current assets | (676 | ) | 187 | |||||
Accounts payable and other current liabilities | (4,883 | ) | (4,977 | ) | ||||
Income taxes payable | 7,954 | (15,803 | ) | |||||
Deferred revenue | 13,662 | 13,650 | ||||||
Other, net | 2,125 | (2,667 | ) | |||||
Net cash provided by operating activities | 32,536 | 13,655 | ||||||
Cash flows from investing activities: | ||||||||
Changes in restricted cash | 204 | — | ||||||
Capital expenditures | (3,616 | ) | (3,669 | ) | ||||
Net cash used in investing activities | (3,412 | ) | (3,669 | ) | ||||
Cash flows from financing activities: | ||||||||
Principal payments on term loan | (10,000 | ) | (7,500 | ) | ||||
Proceeds from the exercise of stock options | 173 | 5 | ||||||
Proceeds from the exercise of warrants | 249 | — | ||||||
Vesting of restricted stock units, net of withholding taxes | (1,723 | ) | (79 | ) | ||||
Excess tax benefits from stock-based awards | 921 | — | ||||||
Release of deferred restricted stock units, net of withholding taxes | — | (431 | ) | |||||
Net cash used in financing activities | (10,380 | ) | (8,005 | ) | ||||
Effect of exchange rate changes on cash and cash equivalents | (1,673 | ) | (2,880 | ) | ||||
Net increase (decrease) in cash and cash equivalents | 17,071 | (899 | ) | |||||
Cash and cash equivalents at beginning of period | 160,014 | 120,277 | ||||||
Cash and cash equivalents at end of period | $ | 177,085 | $ | 119,378 | ||||
Supplemental disclosures of cash flow information: | ||||||||
Cash paid during the period for: | ||||||||
Interest, net of amounts capitalized | $ | 15,116 | $ | 16,952 | ||||
Income taxes, net of refunds | $ | 1,328 | $ | 17,791 |
The accompanying Notes to Consolidated Financial Statements are an integral part of these statements.
5
INTERVAL LEISURE GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED STATEMENTS
March 31, 2010
(Unaudited)
NOTE 1—ORGANIZATION AND BASIS OF PRESENTATION
Company Overview
Interval Leisure Group, Inc. ("ILG") is a leading global provider of membership and leisure services to the vacation industry. We operate in two business segments: Interval and Aston. Our principal business, Interval, offers travel and leisure related products and services to owners of vacation interests and others enrolled in various membership programs, as well as related services to its resort developer clients. Aston, our other business segment, was acquired in May 2007 and provides hotel and resort management and vacation rental services to both vacationers and vacation property owners principally in Hawaii.
ILG was incorporated as a Delaware corporation in May 2008 in connection with a plan by IAC/InterActiveCorp ("IAC") to separate into five publicly traded companies, referred to as the "spin-off." In connection with the spin-off, we entered into an indenture pursuant to which we issued $300.0 million of senior unsecured notes due 2016 and entered into a senior secured credit facility with a maturity in 2013, including a term loan in the original principal amount of $150.0 million and a $50.0 million revolving credit facility.
Basis of Presentation
The accompanying unaudited consolidated financial statements have been prepared in accordance with U.S. generally accepted accounting principles ("GAAP") for interim financial information and with the rules and regulations of the Securities and Exchange Commission. Accordingly, they do not include all of the information and notes required by U.S. GAAP for complete financial statements. In the opinion of ILG's management, all adjustments (including normal recurring accruals) considered necessary for a fair presentation have been included. Interim results are not indicative of the results that may be expected for a full year. The accompanying unaudited consolidated financial statements should be read in conjunction with ILG's audited consolidated financial statements and notes thereto for the year ended December 31, 2009.
Restatement
In our consolidated statements of income, a restatement has been made to the period ended March 31, 2009. This restatement represents the correction of a prior period accounting error related to the pass-through revenue of our Aston reporting unit. Pass-through revenue represents the compensation and other employee-related costs directly associated with Aston's management of the properties that are included in both revenue and cost of sales and that are passed on to the property owners without mark-up. The error resulted from the exclusion of certain employee-related costs being paid to third parties which otherwise should be included in pass-through revenue. The exclusion of these employee-related costs had no impact on our previously issued consolidated balance sheets, operating income, net income or per share amounts. This restatement only affects the presentation of our pass-through revenue and related cost of sales in our consolidated statements of income. The table
6
INTERVAL LEISURE GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED STATEMENTS (Continued)
March 31, 2010
(Unaudited)
NOTE 1—ORGANIZATION AND BASIS OF PRESENTATION (Continued)
below summarizes, for the periods presented, the effect of this restatement to revenue and cost of sales previously reported (in thousands).
| Three Months Ended March 31, 2009 | |||
---|---|---|---|---|
Increase in revenue | $ | 1,685 | ||
Increase in cost of sales | 1,685 |
We have considered the guidance in Accounting Standard Codification ("ASC") Topic 250, "Accounting Changes and Error Corrections" ("ASC 250"), ASC Topic 270 "Interim Financial Reporting," ASC Topic 250-S99-1, "Assessing Materiality" and ASC Topic 250-S99-2, "Considering the Effects of Prior Year Misstatements when Quantifying Misstatements in Current Year Financial Statements," in evaluating whether restating previously issued consolidated financial statements to reflect the correction of this error is required. ASC 250 requires an adjustment to financial statements for each individual prior period presented to reflect the correction of the period-specific effects of the error if the error is material. Based on our evaluation of quantitative and qualitative factors, we believe the identified misstatement is immaterial to ILG's consolidated financial statements and to the presentation of our Aston reporting unit as we considered it unlikely that the judgment of a reasonable person relying on the report for purposes of analyzing either consolidated or Aston segment information would have been changed or influenced by this prior period accounting error given the nature of pass-through revenue. Regardless, we have restated previously issued financial information herein to reflect the correction of this error.
The table below summarizes the effect of the restatement, for the period presented, on previously reported consolidated financial statements (in thousands).
| Three Months Ended March 31, 2009 | |||||||||
---|---|---|---|---|---|---|---|---|---|---|
| As Previously Reported | Restatement | As Restated | |||||||
Revenue | $ | 111,241 | $ | 1,685 | $ | 112,926 | ||||
Cost of sales | 32,090 | 1,685 | 33,775 |
NOTE 2—SIGNIFICANT ACCOUNTING POLICIES
Our significant accounting policies were described in Note 2 to our audited consolidated financial statements included in our Annual Report on Form 10-K for the fiscal year ended December 31, 2009. There have been no significant changes in our significant accounting policies for the three months ended March 31, 2010.
Accounting Estimates
ILG's management is required to make certain estimates and assumptions during the preparation of its consolidated financial statements in accordance with U.S. GAAP. These estimates and assumptions impact the reported amounts of assets and liabilities and disclosures of contingent assets
7
INTERVAL LEISURE GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED STATEMENTS (Continued)
March 31, 2010
(Unaudited)
NOTE 2—SIGNIFICANT ACCOUNTING POLICIES (Continued)
and liabilities as of the date of the consolidated financial statements. They also impact the reported amount of net earnings during any period. Actual results could differ from those estimates.
Significant estimates underlying the accompanying consolidated financial statements include: the recovery of goodwill and long-lived and other intangible assets; purchase price allocations; the determination of deferred income taxes including related valuation allowances; the determination of deferred revenue and membership costs; and the determination of stock-based compensation.
Earnings per Share
Basic earnings per share attributable to common stockholders is computed by dividing the net income attributable to common stockholders by the weighted average number of shares of common stock outstanding for the period. Diluted earnings per share attributable to common stockholders is computed based on the weighted average number of shares of common stock and dilutive securities outstanding during the period. Dilutive securities are common stock equivalents that are freely exercisable into common stock at less than market prices or otherwise dilute earnings if converted. The net effect of common stock equivalents is based on the incremental common stock that would be issued upon the assumed exercise of common stock options and the vesting of restricted stock units using the treasury stock method. Common stock equivalents are not included in diluted earnings per share when their inclusion is anti-dilutive. The computations of diluted earnings per share available to common stockholders for the three months ended March 31, 2010 does not include approximately 1.5 million stock options and restricted stock units ("RSUs"), as the effect of their inclusion would have been anti-dilutive to earnings per share.
The computation of weighted average common and common equivalent shares used in the calculation of basic and diluted earnings per share is as follows (in thousands):
| Three Months Ended March 31, | ||||||
---|---|---|---|---|---|---|---|
| 2010 | 2009 | |||||
Basic weighted average shares of common stock outstanding | 56,627 | 56,331 | |||||
Net effect of common stock equivalents assumed to be vested related to RSUs | 749 | 218 | |||||
Net effect of common stock equivalents assumed to be exercised related to stock options held by non-employees | 60 | 22 | |||||
Diluted weighted average shares of common stock outstanding | 57,436 | 56,571 | |||||
Recent Accounting Pronouncements
With the exception of those discussed below, there have been no recent accounting pronouncements or changes in accounting pronouncements since the recent accounting pronouncements described in our Annual Report on Form 10-K for the fiscal year ended December 31, 2009, that are of significance, or potential significance to ILG.
8
INTERVAL LEISURE GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED STATEMENTS (Continued)
March 31, 2010
(Unaudited)
NOTE 2—SIGNIFICANT ACCOUNTING POLICIES (Continued)
In October 2009, the Financial Accounting Standards Board ("FASB") issued Accounting Standards Updates ("ASU") 2009-13, "Multiple-Deliverable Revenue Arrangements," (amendments to ASC Topic 605, "Revenue Recognition") ("ASU 2009-13"). ASU 2009-13 updates the existing multiple-element revenue arrangements guidance currently included under ASC 605-25. The revised guidance modifies the criteria for recognizing revenue in multiple element arrangements and expands the disclosure requirements for revenue recognition. ASU 2009-13 will be effective for the first annual reporting period beginning on or after June 15, 2010, with early adoption permitted provided that the revised guidance is retroactively applied to the beginning of the year of adoption. We are currently assessing the future impact of this new accounting update to our consolidated financial statements.
Adopted Accounting Pronouncements
In January 2010, the FASB issued ASU2010-06, "Improving Disclosures About Fair Value Measurements," (amendments to ASC Topic 820, "Fair Value Measurements and Disclosures") which requires reporting entities to make new disclosures about recurring or nonrecurring fair-value measurements including significant transfers into and out of Level 1 and Level 2 fair-value measurements and information on purchases, sales, issuances, and settlements on a gross basis in the reconciliation of Level 3 fair value measurements. The ASU also clarifies existing fair value disclosures about the level of disaggregation and about inputs and valuation techniques used to measure fair value. ASU 2010-06 is effective for annual reporting periods beginning after December 15, 2009, except for Level 3 reconciliation disclosures which are effective for annual periods beginning after December 15, 2010. We adopted this guidance as of January 1, 2010. The adoption did not have a material impact on our consolidated financial position, results of operations, cash flows or related disclosures.
NOTE 3—GOODWILL AND OTHER INTANGIBLE ASSETS
Goodwill
Pursuant to FASB guidance as codified within ASC 350, goodwill acquired in business combinations is assigned to the reporting unit that is expected to benefit from the combination as of the acquisition date. ILG tests goodwill and other indefinite-lived intangible assets for impairment annually as of October 1, or more frequently if events or changes in circumstances indicate that the assets might be impaired. If the carrying amount of a reporting unit's goodwill exceeds its implied fair value, an impairment loss equal to the excess is recorded. If the carrying amount of an indefinite-lived intangible asset exceeds its estimated fair value, an impairment loss equal to the excess is recorded.
On October 1, 2009, we performed our required annual impairment test by reviewing the carrying value of goodwill and indefinite-lived intangible assets of each of our reporting units. We performed the first step of the two step impairment test on both our Interval and Aston reporting units and concluded that Interval's fair value significantly exceeded its carrying value, however, the carrying value of our Aston reporting unit exceeded its fair value by 6%. Consequently, we performed the second step of the impairment test for the Aston reporting unit to measure the amount of any impairment loss. The resulting analysis concluded Aston's implied fair value of goodwill exceeded the carrying value of goodwill and, therefore, no impairment loss was recorded. The excess in the implied fair value of
9
INTERVAL LEISURE GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED STATEMENTS (Continued)
March 31, 2010
(Unaudited)
NOTE 3—GOODWILL AND OTHER INTANGIBLE ASSETS (Continued)
goodwill over its carrying value is attributable to declines in the fair value of other assets or group of assets.
During the year, we monitor the actual performance of our reporting units relative to the fair value assumptions used in our annual goodwill impairment test, including potential events and changes in circumstance affecting our key estimates and assumptions. For the year-ended December 31, 2009, we did not identify any triggering events which required an interim impairment test prior or subsequent to our annual impairment test on October 1, 2009.
Interim Goodwill Impairment Test
During the first quarter, we determined the Aston reporting unit's actual performance was negatively tracking the fair value assumptions used in our annual goodwill impairment test as of October 1, 2009, as evidenced by notable declines in RevPAR relative to the prior projections. Based on this, we concluded that indicators of impairment were present and could result in a reduction in the fair value of our Aston reporting unit below its carrying amount. There were no indicators of impairment pertaining to our Interval reporting unit.
Consequently, we performed an interim impairment test for our Aston reporting unit as of March 31, 2010. The first step of the two step impairment test concluded that the carrying value of our Aston reporting unit exceeded its fair value by approximately 5%. As a result, we performed the second step of the impairment test to measure the amount of any impairment loss, which concluded that Aston's implied fair value of goodwill exceeded the carrying value of goodwill by a marginal amount and, therefore, no impairment loss was recorded. The excess of the implied fair value of goodwill over its carrying value, computed in the second step, was primarily attributable to net declines in the fair value of an asset group consisting of Aston's property management contracts and wholesaler agreements definite-lived intangible assets, certain real estate assets owned by Aston and used in the purveyance of revenue generating services pursuant to the aforementioned property management contracts and wholesaler agreements, and Aston's tradename definite-lived intangible asset. As a result of the decline in fair value of these long-lived assets, we performed a recoverability test pursuant to ASC Topic 360, "Property Plant and Equipment," ("ASC 360") as subsequently discussed in the Recoverability of Long-Lived Assets section below.
As previously discussed in our 2009 Annual Report on Form 10-K, we used the average of an income approach and a market comparison approach to calculate the fair value of our reporting units. In our March 31, 2010 interim impairment test of our Aston reporting unit, we continued to equally weigh the income approach and market comparison approach but also included in our valuation a comparable market transaction, weighed to a lesser extent, which occurred subsequent to our annual impairment test as of October 1, 2009. With respect to our Aston reporting unit's step-one analysis, the primary examples of key estimates include forecasted available and occupied room nights, average daily rates, long-term growth rates, and our discount rate.
10
INTERVAL LEISURE GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED STATEMENTS (Continued)
March 31, 2010
(Unaudited)
NOTE 3—GOODWILL AND OTHER INTANGIBLE ASSETS (Continued)
The balance of goodwill and other intangible assets, net is as follows (in thousands):
| March 31, 2010 | December 31, 2009 | ||||||
---|---|---|---|---|---|---|---|---|
Goodwill | $ | 479,867 | $ | 479,867 | ||||
Other intangible assets with indefinite lives | 35,300 | 35,300 | ||||||
Intangible assets with definite lives, net | 97,449 | 104,024 | ||||||
Total goodwill and other intangible assets, net | $ | 612,616 | $ | 619,191 | ||||
There were no changes in the carrying amount of goodwill for the three months ended March 31, 2010. Goodwill related to the Interval and Aston segments (each a reporting unit) was $474.7 million and $5.2 million, respectively, as of March 31, 2010.
Intangible assets with indefinite lives relate principally to tradenames and trademarks. At March 31, 2010, intangible assets with definite lives relate to the following (in thousands):
| Cost | Accumulated Amortization | Net | ||||||||
---|---|---|---|---|---|---|---|---|---|---|---|
Customer relationships | $ | 129,500 | $ | (97,400 | ) | $ | 32,100 | ||||
Purchase agreements | 73,500 | (55,281 | ) | 18,219 | |||||||
Resort management contracts | 45,700 | (9,249 | ) | 36,451 | |||||||
Technology | 24,630 | (24,630 | ) | — | |||||||
Other | 17,151 | (6,472 | ) | 10,679 | |||||||
Total | $ | 290,481 | $ | (193,032 | ) | $ | 97,449 | ||||
Recoverability of Long-Lived Assets
As of March 31, 2010, as a consequence of Aston failing step-one of the two step process for testing goodwill for impairment, we performed a recoverability test on an asset group within our Aston reporting unit. The asset group consisted of Aston's property management contracts and wholesaler agreements definite-lived intangible assets, certain real estate assets owned by Aston and used in the purveyance of revenue generating services pursuant to the aforementioned property management contracts and wholesaler agreements, and Aston's tradename definite-lived intangible asset. The resulting recoverability analysis concluded that the undiscounted estimated future cash flows of the asset group exceeded its carrying value by approximately 19% of the asset group's carrying value. Accordingly, the asset group was not considered impaired. The measurement period used for the recoverability analysis was 11 years, the remaining useful life of the property management contracts asset (the asset group's primary asset). The fact that the asset group's cash flows exceeded their carrying amounts in our recoverability test is largely because, pursuant to U.S. GAAP, this analysis utilizes an undiscounted cash flow approach. This method differs from the manner in which the fair value of the asset group is calculated as part of our step-two goodwill and other intangibles impairment analysis previously discussed.
11
INTERVAL LEISURE GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED STATEMENTS (Continued)
March 31, 2010
(Unaudited)
NOTE 3—GOODWILL AND OTHER INTANGIBLE ASSETS (Continued)
At December 31, 2009, intangible assets with definite lives relate to the following (in thousands):
| Cost | Accumulated Amortization | Net | ||||||||
---|---|---|---|---|---|---|---|---|---|---|---|
Customer relationships | $ | 129,500 | $ | (94,161 | ) | $ | 35,339 | ||||
Purchase agreements | 73,500 | (53,443 | ) | 20,057 | |||||||
Resort management contracts | 45,700 | (8,433 | ) | 37,267 | |||||||
Technology | 24,630 | (24,630 | ) | — | |||||||
Other | 17,151 | (5,790 | ) | 11,361 | |||||||
Total | $ | 290,481 | $ | (186,457 | ) | $ | 104,024 | ||||
Amortization of intangible assets with definite lives is computed primarily on a straight-line basis. Total amortization expense for intangible assets with definite lives was $6.6 million and $6.5 million for the three months ended March 31, 2010 and 2009, respectively. Based on December 31, 2009 balances, such amortization for the next five years and thereafter are estimated to be as follows (in thousands):
Years Ending December 31, | | |||
---|---|---|---|---|
2010 | $ | 25,972 | ||
2011 | 25,903 | |||
2012 | 19,650 | |||
2013 | 4,373 | |||
2014 | 4,350 | |||
2015 and thereafter | 23,776 | |||
$ | 104,024 | |||
NOTE 4—PROPERTY AND EQUIPMENT
Property and equipment, net is as follows (in thousands):
| March 31, 2010 | December 31, 2009 | ||||||
---|---|---|---|---|---|---|---|---|
Computer equipment | $ | 15,391 | $ | 14,978 | ||||
Capitalized software | 46,284 | 45,423 | ||||||
Buildings and leasehold improvements | 21,102 | 21,080 | ||||||
Furniture and other equipment | 10,614 | 10,629 | ||||||
Projects in progress | 12,062 | 10,011 | ||||||
105,453 | 102,121 | |||||||
Less: accumulated depreciation and amortization | (59,918 | ) | (57,721 | ) | ||||
Total property and equipment, net | $ | 45,535 | $ | 44,400 | ||||
12
INTERVAL LEISURE GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED STATEMENTS (Continued)
March 31, 2010
(Unaudited)
NOTE 5—LONG-TERM DEBT
Long-term debt is as follows (in thousands):
| March 31, 2010 | December 31, 2009 | ||||||
---|---|---|---|---|---|---|---|---|
9.5% Interval Senior Notes, net of unamortized discount of $20,160 and $20,710, respectively | $ | 279,840 | $ | 279,290 | ||||
Term loan (interest rate of 3.00% at March 31, 2010 and 2.73% at December 31, 2009) | 106,000 | 116,000 | ||||||
Revolving credit facility | — | — | ||||||
Total long-term debt | 385,840 | 395,290 | ||||||
Less: Current maturities | — | — | ||||||
Total long-term debt, net of current maturities | $ | 385,840 | $ | 395,290 | ||||
9.5% Interval Senior Notes
In connection with the spin-off of ILG, on July 17, 2008, Interval Acquisition Corp., a subsidiary of ILG, ("Issuer") agreed to issue $300.0 million of aggregate principal amount of 9.5% Senior Notes due 2016 ("Interval Senior Notes") to IAC, and IAC agreed to exchange such Interval Senior Notes for certain of IAC's 7% senior unsecured notes due 2013 pursuant to a notes exchange and consent agreement. The issuance occurred on August 19, 2008 with original issue discount of $23.5 million, based on the difference between the interest rate on the notes and the effective interest rate that would have been payable on the notes if issued in a market transaction based on market conditions existing on July 17, 2008, the date of pricing, estimated to be 11%. The exchange occurred on August 20, 2008. Interest on the Interval Senior Notes is payable semi-annually in cash in arrears on September 1 and March 1 of each year, commencing March 1, 2009. The Interval Senior Notes are guaranteed by all entities that are domestic subsidiaries of the Issuer and by ILG. The Interval Senior Notes are redeemable by the Issuer in whole or in part, on or after September 1, 2012 at a redemption price equal to 100% of the principal amount plus accrued and unpaid interest. In addition, in the event of a change of control (as defined in the indenture), the Issuer is obligated to make an offer to all holders to purchase the Interval Senior Notes at a price equal to 101% of the face amount. The change of control put option is a derivative pursuant to FASB guidance as codified in ASC 815, that is required to be bifurcated from the host instrument, however, the value of the derivative is not material to our current financial position and results of operations. Subject to specified exceptions, the Issuer is required to make an offer to purchase Interval Senior Notes at a price equal to 100% of the face amount, in the event the Issuer or its restricted subsidiaries complete one or more asset sales and more than $25.0 million of the aggregate net proceeds are not invested (or committed to be invested) in the business or used to repay senior debt within one year after receipt of such proceeds. The original issue discount is being amortized to "Interest expense" using the effective interest method through maturity.
Senior Secured Credit Facility
In connection with the spin-off of ILG, on July 25, 2008, the Issuer entered into a senior secured credit facility with a maturity of five years, which consists of a $150.0 million term loan, of which $106.0 million is outstanding at March 31, 2010, and a $50.0 million revolving credit facility.
13
INTERVAL LEISURE GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED STATEMENTS (Continued)
March 31, 2010
(Unaudited)
NOTE 5—LONG-TERM DEBT (Continued)
As of March 31, 2010, the remaining principal amount of the term loan is payable quarterly through July 25, 2013 ($5.2 million quarterly for fiscal years 2011 and 2012 and approximately $23.2 million quarterly thereafter). During 2009, we made $34.0 million of principal payments on the Term Loan, which included scheduled principal payments through December 31, 2010 and $4.0 million of which was applied pro rata to the remaining scheduled principal payments. During the first quarter 2010, we paid $10.0 million of principal payments on the term loan which included a voluntary prepayment of the first quarter 2011 scheduled principal payment and $4.6 million which was applied pro rata to the remaining scheduled principal payments. Any principal amounts outstanding under the revolving credit facility are due at maturity. The interest rates per annum applicable to loans under the senior secured credit facility are, at the Issuer's option, equal to either a base rate or a LIBOR rate plus an applicable margin, which varies with the total leverage ratio of the Issuer. As of March 31, 2010, the applicable margin was 2.75% per annum for LIBOR term loans, 2.25% per annum for LIBOR revolving loans, 1.75% per annum for base rate term loans and 1.25% per annum for base rate revolving loans. The revolving credit facility has a facility fee of 0.50%.
We have a letter of credit sublimit as part of our revolving credit facility. The amount available to be borrowed under the revolving credit facility is reduced on a dollar-for-dollar basis by the cumulative amount of any outstanding letters of credit, which totaled $70,000 at March 31, 2010, leaving $49.9 million of borrowing capacity at March 31, 2010. There have been no borrowings under the revolving credit facility through March 31, 2010.
All obligations under the senior secured credit facilities are unconditionally guaranteed by ILG and each of the Issuer's existing and future direct and indirect domestic subsidiaries, subject to certain exceptions, and are secured by substantially all their assets. The secured credit facility ranks prior to the Interval Senior Notes to the extent of the value of the assets that secure it.
Restrictions and Covenants
The Interval Senior Notes and senior secured credit facility have various financial and operating covenants that place significant restrictions on us, including our ability to incur additional indebtedness, to incur additional liens, issue redeemable stock and preferred stock, pay dividends or distributions or redeem or repurchase capital stock, prepay, redeem or repurchase debt, make loans and investments, enter into agreements that restrict distributions from our subsidiaries, sell assets and capital stock of our subsidiaries, enter into certain transactions with affiliates and consolidate or merge with or into or sell substantially all of our assets to another person. The senior secured credit facility requires us to meet certain financial covenants requiring the maintenance of a maximum consolidated leverage ratio of consolidated debt over consolidated Earnings Before Interest, Taxes, Depreciation and Amortization ("EBITDA"), as defined in the credit agreement (3.90 through December 31, 2009, 3.65 from January 1, 2010 through December 31, 2010 and 3.40 thereafter), and a minimum consolidated interest coverage ratio of consolidated EBITDA over consolidated interest expense, as defined in the credit agreement (2.75 through December 31, 2009 and 3.00 thereafter). In addition, we may be required to use a portion of our consolidated excess cash flow (as defined in the credit agreement) to prepay the senior secured credit facility based on our consolidated leverage ratio at the end of each fiscal year. If our consolidated leverage ratio equals or exceeds 3.5, we must prepay 50% of consolidated excess cash flow, if our consolidated leverage ratio equals or exceeds 2.85 but is less than 3.5, we must prepay 25%
14
INTERVAL LEISURE GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED STATEMENTS (Continued)
March 31, 2010
(Unaudited)
NOTE 5—LONG-TERM DEBT (Continued)
of consolidated excess cash flow, and if our consolidated leverage ratio is less than 2.85, then no prepayment is required. As of March 31, 2010, ILG was in compliance in all material respects with the requirements of all applicable financial and operating covenants and our consolidated leverage ratio and consolidated interest coverage ratio under the credit agreement were 2.74 and 4.43, respectively.
Debt Issuance Costs
At March 31, 2010, total unamortized debt issue costs were $9.0 million, net of $4.4 million of accumulated amortization, which was included in "Other non-current assets." Debt issuance costs are amortized to "Interest expense" through maturity of the related debt using the effective interest method.
NOTE 6—FINANCIAL INSTRUMENTS
The additional disclosure below of the estimated fair value of financial instruments has been determined using available market information and appropriate valuation methodologies, as applicable. There have been no changes in the methods and significant assumptions used to estimate the fair value of financial instruments during the three months ended March 31, 2010. Our financial instruments include guarantees, letters of credit and surety bonds. These commitments are in place to facilitate our commercial operations.
| March 31, 2010 | December 31, 2009 | |||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| Carrying Amount | Fair Value | Carrying Amount | Fair Value | |||||||||
| (In thousands) | ||||||||||||
Cash and cash equivalents | $ | 177,085 | $ | 177,085 | $ | 160,014 | $ | 160,014 | |||||
Restricted cash and cash equivalents | 4,641 | 4,641 | 5,243 | 5,243 | |||||||||
Long-term debt | (385,840 | ) | (433,750 | ) | (395,290 | ) | (443,000 | ) | |||||
Guarantees, surety bonds and letters of credit | N/A | (26,369 | ) | N/A | (29,166 | ) |
The carrying amounts of cash and cash equivalents and restricted cash and cash equivalents reflected in the accompanying consolidated balance sheets approximate fair value as they are redeemable at par upon notice or maintained with various high-quality financial institutions and have original maturities of three months or less. Under the fair value hierarchy established in ASC 820, cash and cash equivalents and restricted cash and cash equivalents are stated at fair value based on quoted prices in active markets for identical assets or liabilities. Borrowings under our long-term debt are carried at historical cost and adjusted for amortization of the discount on our Interval Senior Notes and principal payments. The fair value of these borrowings was estimated using quoted prices for our Interval Senior Notes as of March 31, 2010 and December 31, 2009 and inputs other than quoted prices that are observable for the term loan as of March 31, 2010 and December 31, 2009, either directly or indirectly, which are intrinsic to the terms of the related agreement, such as interest rates and credit risk. The guarantees, surety bonds, and letters of credit represent liabilities that are carried on our balance sheet only when a future related contingent event becomes probable and reasonably estimable.
15
INTERVAL LEISURE GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED STATEMENTS (Continued)
March 31, 2010
(Unaudited)
NOTE 7—STOCKHOLDERS' EQUITY
ILG has 300 million authorized shares of common stock, par value of $.01 per share. At March 31, 2010, there were 56.9 million shares of ILG common stock outstanding.
ILG has 25 million authorized shares of preferred stock, par value $.01 per share, none of which are issued or outstanding as of March 31, 2010. The Board of Directors has the authority to issue the preferred stock in one or more series and to establish the rights, preferences, and dividends.
Stockholder Rights Plan
In June 2009, ILG's Board of Directors approved the creation of a Series A Junior Participating Preferred Stock, adopted a stockholders rights plan and declared a dividend of one right for each outstanding share of common stock held by our stockholders of record as of the close of business on June 22, 2009. The rights attach to any additional shares of common stock issued after June 22, 2009. These rights, which trade with the shares of our common stock, currently are not exercisable. Under the rights plan, these rights will be exercisable if a person or group acquires or commences a tender or exchange offer for 15% or more of our common stock. The rights plan provides certain exceptions for acquisitions by Liberty Media Corporation in accordance with an agreement entered into with ILG in connection with its spin-off from IAC/InterActiveCorp. If the rights become exercisable, each right will permit its holder, other than the "acquiring person," to purchase from us shares of common stock at a 50% discount to the then prevailing market price. As a result, the rights will cause substantial dilution to a person or group that becomes an "acquiring person" on terms not approved by our Board of Directors.
NOTE 8—BENEFIT PLANS
Prior to the spin-off and through December 31, 2008, ILG participated in a retirement savings plan sponsored by IAC that qualified under Section 401(k) of the Internal Revenue Code. Effective January 1, 2009, the net assets available for benefits for the employees of ILG were transferred from the IAC plan to a newly created ILG plan. Under the ILG plan, participating employees may contribute up to 50.0% of their pre-tax earnings, but not more than statutory limits. ILG originally provided a discretionary match under the ILG plan of fifty cents for each dollar a participant contributed into the plan with a maximum contribution of 3% of a participant's eligible earnings, subject to IRS restrictions. Effective March 1, 2009, we suspended matching contributions for the remainder of the 2009 calendar year. There were no matching contributions for the ILG plan for the three months ended March 31, 2010 and there was approximately $0.3 million for the three months ended March 31, 2009. Matching contributions were invested in the same manner as each participant's voluntary contributions in the investment options provided under the plan.
Effective August 20, 2008, a deferred compensation plan (the "Director Plan") was established to provide non-employee directors of ILG an option to defer director fees on a tax-deferred basis. Participants in the Director Plan are allowed to defer a portion or all of their compensation and are 100% vested in their respective deferrals and earnings. With respect to director fees earned for services performed after the date of such election, participants may choose from receiving cash or stock at the end of the deferral period. ILG has reserved 100,000 shares of common stock for issuance pursuant to this plan, of which 14,100 share units were outstanding at March 31, 2010. ILG does not provide matching or discretionary contributions to participants in the Director Plan. Any deferred compensation elected to be received in stock is included in diluted earnings per share.
16
INTERVAL LEISURE GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED STATEMENTS (Continued)
March 31, 2010
(Unaudited)
NOTE 9—STOCK-BASED COMPENSATION
RSUs are awards in the form of phantom shares or units, denominated in a hypothetical equivalent number of shares of ILG common stock and with the value of each award equal to the fair value of ILG common stock at the date of grant. All outstanding award agreements provide for settlement, upon vesting, in stock for U.S. employees. For non-U.S. employees, all grants issued prior to the spin-off provide for settlement upon vesting in cash, while grants since the spin-off provide for settlement upon vesting in stock. Each RSU is subject to service-based vesting, where a specific period of continued employment must pass before an award vests. Certain RSUs, in addition, are subject to attaining specific performance criteria. ILG recognizes non-cash compensation expense for all RSUs held by ILG's employees (including RSUs for stock of IAC or the other spun-off companies held by ILG employees) for which vesting is considered probable. For RSUs to be settled in stock, the accounting charge is measured at the grant date as the fair value of ILG common stock and expensed on a straight-line basis as non-cash compensation over the vesting term. The expense associated with RSU awards (including RSUs for stock of IAC or the other spun-off companies) to be settled in cash is initially measured at fair value at the grant date and expensed ratably over the vesting term, recording a liability subject to mark-to-market adjustments for changes in the price of the respective common stock, as compensation expense within general and administrative expense.
On August 20, 2008, ILG established the ILG 2008 Stock and Annual Incentive Plan (the "2008 Incentive Plan") which provides for the grant of stock options, stock appreciation rights, restricted stock, restricted stock units, and other stock-based awards. In connection with the spin-off, certain prior awards under IAC's plans were adjusted to convert, in whole or in part, to awards under the 2008 Incentive Plan under which RSUs and options relating to 2.9 million shares of common stock were issued. At the time of the spin-off, an additional 5.0 million shares of common stock were reserved for issuance under the 2008 Incentive Plan. As of March 31, 2010, 2.4 million shares remain available for future grants under this plan.
On March 24, 2009, the Compensation Committee granted 1.2 million RSUs to certain officers and employees of ILG and its subsidiaries. Of these RSUs, 183,391 were subject to 2009 performance criteria that could result between 0% and 200% of these awards being earned based on EBITDA hurdles. These performance RSUs were earned at 117.9% of target. However, vesting is subject to additional service requirements.
On March 2, 2010, the Compensation Committee granted approximately 460,000 RSUs to certain officers and employees of ILG and its subsidiaries. Of these RSUs granted, approximately 64,000 are subject to performance criteria that could result between 0% and 200% of these awards being earned based on EBITDA hurdles.
Non-cash compensation expense related to RSUs for the three months ended March 31, 2010 and 2009 was $2.5 million and $1.9 million, respectively. At March 31, 2010, there was approximately $23.9 million of unrecognized compensation cost, net of forfeitures, related to RSUs, which is currently expected to be recognized over a weighted average period of approximately 2.3 years.
The amount of stock-based compensation expense recognized in the consolidated statements of income is reduced by estimated forfeitures, as the amount recorded is based on awards ultimately expected to vest. The forfeiture rate is estimated at the grant date based on historical experience and revised, if necessary, in subsequent periods for any changes to the estimated forfeiture rate from that
17
INTERVAL LEISURE GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED STATEMENTS (Continued)
March 31, 2010
(Unaudited)
NOTE 9—STOCK-BASED COMPENSATION (Continued)
previously estimated. For any vesting tranche of an award, the cumulative amount of compensation cost recognized is at least equal to the portion of the grant-date value of the award tranche that is actually vested at that date.
Non-cash stock-based compensation expense related to equity awards is included in the following line items in the accompanying consolidated statements of income for the three months ended March 31, 2010 and 2009 (in thousands):
| Three Months Ended March 31, | ||||||
---|---|---|---|---|---|---|---|
| 2010 | 2009 | |||||
Cost of sales | $ | 110 | $ | 133 | |||
Selling and marketing expense | 145 | 146 | |||||
General and administrative expense | 2,239 | 1,666 | |||||
Non-cash compensation expense | $ | 2,494 | $ | 1,945 | |||
The following table summarizes RSU activity during the three months ended March 31, 2010:
| Shares | Weighted- Average Grant Date Fair Value | |||||
---|---|---|---|---|---|---|---|
| (In thousands) | | |||||
Non-vested RSUs at January 1 | 2,643 | $ | 12.46 | ||||
Granted | 493 | 13.25 | |||||
Vested | (470 | ) | 15.66 | ||||
Forfeited | (4 | ) | 22.29 | ||||
Non-vested RSUs at March 31 | 2,662 | $ | 12.02 | ||||
In connection with the acquisition of Aston by ILG in 2007, a member of Aston's management was granted non-voting restricted common equity in Aston. This award was granted on May 31, 2007 and was initially measured at fair value, which is being amortized over the vesting period. This award vests ratably over four and a half years, or earlier based upon the occurrence of certain prescribed events. These shares are subject to a put right by the holder and a call right by ILG, which are not exercisable until the first quarter of 2013 and annually thereafter. The value of these shares upon exercise of the put or call is equal to their fair market value, determined by negotiation or arbitration, reduced by the accreted value of the preferred interest that was taken by ILG upon the purchase of Aston. The initial value of the preferred interest was equal to the acquisition price of Aston. The preferred interest accretes at a 10% annual rate. Upon exercise of the put or call, the consideration is payable in ILG shares or cash or a combination thereof at ILG's option. An additional put right by the holder and call right by ILG would require, upon exercise, the purchase of these non-voting common shares by ILG immediately prior to a registered public offering by Aston, at the public offering price. The unrecognized compensation cost related to this equity award is $0.2 million at March 31, 2010 and December 31, 2009.
18
INTERVAL LEISURE GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED STATEMENTS (Continued)
March 31, 2010
(Unaudited)
NOTE 10—SEGMENT INFORMATION
The overall concept that ILG employs in determining its operating segments and related financial information is to present them in a manner consistent with how the chief operating decision maker views the businesses, how the businesses are organized as to segment management, and the focus of the businesses with regards to the types of products or services offered or the target market. ILG has two operating segments, which are also reportable segments, Interval, its vacation ownership membership services business, and Aston, its hotel and resort management and vacation rental business.
Information on reportable segments and a reconciliation to consolidated operating income is as follows (in thousands):
| Three Months Ended March 31, | ||||||||
---|---|---|---|---|---|---|---|---|---|
| 2010 | 2009 | |||||||
Interval | |||||||||
Revenue | $ | 97,541 | $ | 97,322 | |||||
Cost of sales | 21,504 | 22,282 | |||||||
Gross profit | 76,037 | 75,040 | |||||||
Selling and marketing expense | 12,722 | 12,404 | |||||||
General and administrative expense | 21,102 | 20,207 | |||||||
Amortization expense of intangibles | 5,257 | 5,240 | |||||||
Depreciation expense | 2,260 | 1,958 | |||||||
Segment operating income | $ | 34,696 | $ | 35,231 | |||||
Aston | |||||||||
Management fee revenue | $ | 5,984 | $ | 6,478 | |||||
Pass-through revenue | 10,313 | 9,126 | |||||||
Total revenue | $ | 16,297 | $ | 15,604 | |||||
Cost of sales | 12,677 | 11,493 | |||||||
Gross profit | 3,620 | 4,111 | |||||||
Selling and marketing expense | 809 | 714 | |||||||
General and administrative expense | 1,188 | 1,218 | |||||||
Amortization expense of intangibles | 1,318 | 1,236 | |||||||
Depreciation expense | 188 | 205 | |||||||
Segment operating income | $ | 117 | $ | 738 | |||||
Consolidated | |||||||||
Revenue | $ | 113,838 | $ | 112,926 | |||||
Cost of sales | 34,181 | 33,775 | |||||||
Gross profit | 79,657 | 79,151 | |||||||
Direct segment operating expenses | 44,844 | 43,182 | |||||||
Operating income | $ | 34,813 | $ | 35,969 | |||||
19
INTERVAL LEISURE GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED STATEMENTS (Continued)
March 31, 2010
(Unaudited)
NOTE 10—SEGMENT INFORMATION (Continued)
ILG maintains operations in the United States and other international territories, primarily the United Kingdom. Geographic information on revenue, which is based on sourcing, and long-lived assets, which are based on physical location, is presented below (in thousands):
| Three Months Ended March 31, | |||||||
---|---|---|---|---|---|---|---|---|
| 2010 | 2009 | ||||||
Revenue: | ||||||||
United States | $ | 95,736 | $ | 95,648 | ||||
All other countries | 18,102 | 17,278 | ||||||
Total | $ | 113,838 | $ | 112,926 | ||||
| March 31, 2010 | December 31, 2009 | ||||||
---|---|---|---|---|---|---|---|---|
Long-lived assets (excluding goodwill and intangible assets): | ||||||||
United States | $ | 44,374 | $ | 43,156 | ||||
All other countries | 1,161 | 1,244 | ||||||
Total | $ | 45,535 | $ | 44,400 | ||||
NOTE 11—COMPREHENSIVE INCOME
Comprehensive income is comprised of (in thousands):
| Three Months Ended March 31, | ||||||
---|---|---|---|---|---|---|---|
| 2010 | 2009 | |||||
Net income attributable to common stockholders | $ | 15,413 | $ | 16,834 | |||
Foreign currency translation | (306 | ) | (1,948 | ) | |||
Comprehensive income | $ | 15,107 | $ | 14,886 | |||
Accumulated other comprehensive income is solely related to foreign currency translation. Only the accumulated other comprehensive income exchange rate adjustment related to Venezuela is tax effected, as required by FASB guidance codified in ASC Topic 740, "Income Taxes" ("ASC 740"), since the earnings in Venezuela are not indefinitely reinvested in that jurisdiction.
NOTE 12—INCOME TAXES
ILG calculates its interim income tax provision in accordance with ASC 740. At the end of each interim period, ILG makes its best estimate of the annual expected effective tax rate and applies that rate to its ordinary year-to-date earnings or loss. The tax or benefit related to significant, unusual, or extraordinary items that will be separately reported or reported net of their related tax effect are individually computed and recognized in the interim period in which those items occur. In addition, the effect of a change in enacted tax laws or rates, tax status, or judgment on the realizability of a beginning-of-the-year deferred tax asset in future years is recognized in the interim period in which the change occurs.
20
INTERVAL LEISURE GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED STATEMENTS (Continued)
March 31, 2010
(Unaudited)
NOTE 12—INCOME TAXES (Continued)
The computation of the annual expected effective tax rate at each interim period requires certain estimates and assumptions including, but not limited to, the expected operating income for the year, projections of the proportion of income (or loss) earned and taxed in foreign jurisdictions, permanent and temporary differences, and the likelihood of recovering deferred tax assets generated in the current year. The accounting estimates used to compute the provision for income taxes may change as new events occur, more experience is acquired, additional information is obtained or ILG's tax environment changes. To the extent that the estimated annual effective tax rate changes during a quarter, the effect of the change on prior quarters is included in tax expense for the current quarter.
A valuation allowance for deferred tax assets is provided when it is more likely than not that certain deferred tax assets will not be realized. Realization is dependent upon the generation of future taxable income or the reversal of deferred tax liabilities during the periods in which those temporary differences become deductible. We consider the history of taxable income in recent years, the scheduled reversal of deferred tax liabilities, projected future taxable income and tax planning strategies to make this assessment.
For the three months ended March 31, 2010, ILG recorded a tax provision of $9.7 million, which represents an effective tax rate of 38.7%. This tax rate is higher than the federal statutory rate of 35% due principally to state and local income taxes partially offset by foreign income taxed at lower rates.
For the three months ended March 31, 2009, ILG recorded a tax provision of $11.5 million, which represents an effective tax rate of 40.5%. This tax rate is higher than the federal statutory rate of 35% due principally to state and local income taxes partially offset by foreign income taxed at lower rates. During the three months ended March 31, 2009, the effective tax rate increased due to income taxes associated with the effects of a change in California tax law that was enacted during the quarter.
As of March 31, 2010 and December 31, 2009, ILG had unrecognized tax benefits of $0.1 million. There were no material increases or decreases in unrecognized tax benefits for the three months ended March 31, 2010. ILG recognizes interest and, if applicable, penalties related to unrecognized tax benefits in income tax expense. There were no material accruals for interest for the three months ended March 31, 2010. As of March 31, 2010, ILG had accrued $0.2 million for the payment of interest and penalties.
By virtue of previously filed separate company and consolidated tax returns with IAC, ILG is routinely under audit by federal, state, local and foreign taxing authorities. These audits include questioning the timing and the amount of deductions and the allocation of income among various tax jurisdictions. Income taxes payable include amounts considered sufficient to pay assessments that may result from examination of prior year returns; however, the amount paid upon resolution of issues raised may differ from the amount provided. Differences between the reserves for tax contingencies and the amounts owed by ILG are recorded in the period they become known. Under the Tax Sharing Agreement, as discussed below, IAC indemnifies ILG for all consolidated tax liabilities and related interest and penalties for the pre-spin period.
The Internal Revenue Service (IRS) is currently examining the IAC consolidated tax returns for the years ended December 31, 2001 through 2006, which includes our operations from September 24, 2002, our date of acquisition by IAC. The statute of limitations for these years has been extended to
21
INTERVAL LEISURE GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED STATEMENTS (Continued)
March 31, 2010
(Unaudited)
NOTE 12—INCOME TAXES (Continued)
December 31, 2010. The IRS examination for these years is expected to be completed in 2011. Various IAC consolidated tax returns that include our operations, filed with state and local jurisdictions, are currently under examination, the most significant of which are California, New York State and New York City, for various tax years beginning with December 31, 2003. These state and local examinations are expected to be completed in 2011.
ILG believes that it is reasonably possible that its unrecognized tax benefits could decrease by approximately $0.1 million within twelve months of the current reporting date due primarily to anticipated settlements with taxing authorities. An estimate of other changes in unrecognized tax benefits cannot be made, but is not expected to be significant.
Tax Sharing Agreement
In connection with the spin-off, we entered into a Tax Sharing Agreement with members of the IAC group that were spun-off, as more fully described in our 2009 Annual Report on Form 10-K.
NOTE 13—CONTINGENCIES
In the ordinary course of business, ILG is a party to various legal proceedings. ILG establishes reserves for specific legal matters when it determines that the likelihood of an unfavorable outcome is probable and the loss is reasonably estimable. ILG does not establish reserves for identified legal matters when ILG believes that the likelihood of an unfavorable outcome is not probable. Although management currently believes that an unfavorable resolution of claims against ILG, including claims where an unfavorable outcome is reasonably possible, will not have a material impact on the liquidity, results of operations, or financial condition of ILG, these matters are subject to inherent uncertainties and management's view of these matters may change in the future. ILG also evaluates other contingent matters, including tax contingencies, to assess the probability and estimated extent of potential loss. See Note 12 for a discussion of income tax contingencies.
ILG has funding commitments that could potentially require its performance in the event of demands by third parties or contingent events. At March 31, 2010, total guarantees, surety bonds and letters of credit total $26.4 million, with the highest annual amount of $12.0 million occurring in year one. Guarantees represent $23.8 million of this total and primarily relate to Aston's property management agreements, including those with guaranteed dollar amounts, and accommodation leases supporting the management activities, entered into on behalf of the property owners for which either party may terminate such leases upon 60 days prior written notice to each other. In addition, certain of Aston's property management agreements provide that owners receive specified percentages of the revenue generated under Aston management. In these cases, the operating expenses for the rental operations are paid from the revenue generated by the rentals, the owners are then paid their contractual percentages, and Aston either retains the balance (if any) as its management fee or makes up the deficit. Although such deficits are reasonably possible in a few of these agreements, amounts as of March 31, 2010 are not expected to be significant, individually or in the aggregate.
22
INTERVAL LEISURE GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED STATEMENTS (Continued)
March 31, 2010
(Unaudited)
NOTE 13—CONTINGENCIES (Continued)
During 2009, ILG recorded an incremental $2.3 million accrual related to Value Added Tax ("VAT") in Europe. This accrual was made based on a judgment issued by the European Court of Justice against an unrelated party. The judgment affects companies who transact within the European Union ("EU"), specifically providers of vacation interest exchange services, and alters the manner in which Interval will account for VAT on its revenues as well as to which EU country VAT is owed. As of March 31, 2010 and December 31, 2009, ILG had a $3.5 million and $3.7 million accrual, respectively, related to this matter. The change in the accrual relates to the effect of foreign currency translation. Because of the uncertainty surrounding the ultimate outcome and settlement of these VAT liabilities, it is reasonably possible that future costs to settle these VAT liabilities may range from $3.5 million up to approximately $6.6 million based on quarter end exchange rates. The difference between the probable and reasonably possible amounts is primarily attributable to the assessment of certain potential penalties. ILG believes that the $3.5 million accrual at March 31, 2010 is our best estimate of probable future obligations for the settlement of these VAT liabilities.
NOTE 14—SUPPLEMENTAL GUARANTOR INFORMATION
The Interval Senior Notes are guaranteed by ILG and the domestic subsidiaries of the Issuer. These guarantees are full and unconditional and joint and several.
The following tables present condensed consolidating financial information as of March 31, 2010 and December 31, 2009 and for the three months ended March 31, 2010 and 2009 for ILG on a stand-alone basis, the Issuer on a stand-alone basis, the combined guarantor subsidiaries of ILG (collectively, the "Guarantor Subsidiaries"), the combined non-guarantor subsidiaries of ILG (collectively, the "Non-Guarantor Subsidiaries") and ILG on a consolidated basis (in thousands).
Balance Sheet as of March 31, 2010 | ILG | Interval Acquisition Corp. | Guarantor Subsidiaries | Non- Guarantor Subsidiaries | Total Eliminations | ILG Consolidated | ||||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
Current assets | $ | 408 | $ | 33 | $ | 194,260 | $ | 80,775 | $ | — | $ | 275,476 | ||||||||
Property and equipment, net | 829 | — | 43,545 | 1,161 | — | 45,535 | ||||||||||||||
Goodwill and intangible assets, net | — | 321,598 | 291,018 | — | — | 612,616 | ||||||||||||||
Investment in subsidiaries | 193,024 | 781,117 | 43,958 | — | (1,018,099 | ) | — | |||||||||||||
Other assets | — | 6,182 | 39,018 | 9,081 | — | 54,281 | ||||||||||||||
Total assets | $ | 194,261 | $ | 1,108,930 | $ | 611,799 | $ | 91,017 | $ | (1,018,099 | ) | $ | 987,908 | |||||||
Current liabilities | $ | 731 | $ | 2,796 | $ | 157,005 | $ | 26,278 | $ | — | $ | 186,810 | ||||||||
Other liabilities | — | 382,721 | 208,589 | 17,146 | — | 608,456 | ||||||||||||||
Intercompany liabilities (receivables) / equity | 1,310 | 530,389 | (535,334 | ) | 3,635 | — | — | |||||||||||||
Redeemable noncontrolling interest | 422 | 422 | ||||||||||||||||||
Stockholders' equity | 192,220 | 193,024 | 781,117 | 43,958 | (1,018,099 | ) | 192,220 | |||||||||||||
Total liabilities and equity | $ | 194,261 | $ | 1,108,930 | $ | 611,799 | $ | 91,017 | $ | (1,018,099 | ) | $ | 987,908 | |||||||
23
INTERVAL LEISURE GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED STATEMENTS (Continued)
March 31, 2010
(Unaudited)
NOTE 14—SUPPLEMENTAL GUARANTOR INFORMATION (Continued)
Balance Sheet as of December 31, 2009 | ILG | Interval Acquisition Corp. | Guarantor Subsidiaries | Non- Guarantor Subsidiaries | Total Eliminations | ILG Consolidated | ||||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
Current assets | $ | 52 | $ | 70 | $ | 171,590 | $ | 75,036 | $ | — | $ | 246,748 | ||||||||
Property and equipment, net | 859 | — | 42,297 | 1,244 | — | 44,400 | ||||||||||||||
Goodwill and intangible assets, net | — | 326,837 | 292,354 | — | — | 619,191 | ||||||||||||||
Investment in subsidiaries | 175,495 | 731,994 | 40,675 | — | (948,164 | ) | — | |||||||||||||
Other assets | — | 6,824 | 31,345 | 10,073 | — | 48,242 | ||||||||||||||
Total assets | $ | 176,406 | $ | 1,065,725 | $ | 578,261 | $ | 86,353 | $ | (948,164 | ) | $ | 958,581 | |||||||
Current liabilities | $ | 162 | $ | 9,921 | $ | 139,905 | $ | 24,299 | $ | — | $ | 174,287 | ||||||||
Other liabilities | — | 392,172 | 197,244 | 18,080 | — | 607,496 | ||||||||||||||
Intercompany liabilities (receivables) / equity | (132 | ) | 488,137 | (491,304 | ) | 3,299 | — | — | ||||||||||||
Redeemable noncontrolling interest | 422 | 422 | ||||||||||||||||||
Stockholders' equity | 176,376 | 175,495 | 731,994 | 40,675 | (948,164 | ) | 176,376 | |||||||||||||
Total liabilities and equity | $ | 176,406 | $ | 1,065,725 | $ | 578,261 | $ | 86,353 | $ | (948,164 | ) | $ | 958,581 | |||||||
Statement of Income for the Three Months Ended March 31, 2010 | ILG | Interval Acquisition Corp. | Guarantor Subsidiaries | Non- Guarantor Subsidiaries | Total Eliminations | ILG Consolidated | |||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
Revenue | $ | — | $ | — | $ | 100,152 | $ | 13,686 | $ | — | $ | 113,838 | |||||||
Operating expenses | (656 | ) | (5,240 | ) | (63,739 | ) | (9,390 | ) | — | (79,025 | ) | ||||||||
Interest income (expense), net | — | (9,206 | ) | 217 | 53 | — | (8,936 | ) | |||||||||||
Other income (expense), net | 15,816 | 24,689 | 2,264 | (783 | ) | (42,720 | ) | (734 | ) | ||||||||||
Income tax benefit (provision) | 253 | 5,573 | (14,205 | ) | (1,351 | ) | — | (9,730 | ) | ||||||||||
Net income | 15,413 | 15,816 | 24,689 | 2,215 | (42,720 | ) | 15,413 | ||||||||||||
Net income attributable to noncontrolling interest | — | — | — | — | — | — | |||||||||||||
Net income attributable to common stockholders | $ | 15,413 | $ | 15,816 | $ | 24,689 | $ | 2,215 | $ | (42,720 | ) | $ | 15,413 | ||||||
24
INTERVAL LEISURE GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED STATEMENTS (Continued)
March 31, 2010
(Unaudited)
NOTE 14—SUPPLEMENTAL GUARANTOR INFORMATION (Continued)
Statement of Income for the Three Months Ended March 31, 2009 | ILG | Interval Acquisition Corp. | Guarantor Subsidiaries | Non- Guarantor Subsidiaries | Total Eliminations | ILG Consolidated | |||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
Revenue | $ | — | $ | — | $ | 100,013 | $ | 12,913 | $ | — | $ | 112,926 | |||||||
Operating expenses | (694 | ) | (5,240 | ) | (62,297 | ) | (8,726 | ) | — | (76,957 | ) | ||||||||
Interest income (expense), net | — | (9,431 | ) | (27 | ) | 382 | — | (9,076 | ) | ||||||||||
Other income (expense), net | 17,266 | 26,406 | 3,755 | 1,330 | (47,347 | ) | 1,410 | ||||||||||||
Income tax benefit (provision) | 262 | 5,531 | (15,036 | ) | (2,224 | ) | — | (11,467 | ) | ||||||||||
Net income | 16,834 | 17,266 | 26,408 | 3,675 | (47,347 | ) | 16,836 | ||||||||||||
Net income attributable to noncontrolling interest | — | — | (2 | ) | — | — | (2 | ) | |||||||||||
Net income attributable to common stockholders | $ | 16,834 | $ | 17,266 | $ | 26,406 | $ | 3,675 | $ | (47,347 | ) | $ | 16,834 | ||||||
Statement of Cash Flows for the Three Months Ended March 31, 2010 | ILG | Interval Acquisition Corp. | Guarantor Subsidiaries | Non- Guarantor Subsidiaries | ILG Consolidated | ||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
Cash flows provided by (used in) operating activities | $ | (9,501 | ) | $ | (931 | ) | $ | 38,858 | $ | 4,110 | $ | 32,536 | |||||
Cash flows provided by (used in) investing activities | 19,328 | 352 | (23,605 | ) | 513 | (3,412 | ) | ||||||||||
Cash flows provided by (used in) financing activities | (9,827 | ) | 579 | (1,132 | ) | — | (10,380 | ) | |||||||||
Effect of exchange rate changes on cash and cash equivalents | — | — | — | (1,673 | ) | (1,673 | ) | ||||||||||
Cash and cash equivalents at beginning of period | — | — | 92,265 | 67,749 | 160,014 | ||||||||||||
Cash and cash equivalents at end of period | $ | — | $ | — | $ | 106,386 | $ | 70,699 | $ | 177,085 | |||||||
25
INTERVAL LEISURE GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED STATEMENTS (Continued)
March 31, 2010
(Unaudited)
NOTE 14—SUPPLEMENTAL GUARANTOR INFORMATION (Continued)
Statement of Cash Flows for the Three Months March 31, 2009 | ILG | Interval Acquisition Corp. | Guarantor Subsidiaries | Non- Guarantor Subsidiaries | ILG Consolidated | ||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
Cash flows provided by (used in) operating activities | $ | 147 | $ | (11,788 | ) | $ | 23,276 | $ | 2,020 | $ | 13,655 | ||||||
Cash flows provided by (used in) investing activities | 282 | 19,283 | (24,870 | ) | 1,636 | (3,669 | ) | ||||||||||
Cash flows used in financing activities | (429 | ) | (7,495 | ) | (81 | ) | — | (8,005 | ) | ||||||||
Effect of exchange rate changes on cash and cash equivalents | — | — | — | (2,880 | ) | (2,880 | ) | ||||||||||
Cash and cash equivalents at beginning of period | — | — | 58,913 | 61,364 | 120,277 | ||||||||||||
Cash and cash equivalents at end of period | $ | — | $ | — | $ | 57,238 | $ | 62,140 | $ | 119,378 | |||||||
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations
Cautionary Statement Regarding Forward-Looking Information
This quarterly report on Form 10-Q contains "forward looking statements" within the meaning of the Private Securities Litigation Reform Act of 1995. The use of 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" among others, generally identify forward-looking statements. 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.
Actual results could differ materially from those contained in the forward looking statements included in this quarterly report for a variety of reasons, including, among others: adverse trends in economic conditions generally or in the vacation ownership, vacation rental and travel industries; adverse changes to, or interruptions in, relationships with third parties; lack of available financing for or insolvency of developers; decreased demand from prospective purchasers of vacation interests; travel related health concerns, such as pandemics; changes in our senior management; regulatory changes; our ability to compete effectively; the effects of our significant indebtedness and our compliance with the terms thereof; adverse events or trends in key vacation destinations; and our ability to expand successfully in international markets and manage risks specific to international operations. Certain of these and other risks and uncertainties are discussed in our filings with the SEC, including in Item 1A "Risk Factors" of our Annual Report on Form 10-K for the fiscal year ended December 31, 2009. In light of these risks and uncertainties, the forward looking statements discussed in this report may not prove to be accurate. Accordingly, you should not place undue reliance on these forward looking statements, which only reflect the views of our management as of the date of this report. Except as required by applicable law, we do not undertake to update these forward-looking statements.
26
Management Overview
General Description of our Business
ILG is a leading global provider of membership and leisure services to the vacation industry. We operate in two business segments: Interval and Aston. Our principal business segment, Interval, offers travel and leisure related products and services to owners of vacation interests and others enrolled in various membership programs, as well as related services to its resort developer clients. Aston, our other business segment, was acquired in May 2007 and provides hotel and resort management and vacation rental services to both vacationers and vacation property owners principally in Hawaii.
ILG was incorporated as a Delaware corporation in May 2008 in connection with a plan by IAC to separate into five publicly traded companies, referred to as the "spin-off." In connection with the spin-off, we entered into an indenture pursuant to which we issued $300.0 million of senior unsecured notes due 2016 and entered into a senior secured credit facility with a maturity in 2013, including a term loan in the original principal amount of $150.0 million and a $50.0 million revolving credit facility.
Vacation Ownership Membership Services (Interval)
Interval has been a leader in the vacation ownership membership services industry since its founding in 1976, and we operate a quality international vacation ownership membership exchange network, the Interval Network. As of March 31, 2010:
- •
- the large and diversified base of resorts participating in the Interval Network consisted of more than 2,500 resorts located in more than 75 countries and included both leading independent resort developers and branded hospitality companies;
- •
- over 1.8 million vacation ownership interest owners were enrolled as members of the Interval Network; and
- •
- the average tenure of the relationships with the top 25 resort developers (as determined by the number of new members enrolled during the year ended December 31, 2009) was approximately 14 years.
Interval typically enters into multi-year contracts with developers of vacation ownership resorts, pursuant to which the resort developers agree to enroll all purchasers of vacation interests at the applicable resort as members of an Interval exchange program. In return, Interval provides enrolled purchasers with the ability to exchange the use and occupancy of their vacation interest at the home resort (generally for a period of one week) for the right to occupy accommodations at a different resort participating in an Interval exchange network. Through Interval's Getaways, members may rent resort accommodations for a fee without relinquishing the use of their vacation interest. In addition, Interval offers support, consulting and back-office services, including reservation servicing, for certain resort developers participating in the Interval Network, upon their request and for additional consideration.
Interval earns most of its revenue from (i) fees paid for membership in the Interval Network and (ii) transactional and service fees paid primarily for Interval Network exchanges, Getaways and reservation servicing, collectively referred to as "transaction revenue."
Hotel and Resort Management and Vacation Rental Services (Aston)
Through Aston, we provide hotel and resort management and vacation rental services for owners of resort condominiums, hotels and other vacation properties. Such vacation properties and hotels are not owned by us. As of March 31, 2010, Aston provided hotel and resort management services to 26 resorts and hotels primarily in Hawaii, as well as more limited management services to certain additional properties.
27
Revenue from Aston is derived principally from management fees for hotel and resort management and vacation rental services. Fees consist of a base management fee and, in some instances, an incentive management fee which is generally a percentage of operating profits or improvement in operating profits. Service fee revenue is based on the services provided to owners including reservations, sales and marketing, property accounting and information technology services either internally or through third party providers. A majority of the resort management agreements provide that owners receive either specified percentages of the revenue generated under Aston management or guaranteed dollar amounts. In these cases, the operating expenses for the rental operation are paid from the revenue generated by the rentals, the owners are then paid their contractual percentages or amounts, and Aston either retains the balance (if any) as its management fee or makes up the deficit.
In January 2009, as part of its re-branding campaign, ResortQuest Hawaii returned to the name of Aston Hotels & Resorts.
International Operations
International revenue increased approximately 4.8% in the three months ended March 31, 2010 compared to the same period in 2009. As a percentage of our total revenue, international revenue increased to 15.9% in the three months ended March 31, 2010 from 15.3% in 2009. International revenue in the first quarter 2010 was affected by favorable foreign currency translations when compared to 2009. In constant currency, international revenue remained relatively flat in the first quarter 2010 compared to 2009, as did international revenue as a percentage of our total revenue.
Constant currency represents current period results of operations determined by translating our functional currency results to U.S. dollars (our reporting currency) using the actual prior quarter blended rate of translation from the comparable prior period. We believe that the presentation of our results of operations excluding the effect of foreign currency translations serves to enhance the understanding of our performance, improves transparency of our disclosures, provides meaningful presentations of our results from our business operations by excluding this effect not related to our core business operations and improves the period to period comparability of results from business operations.
Other Factors Affecting Results
The reduction in sales and marketing expenditures by resort developers spurred by the lack of receivables financing has continued, leading to a decrease in the flow of new members to our exchange networks. There has been some easing of credit markets, primarily in securitization transactions available to certain large developers. At the same time, developers are continuing to modify their business models to reduce reliance on receivables financing.
Our Aston segment continues to be impacted by overall macroeconomic conditions. Visitor arrivals in Hawaii have increased 4.5% year over year, according to the Hawaii Department of Business, Economic Development & Tourism, ("DBEDT"). This is consistent with Aston experiencing a slight increase in occupancy rates. However, this increased occupancy was offset by a general decrease in average daily rates. The DBEDT forecasts a slight increase in visitors to Hawaii in 2010, and visitor expenditures are forecasted to increase slightly from 2009. During the fourth quarter of 2009, Aston expanded beyond the Hawaiian islands adding certain mainland locations. We expect a ramp-up period for these locations.
Throughout 2009, we saw continued pressures in the U.S. and global economy related to the global economic downturn, the credit crisis, investment returns, and general negative consumer sentiment, all of which has impacted consumer discretionary spending in travel and leisure services. We expect to continue to operate, for the most part, in a challenging business environment throughout 2010.
28
Results of operations for the three months ended March 31, 2010 compared to the three months ended March 31, 2009:
Revenue
For the three months ended March 31, 2010 compared to the three months ended March 31, 2009
| Three Months Ended March 31, | |||||||||
---|---|---|---|---|---|---|---|---|---|---|
| 2010 | % Change | 2009 | |||||||
| (Dollars in thousands) | |||||||||
Interval | $ | 97,541 | 0.2 | % | $ | 97,322 | ||||
Aston | 16,297 | 4.4 | % | 15,604 | ||||||
Total revenue | $ | 113,838 | 0.8 | % | $ | 112,926 | ||||
Revenue for the three months ended March 31, 2010 increased $0.9 million, or 0.8%, from the comparable period in 2009.
The Interval segment revenue increased by $0.2 million from the prior year period. Total member revenue, which primarily consists of membership fees and transactional revenue, was relatively flat, decreasing $0.1 million, or 0.1%. Total active members in the Interval Network at March 31, 2010 decreased to approximately 1.8 million members as compared to approximately 1.9 million members at March 31, 2009, a decrease of 3.6%. Overall average revenue per member increased 4.3% to $51.31 in the first quarter 2010 from $49.18 in 2009. Transaction revenue was relatively flat, increasing $0.4 million, or 0.6%, primarily due to a $0.7 million increase in transaction revenue from exchanges and Getaways due to a 3.0% increase in average transaction fees, offset by a 1.7% decrease in volume for exchanges and Getaways and a $0.5 million decrease in reservation servicing fees related to decreases in call volume and average fee per call. Membership fee revenue decreased $0.5 million, or 1.7%, primarily due to a decrease of 4.3% in average active members, partially offset by a 2.8% increase in average membership fees and favorable foreign currency translations of $0.3 million.
The Interval segment revenue in the first quarter 2010 was affected by favorable foreign currency translations of $0.8 million resulting from the weakening of the U.S. dollar when compared to 2009. In constant currency, Interval segment revenue would have decreased $0.6 million in 2010 compared to 2009.
The Aston segment revenue increased 4.4%, or $0.7 million, which included a 13% increase in reimbursed compensation and other employee-related costs directly associated with managing properties that are included in both revenue and expenses and that are passed on to the property owners without mark-up. The decrease in fee income earned by Aston from managed vacation properties was driven by a reduction of 8.3% in revenue per available room ("RevPAR"). Lower average daily rate, offset by a slight increase in occupancy, led to the overall reduction in RevPAR. The increase in occupancy rates during the first quarter 2010 compared to 2009 can be attributed to a decrease in average daily rate resulting from continued competitive pricing pressures. We expect overall macroeconomic conditions driving consumer discretionary spending to continue to impact demand and average daily rates. Aston has been generally tracking the results of comparable properties in the Hawaii market.
29
Cost of Sales
For the three months ended March 31, 2010 compared to the three months ended March 31, 2009
| Three Months Ended March 31, | |||||||||
---|---|---|---|---|---|---|---|---|---|---|
| 2010 | % Change | 2009 | |||||||
| (Dollars in thousands) | |||||||||
Interval | $ | 21,504 | (3.5 | )% | $ | 22,282 | ||||
Aston | 12,677 | 10.3 | % | 11,493 | ||||||
Total cost of sales | $ | 34,181 | 1.2 | % | $ | 33,775 | ||||
As a percentage of total revenue | 30.0 | % | 0.4 | % | 29.9 | % | ||||
Gross margin | 70.0 | % | (0.2 | )% | 70.1 | % |
Cost of sales consists primarily of compensation and other employee-related costs (including stock-based compensation) for personnel engaged in servicing Interval's members and providing services to property owners and/or guests of Aston managed vacation properties, as well as the cost of rental inventory used primarily for Getaways.
Cost of sales in the first quarter 2010 increased $0.4 million from 2009, of which Aston contributed $1.2 million to the increase, offset by a decrease of $0.8 million at Interval. The increase in Aston was largely due to an increase in reimbursed compensation and other employee-related costs directly associated with managing properties that are included in both revenue and expenses and that are passed on to the property owners without mark-up. Overall gross margin was relatively flat, decreasing by 0.2% to 70.0% for the three months ended March 31, 2010 compared to 2009.
Interval's gross margin increased by 1.1% as compared to the prior year. Interval's cost of sales decreased primarily due to decreases of $0.6 million in compensation and other employee-related costs, $0.1 million in the cost of rental inventory for use primarily in Getaways, and decreases in membership fulfillment related expenses. The decrease in Interval's compensation and other employee-related costs is due primarily to a decrease of 5.2% in average operational headcount.
Aston's gross margin decreased 15.7% as compared to the prior year. Aston has lower gross margins than Interval primarily due to the compensation and other employee-related costs of $10.3 million and $9.1 million for the three months ended March 31, 2010 and 2009, respectively, directly associated with managing properties that are included in both revenue and expenses and that are passed on to the property owners without mark-up. The first quarter 2010 increase in reimbursed compensation and other employee-related costs compared to 2009 was not proportional to the increase in Aston's segment revenue, excluding such reimbursed costs. The increase of $1.2 million in Aston's cost of sales was primarily due to an increase in average operational headcount related to the addition of new properties and employing existing personnel at another managed property.
Selling and Marketing Expense
For the three months ended March 31, 2010 compared to the three months ended March 31, 2009
| Three Months Ended March 31, | |||||||||
---|---|---|---|---|---|---|---|---|---|---|
| 2010 | % Change | 2009 | |||||||
| (Dollars in thousands) | |||||||||
Selling and marketing expense | $ | 13,531 | 3.1 | % | $ | 13,118 | ||||
As a percentage of total revenue | 11.9 | % | 2.3 | % | 11.6 | % |
Selling and marketing expense consists primarily of advertising and promotional expenditures and compensation and other employee-related costs (including stock-based compensation) for personnel engaged in sales and sales support functions. Advertising and promotional expenditures primarily include printing costs of directories and magazines, promotions, tradeshows, agency fees, marketing fees and related commissions.
30
Selling and marketing expense in the first quarter 2010 increased $0.4 million from 2009, primarily due to an increase in advertising and promotional expenses related to certain sales incentives and to a lesser extent the timing of an industry tradeshow which occurred in the first quarter 2010 compared to partly in the first quarter 2009, and to an increase in compensation and other employee-related costs of $0.1 million, offset by decreases in printing costs related to printing of directories. The decrease in the printing of directories is primarily due to decreases in new and active members coupled with a decrease in the cost of Interval resort directories.
General and Administrative Expense
For the three months ended March 31, 2010 compared to the three months ended March 31, 2009
| Three Months Ended March 31, | |||||||||
---|---|---|---|---|---|---|---|---|---|---|
| 2010 | % Change | 2009 | |||||||
| (Dollars in thousands) | |||||||||
General and administrative expense | $ | 22,290 | 4.0 | % | $ | 21,425 | ||||
As a percentage of total revenue | 19.6 | % | 3.2 | % | 19.0 | % |
General and administrative expense consists primarily of compensation and other employee-related costs (including stock-based compensation) for personnel engaged in finance, legal, tax, human resources, information technology and executive management functions, certain facility costs and fees for professional services.
General and administrative expense in the first quarter 2010 increased $0.9 million from 2009, primarily due to increases in fees for professional services of $0.4 million largely pertaining to due diligence related services involving potential acquisitions, increases in IT maintenance and support services of $0.3 million and an increase of $0.6 million in non-cash compensation expense, partially offset by decreases of $0.5 million in overall compensation and other employee-related costs
General and administrative related non-cash compensation expense for the three months ended March 31, 2010 was $2.2 million, an increase of $0.6 million compared to $1.7 million in 2009. The increase in non-cash compensation expense is primarily related to awards granted at the end of March 2009 through the beginning of March 2010.
As of March 31, 2010, there was approximately $23.9 million of unrecognized non-cash compensation expense, net of estimated forfeitures, related to all equity-based awards, which is currently expected to be recognized over a weighted average period of approximately 2.3 years.
Amortization Expense of Intangibles
For the three months ended March 31, 2010 compared to the three months ended March 31, 2009
| Three Months Ended March 31, | |||||||||
---|---|---|---|---|---|---|---|---|---|---|
| 2010 | % Change | 2009 | |||||||
| (Dollars in thousands) | |||||||||
Amortization | $ | 6,575 | 1.5 | % | $ | 6,476 | ||||
As a percentage of total revenue | 5.8 | % | 0.7 | % | 5.7 | % |
Amortization expense of intangibles for the three months ended March 31, 2010 was consistent with the comparable 2009 period for both Interval and Aston.
31
Depreciation Expense
For the three months ended March 31, 2010 compared to the three months ended March 31, 2009
| Three Months Ended March 31, | |||||||||
---|---|---|---|---|---|---|---|---|---|---|
| 2010 | % Change | 2009 | |||||||
| (Dollars in thousands) | |||||||||
Depreciation | $ | 2,448 | 13.2 | % | $ | 2,163 | ||||
As a percentage of total revenue | 2.2 | % | 12.3 | % | 1.9 | % |
Depreciation expense for the three months ended March 31, 2010 as compared to 2009 increased $0.3 million primarily due to depreciable assets, related to IT initiatives, placed in service subsequent to March 31, 2009.
Operating Income
For the three months ended March 31, 2010 compared to the three months ended March 31, 2009
| Three Months Ended March 31, | |||||||||
---|---|---|---|---|---|---|---|---|---|---|
| 2010 | % Change | 2009 | |||||||
| (Dollars in thousands) | |||||||||
Interval | $ | 34,696 | (1.5 | )% | $ | 35,231 | ||||
Aston | 117 | (84.1 | )% | 738 | ||||||
Total operating income | $ | 34,813 | (3.2 | )% | $ | 35,969 | ||||
As a percentage of total revenue | 30.6 | % | (4.0 | )% | 31.9 | % |
Operating income for the three months ended March 31, 2010 decreased $1.2 million from the comparable period in 2009 primarily due to an increase of $0.7 million in selling and marketing and general and administrative expense, excluding non-cash compensation, an increase in depreciation expense of $0.3 million and an increase of $0.5 million in non-cash compensation expense, offset by an increase in gross profit of $0.5 million as compared to 2009.
Operating income for our Interval segment decreased $0.5 million to $34.7 million in 2010 from $35.2 million in 2009. Excluding the effect of the favorable currency translations of $0.2 million resulting from the weakening of the U.S. dollar, Interval segment operating income in constant currency would have decreased $0.7 million, or 2.1%, in 2010 compared to 2009.
The decrease in operating income at Aston is primarily due to a decrease in gross profit.
Earnings Before Interest, Taxes, Depreciation and Amortization
For the three months ended March 31, 2010 compared to the three months ended March 31, 2009
Earnings Before Interest, Taxes, Depreciation and Amortization ("EBITDA") is a non-GAAP measure and is defined in "ILG's Principles of Financial Reporting."
| Three Months Ended March 31, | |||||||||
---|---|---|---|---|---|---|---|---|---|---|
| 2010 | % Change | 2009 | |||||||
| (Dollars in thousands) | |||||||||
Interval | $ | 44,514 | 0.6 | % | $ | 44,256 | ||||
Aston | 1,816 | (20.9 | )% | 2,297 | ||||||
Total EBITDA | $ | 46,330 | (0.5 | )% | $ | 46,553 | ||||
As a percentage of total revenue | 40.7 | % | (1.3 | )% | 41.2 | % |
EBITDA in the first quarter 2010 decreased $0.2 million from 2009, of which Aston contributed $0.5 million to the decrease, offset by an increase of $0.3 million at Interval. The increase in the
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Interval segment is primarily due to an increase in gross profit of $1.0 million, offset by an increase of $0.7 million in selling and marketing and general and administrative expenses, excluding non-cash compensation.
EBITDA from our Interval segment increased $0.3 million to $44.5 million in 2010 from $44.3 million in 2009. In 2010, excluding the effect of the favorable currency translations of $0.2 million resulting from the weakening of the U.S. dollar, Interval segment EBITDA in constant currency would have been consistent with 2009.
Other Income (Expense)
For the three months ended March 31, 2010 compared to the three months ended March 31, 2009
| Three Months Ended March 31, | |||||||||
---|---|---|---|---|---|---|---|---|---|---|
| 2010 | % Change | 2009 | |||||||
| (Dollars in thousands) | |||||||||
Interest income | $ | 78 | (79.9 | )% | $ | 389 | ||||
Interest expense | (9,014 | ) | (4.8 | )% | (9,465 | ) | ||||
Other income (expense) | $ | (734 | ) | (152.1 | )% | $ | 1,410 |
Interest income decreased $0.3 million for the three months ended March 31, 2010 compared to 2009, primarily due to generally lower interest rates in 2010, partially offset by higher average cash balances in 2010.
Interest expense in the first quarter 2010 primarily relates to interest and the amortization of debt costs on the $300.0 million face value 9.5% senior notes issued and the senior secured credit facility, which includes a $150.0 million term loan and a $50.0 million revolving credit facility, entered into in connection with the spin-off on August 20, 2008. The senior notes were initially recorded with an original issue discount of $23.5 million based on the prevailing interest rate at the time of pricing, estimated at 11.0%, of which $0.5 million was amortized each in the first quarter 2010 and 2009.
Other income (expense) primarily relates to gain (loss) on foreign currency exchange related to cash held in certain countries in currencies other than their local currency. Unfavorable fluctuations in foreign currency exchange rates caused a net loss during the three months ended March 31, 2010. The unfavorable fluctuations in first quarter 2010 were principally driven by U.S. dollar positions held at March 31, 2010 affected by the weaker dollar compared to the Mexican peso and Colombian peso, partly offset by the stronger dollar compared to the British pound. Effective December 31, 2009, our Venezuelan entity changed to the parallel market rate (which is subject to market fluctuation, as more fully described in the Financial Position, Liquidity and Capital Resources section) and effective January 1, 2010, we changed to the U.S. dollar as the functional currency for that entity due to the adoption of highly inflationary accounting. Thus, remeasurement of cash denominated in Bolivars at March 31, 2010 is recognized in earnings. This contributed to the unfavorable foreign currency fluctuation in first quarter 2010.
Favorable fluctuations in foreign currency exchange rates caused a net gain during the three months ended March 31, 2009. The favorable fluctuations in first quarter 2009 were principally driven by U.S. dollar positions held at March 31, 2009 affected by the stronger dollar compared to the Mexican peso and Colombian peso.
Income Tax Provision
For the three months ended March 31, 2010 and 2009, ILG recorded tax provisions of $9.7 million and $11.5 million, respectively, which represent effective tax rates of 38.7% and 40.5%, respectively. These tax rates are higher than the federal statutory rate of 35% due principally to state and local income taxes partially offset by foreign income taxed at lower rates. During the three months ended March 31, 2009, the effective tax rate increased due to income taxes associated with the effects of a change in California tax law that was enacted during the quarter.
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As of March 31, 2010 and December 31, 2009, ILG had unrecognized tax benefits of $0.1 million. There were no material increases or decreases in unrecognized tax benefits for the three months ended March 31, 2010. ILG recognizes interest and, if applicable, penalties related to unrecognized tax benefits in income tax expense. There were no material accruals for interest for the three months ended March 31, 2010. As of March 31, 2010, ILG had an accrual of $0.2 million for the payment of interest and penalties.
By virtue of previously filed separate ILG and consolidated tax returns with IAC, ILG is routinely under audit by federal, state, local and foreign authorities. These audits include questioning the timing and the amount of deductions and the allocation of income among various tax jurisdictions. Income taxes payable include amounts considered sufficient to pay assessments that may result from examination of prior year returns; however, the amount paid upon resolution of issues raised may differ from the amount provided. Differences between the reserves for tax contingencies and the amounts owed by ILG are recorded in the period they become known. Under the Tax Sharing Agreement, IAC generally retains the liability related to federal and state returns filed on a consolidated or unitary basis and indemnifies ILG for all consolidated tax liabilities and related interest and penalties for the pre-spin period. ILG believes that it is reasonably possible that its unrecognized tax benefits could decrease by approximately $0.1 million within twelve months of the current reporting date due primarily to anticipated settlements with taxing authorities. An estimate of other changes in unrecognized tax benefits cannot be made, but is not expected to be significant.
Interim Goodwill Impairment Test
During the first quarter, we determined the Aston reporting unit's actual performance was negatively tracking the fair value assumptions used in our annual goodwill impairment test as of October 1, 2009, as evidenced by notable declines in RevPAR relative to the prior projections. Based on this, we concluded that indicators of impairment were present and could result in a reduction in the fair value of our Aston reporting unit below its carrying amount. There were no indicators of impairment pertaining to our Interval reporting unit.
Consequently, we performed an interim impairment test for our Aston reporting unit as of March 31, 2010. The first step of the two step impairment test concluded that the carrying value of our Aston reporting unit exceeded its fair value by approximately 5%. As a result, we performed the second step of the impairment test to measure the amount of any impairment loss, which concluded that Aston's implied fair value of goodwill exceeded the carrying value of goodwill by a marginal amount and, therefore, no impairment loss was recorded. The excess of the implied fair value of goodwill over its carrying value, computed in the second step, was primarily attributable to net declines in the fair value of an asset group consisting of Aston's property management contracts and wholesaler agreements definite-lived intangible assets, certain real estate assets owned by Aston and used in the purveyance of revenue generating services pursuant to the aforementioned property management contracts and wholesaler agreements, and Aston's tradename definite-lived intangible asset. As a result of the decline in fair value of these long-lived assets, we performed a recoverability test pursuant to ASC Topic 360, "Property Plant and Equipment," ("ASC 360") as subsequently discussed in the Recoverability of Long-Lived Assets section below.
As previously discussed in our 2009 Annual Report on Form 10-K, we used the average of an income approach and a market comparison approach to calculate the fair value of our reporting units. In our March 31, 2010 interim impairment test of our Aston reporting unit, we continued to equally weigh the income approach and market comparison approach but also included in our valuation a comparable market transaction, weighed to a lesser extent, which occurred subsequent to our annual impairment test as of October 1, 2009. With respect to our Aston reporting unit's step-one analysis, the primary examples of key estimates include forecasted available and occupied room nights, average daily rates, long-term growth rates, and our discount rate. As a measure of sensitivity on the income
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approach, as of March 31, 2010, a hypothetical 10% change to each of these key estimates collectively would have resulted in a change of approximately $17 million in Aston's income approach fair value, or approximately 180% of the deficit of the fair value of the reporting unit over its carrying value. In regards to the market comparison approach, a change in our estimated EBITDA multiple by 10% would have resulted in a change of approximately $14 million in Aston's market comparison approach fair value, or approximately 147% of the deficit of Aston's fair value over its carrying value. If either of these hypothetical changes had occurred, it is possible that Aston's implied fair value of goodwill would have failed to exceed its carrying value of goodwill and, consequently, a goodwill impairment would have been recorded.
Recoverability of Long-Lived Assets
As of March 31, 2010, as a consequence of Aston failing step-one of the two step process for testing goodwill for impairment, we performed a recoverability test on an asset group within our Aston reporting unit. The asset group consisted of Aston's property management contracts and wholesaler agreements definite-lived intangible assets, certain real estate assets owned by Aston and used in the purveyance of revenue generating services pursuant to the aforementioned property management contracts and wholesaler agreements, and Aston's tradename definite-lived intangible asset. The resulting recoverability analysis concluded that the undiscounted estimated future cash flows of the asset group exceeded its carrying value by approximately 19% of the asset group's carrying value. Accordingly, the asset group was not considered impaired. The measurement period used for the recoverability analysis was 11 years, the remaining useful life of the property management contracts asset (the asset group's primary asset). The fact that the asset group's cash flows exceeded their carrying amounts in our recoverability test is largely because, pursuant to U.S. GAAP, this analysis utilizes an undiscounted cash flow approach. This method differs from the manner in which the fair value of the asset group is calculated as part of our step-two goodwill and other intangibles impairment analysis previously discussed.
Our assumptions on key estimates utilized in the recoverability analysis related largely to Aston's forecasted available and occupied room nights, average daily rates and long-term growth rates. We believe there is a low-to-moderate level of uncertainty associated with the assumptions utilized in the development of these four key estimates. In order to evaluate the sensitivity of the assumptions used in determining the undiscounted estimated future cash flows of the asset group, we applied a hypothetical 10% decrease to each of the four forecasted key estimates as of March 31, 2010. This hypothetical 10% decrease collectively would have resulted in the asset group's carrying value exceeding the undiscounted estimated future cash flows by approximately 9%. If these hypothetical changes had occurred, an impairment would have been recorded.
FINANCIAL POSITION, LIQUIDITY AND CAPITAL RESOURCES
As of March 31, 2010, we had $181.7 million of cash and cash equivalents and restricted cash and cash equivalents, including $54.3 million of U.S. dollar equivalent cash deposits held in foreign jurisdictions, principally the United Kingdom which are subject to changes in foreign exchange rates. Earnings of foreign subsidiaries, except Venezuela, are permanently reinvested. Additional tax provisions would be required should such earnings be repatriated to the U.S. Cash generated by operations is used as our primary source of liquidity. We believe that our cash balances, operating cash flows, and access to our $50.0 million revolving credit facility, taken together, provide adequate resources to fund ongoing operating requirements and future capital expenditures. However, our operating cash flow may be impacted by macroeconomic factors outside of our control.
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Venezuela Operations
We conduct business in Venezuela where currency restrictions exist limiting our ability to immediately access cash through repatriations at the government's official exchange rate. Our access to these funds remains available for use within this jurisdiction and is not restricted.
During 2009, the process of exchanging Venezuelan bolivars to U.S. dollars became increasingly challenging as the government's approval process significantly slowed and became more rigorous. Due to the currency restrictions, a "parallel" market exists whereby entities can exchange Venezuelan bolivars into U.S. dollars through a series of market transactions at a specified, and less favorable, parallel market rate. At December 31, 2009, we determined the parallel market rate was the appropriate rate to use for translating the financial statements of our Venezuelan entity for purposes of consolidation based on the current facts and circumstances of operating in Venezuela. Subsequent to March 31, 2010, we transferred U.S. dollar equivalent cash of $1.7 million from our Venezuelan entity's Bolívar denominated bank account in Venezuela to our Venezuelan entity's U.S. dollar denominated bank account in the U.S., utilizing the parallel market.
Effective January 1, 2010, Venezuela is considered to be highly inflationary. Under U.S. GAAP, an economy is considered to be highly inflationary when the three-year cumulative rate of inflation meets or exceeds 100%. Under the highly inflationary basis of accounting, the financial statements of our Venezuelan entity will be remeasured as if its functional currency were the reporting currency (U.S dollars), with remeasurement gains and losses recognized in earnings, rather than in the cumulative translation adjustment component of other comprehensive income within our stockholders' equity. Consequently, because we have decided to adopt the parallel market rate, which is subject to market fluctuation, and because our Venezuelan entity operates in a highly inflationary economy, future remeasurements could increase the volatility of our results of operations. However, since the majority of the cash is now held in U.S. dollars, our exposure to this volatility is reduced.
We are currently evaluating our options regarding our operations in Venezuela to address these aforementioned considerations and the increasing challenges of physically operating in Venezuela. As of March 31, 2010, we had $3.2 million of after tax unrealized loss in other comprehensive income with stockholders' equity pertaining to our Venezuelan entity until such time we sell or liquidate our investment.
Cash Flows Discussion
Net cash provided by operating activities increased to $32.5 million in the three months ended March 31, 2010 from $13.7 million in 2009. The increase of $18.9 million from 2009 was principally due to lower income taxes paid of $16.5 million, a $5.0 million payment made in the first quarter 2009 in connection with a long-term service agreement entered into in 2009, and a decrease of interest payments of $1.8 million, all partially offset by higher cash expenses and lower interest income in 2010. Lower interest payments in 2010 are due to the lower principal balance outstanding subsequent to the first quarter 2009, slightly lower interest rates and to the timing of certain interest payments.
Net cash used in investing activities of $3.4 million in the three months ended March 31, 2010 resulted from capital expenditures of $3.6 million, offset by a slight decrease in the restricted cash of $0.2 million related to a collateral agreement for merchant transactions in the United Kingdom. In the three months ended March 31, 2009, net cash used in investing activities was $3.7 million which related to capital expenditures.
Net cash used in financing activities of $10.4 million in the three months ended March 31, 2010 was principally due to principal payments of $10.0 million on the term loan and vesting of restricted stock units, net of withholding taxes, net of excess tax benefits from stock-based awards and proceeds from the exercise of warrants and stock options. In the three months ended March 31, 2009, net cash
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used in financing activities was principally due to principal payments of $7.5 million on the term loan and the release of deferred restricted stock units, net of withholding taxes
We have a senior secured credit facility which matures on July 25, 2013 and consists of a $50.0 million revolving credit facility (the "Revolver") and $150.0 million term loan (the "Term Loan"). During 2009, we paid $34.0 million of principal payments on the Term Loan, which included scheduled principal payments through December 31, 2009 and $4.0 million of which was applied pro rata to the remaining scheduled principal payments. During the first quarter 2010, we paid $10 million of principal payments on the Term Loan which included voluntary prepayment of the first quarter 2011 scheduled principal payment and $4.6 million which was applied pro rata to the remaining scheduled principal payments. As of March 31, 2010, we had $106.0 million outstanding on the Term Loan. There have been no borrowings under the Revolver through March 31, 2010. In addition, on August 19, 2008, we issued $300.0 million of aggregate principal amounts of 9.5% Senior Notes due 2016 (the "Interval Senior Notes"), reduced by the original issue discount of $23.5 million of which $20.2 million remains unamortized at March 31, 2010. The secured credit facility effectively ranks prior to the Interval Senior Notes to the extent of the value of the assets that secure it.
The Interval Senior Notes and senior secured credit facility have various financial and operating covenants that place significant restrictions on us, including our ability to incur additional indebtedness, to incur additional liens, issue redeemable stock and preferred stock, pay dividends or distributions or redeem or repurchase capital stock, prepay, redeem or repurchase debt, make loans and investments, enter into agreements that restrict distributions from our subsidiaries, sell assets and capital stock of our subsidiaries, enter into certain transactions with affiliates and consolidate or merge with or into or sell substantially all of our assets to another person. The senior secured credit facility requires us to meet certain financial covenants, requiring the maintenance of a maximum consolidated leverage ratio of consolidated debt over consolidated EBITDA, as defined in the credit agreement (3.90 through December 31, 2009, 3.65 from January 1, 2010 through December 31, 2010 and 3.40 thereafter), and a minimum consolidated interest coverage ratio of consolidated EBITDA over consolidated interest expense, as defined in the credit agreement (2.75 through December 31, 2009 and 3.00 thereafter). In addition, we may be required to use a portion of our consolidated excess cash flow (as defined in the credit agreement) to prepay the senior secured credit facility based on our consolidated leverage ratio at the end of each fiscal year. If our consolidated leverage ratio equals or exceeds 3.5, we must prepay 50% of consolidated excess cash flow, if our consolidated leverage ratio equals or exceeds 2.85 but is less than 3.5, we must prepay 25% of consolidated excess cash flow, and if our consolidated leverage ratio is less than 2.85, then no prepayment is required. As of March 31, 2010, we were in compliance in all material respects with the requirements of all applicable financial and operating covenants and our consolidated leverage ratio and consolidated interest coverage ratio under the credit agreement were 2.74 and 4.43, respectively.
We have funding commitments that could potentially require our performance in the event of demands by third parties or contingent events. At March 31, 2010, guarantees, surety bonds and letters of credit totaled $26.4 million. Guarantees represent $23.8 million of this total and primarily relate to Aston's hotel and resort management agreements, including those with guaranteed dollar amounts, and accommodation leases supporting the management activities, entered into on behalf of the property owners for which either party may terminate such leases upon 60 days prior written notice to each other. In addition, certain of Aston's hotel and resort management agreements provide that owners receive specified percentages of the revenue generated under Aston management. In these cases, the operating expenses for the rental operations are paid from the revenue generated by the rentals, the owners are then paid their contractual percentages, and Aston either retains the balance (if any) as its management fee or makes up the deficit. Although such deficits are reasonably possible in a few of these agreements, amounts are not expected to be significant.
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We anticipate that we will make capital and other expenditures in connection with the development and expansion of our operations. Our ability to fund our cash and capital needs will be affected by our ongoing ability to generate cash from operations, the overall capacity and terms of our financing arrangements as discussed above, and access to the capital markets. We believe that our cash on hand along with our anticipated operating future cash flows and availability under the revolving credit facility are sufficient to fund our operating needs, capital expenditures, debt service, investments and other commitments and contingencies for at least the next twelve months.
Contractual Obligations and Commercial Commitments
Contractual obligations and commercial commitments at March 31, 2010 are as follows:
| Payments Due by Period | ||||||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
Contractual Obligations | Total | Up to 1 year | 1-3 years | 3-5 years | More than 5 years | ||||||||||||
| (Dollars in thousands) | ||||||||||||||||
Debt principal(a) | $ | 406,000 | $ | — | $ | 59,652 | $ | 46,348 | $ | 300,000 | |||||||
Debt interest(a) | 193,486 | 31,979 | 62,858 | 57,910 | 40,739 | ||||||||||||
Purchase obligations(b) | 19,387 | 6,691 | 4,318 | 5,264 | 3,114 | ||||||||||||
Operating leases | 66,401 | 10,718 | 16,799 | 13,888 | 24,996 | ||||||||||||
Total contractual obligations | $ | 685,274 | $ | 49,388 | $ | 143,627 | $ | 123,410 | $ | 368,849 | |||||||
- (a)
- Debt principal and debt interest represent principal and interest to be paid on our Term Loan, Interval Senior Notes and certain fees associated with our credit facility. Interest on the Term Loan is calculated using the prevailing rates as of March 31, 2010.
- (b)
- The purchase obligations primarily relate to future guaranteed purchases of rental inventory, operational support services and membership fulfillment benefits.
| Amount of Commitment Expiration Per Period | |||||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
Other Commercial Commitments(c) | Total Amounts Committed | Less than 1 Year | 1-3 Years | 3-5 Years | More than 5 Years | |||||||||||
| (In thousands) | |||||||||||||||
Guarantees, surety bonds and letters of credit | $ | 26,369 | $ | 11,976 | $ | 5,586 | $ | 3,417 | $ | 5,390 | ||||||
- (c)
- Commercial commitments include minimum revenue guarantees related to Aston's hotel and resort management agreements, Aston's accommodation leases entered into on behalf of the property owners, and funding commitments that could potentially require performance in the event of demands by third parties or contingent events, such as under a letter of credit extended or under guarantees.
Recent Accounting Pronouncements
Refer to Note 2 in the consolidated financial statements for a description of recent accounting pronouncements.
Seasonality
Revenue at ILG is influenced by the seasonal nature of travel. Interval recognizes exchange and Getaway revenue based on confirmation of the vacation, with the first quarter generally experiencing higher revenue and the fourth quarter generally experiencing lower revenue. Aston recognizes revenue based on occupancy, with the first and third quarters generally generating higher revenue and the second and fourth quarters generally generating lower revenue.
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CRITICAL ACCOUNTING POLICIES AND ESTIMATES
The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates, judgments and assumptions that affect the amounts reported in our consolidated financial statements and accompanying notes. On an ongoing basis, we evaluate our estimates which are based on historical experience and on various other assumptions that we believe are reasonable under the circumstances. We have discussed those estimates that we believe are critical and required the use of significant judgment and use of estimates that could have a significant impact on our financial statements in our 2009 Annual Report on Form 10-K. There have been no material changes to our critical accounting policies in the interim period.
ILG'S PRINCIPLES OF FINANCIAL REPORTING
Definition of ILG's Non-GAAP Measure
Earnings Before Interest, Taxes, Depreciation and Amortization is defined as net income excluding, if applicable: (1) non-cash compensation expense, (2) depreciation expense, (3) amortization expense, (4) goodwill and asset impairments, (5) income taxes, (6) interest income and interest expense and (7) other non-operating income and expense. Our presentation of EBITDA may not be comparable to similarly-titled measures used by other companies. We believe this measure is useful to investors because it represents the consolidated operating results from our segments, excluding the effects of any non-cash expenses. We also believe this non-GAAP financial measure improves the transparency of our disclosures, provides a meaningful presentation of our results from our business operations, excluding the impact of certain items not related to our core business operations and improves the period to period comparability of results from business operations. EBITDA has certain limitations in that it does not take into account the impact to our statement of operations of certain expenses, including non-cash compensation. We endeavor to compensate for the limitations of the non-GAAP measure presented by also providing the comparable GAAP measure with equal or greater prominence and descriptions of the reconciling items, including quantifying such items, to derive the non-GAAP measure.
We report EBITDA as a supplemental measure to generally accepted accounting principles ("GAAP"). This measure is one of the primary metrics by which we evaluate the performance of our businesses, on which our internal budgets are based and by which management is compensated. We believe that investors should have access to the same set of tools that we use in analyzing our results. This non-GAAP measure should be considered in addition to results prepared in accordance with GAAP, but should not be considered a substitute for or superior to GAAP results. We provide and encourage investors to examine the reconciling adjustments between the GAAP and non-GAAP measure which are discussed below.
Constant Currency represents current period results of operations determined by translating our functional currency results to U.S. dollars (our reporting currency) using the actual prior year blended rate of translation from the comparable prior period. We believe that this measure improves the period to period comparability of results from business operations as it eliminates the effect of foreign currency translation.
Pro Forma Results
We will only present EBITDA on a pro forma basis if we view a particular transaction as significant in size or transformational in nature. For the periods presented in this report, there are no transactions that we have included on a pro forma basis.
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Non-Cash Expenses That Are Excluded From ILG's Non-GAAP Measure
Non-cash compensation expense consists principally of expense associated with the grants, including unvested grants assumed in acquisitions, of restricted stock, restricted stock units and stock options. These expenses are not paid in cash, and we will include the related shares in our future calculations of diluted shares of stock outstanding. Upon vesting of restricted stock and restricted stock units and the exercise of certain stock options, the awards will be settled, at our discretion, on a net basis, with us remitting the required tax withholding amount from our current funds.
Goodwill and asset impairments is a non-cash expense relating to adjustments to goodwill and long-lived assets whereby the carrying value exceeds the fair value of the related assets, and is infrequent in nature.
Amortization expense of intangibles is a non-cash expense relating primarily to acquisitions. At the time of an acquisition, the intangible assets of the acquired company, such as customer relationships, purchase agreements and resort management agreements are valued and amortized over their estimated lives. We believe that since intangibles represent costs incurred by the acquired company to build value prior to acquisition, they were part of transaction costs.
Depreciation expense is a non-cash expense relating to our property and equipment and does not relate to our core business operations. Depreciation expense is recorded on a straight-line basis to allocate the cost of depreciable assets to operations over their estimated service lives.
The following tables reconcile EBITDA to operating income for our operating segments and to net income attributable to common stockholders in total for the three months ended March 31, 2010 and 2009 (in thousands). The noncontrolling interest relates to Aston which was acquired in May 2007.
| For the Three Months Ended March 31, 2010 | |||||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| EBITDA | Non-Cash Compensation Expense | Depreciation Expense | Amortization Expense of Intangibles | Operating Income | |||||||||||
Interval | $ | 44,514 | $ | (2,301 | ) | $ | (2,260 | ) | $ | (5,257 | ) | $ | 34,696 | |||
Aston | 1,816 | (193 | ) | (188 | ) | (1,318 | ) | 117 | ||||||||
Total | $ | 46,330 | $ | (2,494 | ) | $ | (2,448 | ) | $ | (6,575 | ) | 34,813 | ||||
Interest expense, net | (8,936 | ) | ||||||||||||||
Other expense, net | (734 | ) | ||||||||||||||
Earnings before income taxes and noncontrolling interest | 25,143 | |||||||||||||||
Income tax provision | (9,730 | ) | ||||||||||||||
Net income | 15,413 | |||||||||||||||
Net income attributable to noncontrolling interest | — | |||||||||||||||
Net income attributable to common stockholders | $ | 15,413 | ||||||||||||||
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| For the Three Months Ended March 31, 2009 | |||||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| EBITDA | Non-Cash Compensation Expense | Depreciation Expense | Amortization Expense of Intangibles | Operating Income | |||||||||||
Interval | $ | 44,256 | $ | (1,827 | ) | $ | (1,958 | ) | $ | (5,240 | ) | $ | 35,231 | |||
Aston | 2,297 | (118 | ) | (205 | ) | (1,236 | ) | 738 | ||||||||
Total | $ | 46,553 | $ | (1,945 | ) | $ | (2,163 | ) | $ | (6,476 | ) | 35,969 | ||||
Interest expense, net | (9,076 | ) | ||||||||||||||
Other income, net | 1,410 | |||||||||||||||
Earnings before income taxes and noncontrolling interest | 28,303 | |||||||||||||||
Income tax provision | (11,467 | ) | ||||||||||||||
Net income | 16,836 | |||||||||||||||
Net income attributable to noncontrolling interest | (2 | ) | ||||||||||||||
Net income attributable to common stockholders | $ | 16,834 | ||||||||||||||
Item 3. Quantitative and Qualitative Disclosures about Market Risk
Foreign Currency Exchange Risk
We conduct business in certain foreign markets, primarily in the United Kingdom and the European Union. Our foreign currency risk primarily relates to our investments in foreign subsidiaries that transact business in a functional currency other than the U.S. Dollar. This exposure is mitigated as we have generally reinvested profits in our international operations. In addition, we are exposed to foreign currency risk related to our assets and liabilities denominated in a currency other than the functional currency.
As currency exchange rates change, translation of the income statements of our international businesses into U.S. dollars affects year-over-year comparability of operating results. Historically, we have not hedged translation risks because cash flows from international operations were generally reinvested locally. Non-operating foreign exchange net loss for the three months ended March 31, 2010 was $0.8 million and net gain for the three months ended March 31, 2009 was $1.4 million attributable to cash held in certain countries in currencies other than their local currency. This was principally driven by U.S. dollar positions held at December 31, 2009 and 2008 affected by the shift in the value of the dollar to the British pound, Mexican peso, Colombian peso, and the Venezuelan Bolivar. The Venezuelan Bolivar impacted our non-operating foreign exchange net loss in the first quarter 2010 given our change to the U.S. dollar as the functional currency for that entity due to highly inflationary accounting. However, the subsequent transfer of the majority of the cash from our Venezuelan entity's Bolivar denominated bank account in Venezuela to our Venezuelan entity's U.S. dollar denominated bank account in the U.S. has reduced the exposure going forward.
As we increase our operations in international markets we become increasingly exposed to potentially volatile movements in currency exchange rates. The economic impact of currency exchange rate movements on us is often linked to variability in real growth, inflation, interest rates, governmental actions and other factors. These changes, if material, could cause us to adjust our financing, operating and hedging strategies. A hypothetical 10% weakening/strengthening in foreign exchange rates to the U.S. dollar at March 31, 2010 would result in an approximate change to revenue of $1.0 million. There have been no material quantitative changes in market risk exposures since December 31, 2009.
Interest Rate Risk
At March 31, 2010, we had $106.0 million outstanding under the term loan facility. Based on the amount outstanding, a 100 basis point change in interest rates would result in an approximate change
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to interest expense of $1.1 million. Additionally, at March 31, 2010, we had $300.0 million (face amount) of Interval Senior Notes that bear interest at a fixed amount. If market rates decline, we run the risk that the required payments on the fixed rate debt will exceed those based on market rates. Based on our mix of fixed rate and floating rate debt and cash balances, we do not currently hedge our interest rate exposure. There have been no material quantitative changes in market risk exposures since December 31, 2009.
Item 4. Controls and Procedures
We monitor and evaluate on an ongoing basis our disclosure controls and internal control over financial reporting in order to improve our overall effectiveness. In the course of this evaluation, we modify and refine our internal processes as conditions warrant.
As required by Rule 13a-15(b) under the Securities Exchange Act of 1934, as amended (the "Exchange Act"), our management, including our Chief Executive Officer, Chief Financial Officer and Chief Accounting Officer, evaluated the effectiveness of our disclosure controls and procedures (as defined by Rule 13a-15(e) and 15d-15(e) under the Exchange Act). Based upon that evaluation, our Chief Executive Officer, Chief Financial Officer and Chief Accounting Officer concluded that as of the end of the period covered by this report, our disclosure controls and procedures were effective in providing reasonable assurance that information we are required to disclose in our filings with the Securities and Exchange Commission under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the Commission's rules and forms, and include controls and procedures designed to ensure that information required to be disclosed by us in the reports that we file or submit under the Exchange Act is accumulated and communicated to our management, including our principal executive and principal financial officers, as appropriate to allow timely decisions regarding required disclosure.
As required by Rule 13a-15(d) of the Exchange Act, we, under the supervision and with the participation of our management, including the Chief Executive Officer, Chief Financial Officer and Chief Accounting Officer, also evaluated whether any changes occurred to our internal control over financial reporting during the period covered by this report that have materially affected, or are reasonably likely to materially affect, such control. Based on that evaluation, there have been no material changes to internal controls over financial reporting.
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See Part I, Item IA., "Risk Factors," of ILG's Annual Report on Form 10-K for the year ended December 31, 2009, for a detailed discussion of the risk factors affecting ILG. There have been no material changes from the risk factors described in the annual report.
Exhibit Number | Description | Location | |||
---|---|---|---|---|---|
3.1 | Amended and Restated Certificate of Incorporation of Interval Leisure Group, Inc. | Exhibit 3.1 to ILG's Current Report on Form 8-K, filed on August 25, 2008. | |||
3.2 | Certificate of Designations, Preferences and Rights to Series A Junior Participating Preferred Stock | Exhibit 3.2 to ILG's Quarterly Report on Form 10-Q, filed on August 11, 2009. | |||
3.3 | Amended and Restated By-Laws of Interval Leisure Group, Inc. | Exhibit 3.2 to ILG's Current Report on Form 8-K, filed on August 25, 2008. | |||
31.1 | † | Certification of the Chief Executive Officer pursuant to Rule 13a-14(a) or Rule 15d-14(a) of the Securities Exchange Act of 1934 as adopted pursuant to Section 302 of the Sarbanes-Oxley Act | |||
31.2 | † | Certification of the Chief Financial Officer pursuant to Rule 13a-14(a) or Rule 15d-14(a) of the Securities Exchange Act of 1934 as adopted pursuant to Section 302 of the Sarbanes-Oxley Act | |||
31.3 | † | Certification of the Chief Accounting Officer pursuant to Rule 13a-14(a) or Rule 15d-14(a) of the Securities Exchange Act of 1934 as adopted pursuant to Section 302 of the Sarbanes-Oxley Act | |||
32.1 | †† | Certification of the Chief Executive Officer pursuant to 18 U.S.C. Section 1350 as adopted pursuant to Section 906 of the Sarbanes-Oxley Act | |||
32.2 | †† | Certification of the Chief Financial Officer pursuant to 18 U.S.C. Section 1350 as adopted pursuant to Section 906 of the Sarbanes-Oxley Act | |||
32.3 | †† | Certification of the Chief Accounting Officer pursuant to 18 U.S.C. Section 1350 as adopted pursuant to Section 906 of the Sarbanes-Oxley Act |
- †
- Filed herewith.
- ††
- Furnished herewith.
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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.
Date: May 6, 2010
INTERVAL LEISURE GROUP, INC. | ||||
By: | /s/ WILLIAM L. HARVEY William L. Harvey Chief Financial Officer | |||
By: | /s/ JOHN A. GALEA John A. Galea Chief Accounting Officer |
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PART 1—FINANCIAL STATEMENTS
INTERVAL LEISURE GROUP, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF INCOME (In thousands, except per share data) (Unaudited)
INTERVAL LEISURE GROUP, INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS (In thousands, except share and per share data)
INTERVAL LEISURE GROUP, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY (Unaudited)
INTERVAL LEISURE GROUP, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited)
INTERVAL LEISURE GROUP, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED STATEMENTS March 31, 2010 (Unaudited)
GENERAL
FINANCIAL POSITION, LIQUIDITY AND CAPITAL RESOURCES
CRITICAL ACCOUNTING POLICIES AND ESTIMATES
ILG'S PRINCIPLES OF FINANCIAL REPORTING
RECONCILIATION OF EBITDA
PART II OTHER INFORMATION
SIGNATURES