Financial Section
Forward-Looking Statements
This Annual Report contains "forward-looking statements" within the meaning of
the federal securities laws, including statements concerning the Company's
future prospects and financial performance, expansion plans, business strategies
and their intended results, and similar statements about anticipated future
events and expectations that are not historical facts. Such statements are
subject to numerous risks and uncertainties, including the effects of economic
conditions, interest rates, consumer demand, payment and default risks on
customer mortgages receivable, competitive conditions, the impact of government
regulations and approval requirements, the availability and cost of capital to
finance future growth, the ability to acquire, develop and sell vacation
ownership inventory cost-effectively, the availability of qualified personnel,
the ability to transfer the experience and historical operating results of the
Company's mature resorts to its new properties, the ability to avoid disruption
from year 2000 technology problems, the satisfactory completion of proposed
joint venture, licensing, financing and other agreements, and the satisfaction
of various conditions and compliance with various covenants contained in the
Company's existing agreements. Such risks could cause actual results to differ
materially from those expressed or implied by the forward-looking statements
contained in this Annual Report.
Financial Contents
Selected Financial Data...............................................18
Management's Discussion and Analysis..................................19
Report of Management..................................................28
Report of KPMG LLP....................................................29
Consolidated Balance Sheets...........................................30
Consolidated Statements of Income.....................................31
Consolidated Statements of Shareholders' Equity.......................32
Consolidated Statements of Cash Flows.................................33
Notes to Consolidated Financial Statements............................34
Common Stock Data......................................Inside Back Cover
Selected Financial Data
The following table sets forth selected financial data of the Company for the
years ended December 31, 1998, 1997, 1996, 1995, and 1994. The selected
financial data of the Company for the three years ended December 31, 1998, was
derived from the Company's consolidated financial statements which were audited
by KPMG LLP, independent auditors, whose report with respect to the three-year
period ended December 31, 1998, together with such consolidated financial
statements, appears elsewhere herein.
The information set forth below should be read in conjunction with "Management's
Discussion and Analysis of Financial Condition and Results of Operations" and
the historical consolidated financial statements of the Company and Notes
thereto appearing elsewhere in this Annual Report.
(in thousands except per share amounts) 1998 1997 1996 1995 1994
- ----------------------------------------------------------------------------------------------------------
Operating Results for the Years Ended December 31:
Vacation Ownership Interest sales $172,872 $100,887 $ 60,063 $ 50,156 $ 54,186
Interest income 26,538 19,296 15,546 12,886 7,654
Total revenues 233,722 145,352 96,936 81,109 77,636
Vacation Ownership Interest cost of sales 38,622 22,898 14,595 12,053 11,391
Sales and marketing expense 83,138 45,616 27,877 22,318 22,872
Total interest expense 12,909 8,945 11,019 9,684 5,711
Provision for doubtful accounts 12,792 6,971 4,271 3,522 3,803
General and administrative expense 17,869 11,988 7,873 6,979 7,988
Total costs and operating expenses 202,840 122,906 86,447 75,478 67,287
Operating income 30,882 22,446 10,489 5,631 10,349
Income before income taxes and extraordinary item 33,303 23,025 10,594 5,850 10,714
Provision for taxes 12,655 8,101 -- -- --
Non-recurring charge associated
with the change of tax status -- 13,201 -- -- --
Income before extraordinary item 20,648 1,723 10,594 5,850 10,714
Extraordinary item-early
extinguishment of debt (net of tax) -- (1,425) -- -- --
Net income $ 20,648 $ 298 $ 10,594 $ 5,850 $ 10,714
Net income per share--diluted .96 $ .02 $ -- $ -- $ --
Pro forma income before income taxes $ -- $ 23,025 $ 10,594 $ 5,850 $ --
Pro forma net income -- 12,874 6,568 3,627 --
Pro forma net income per share--diluted $ -- $ .69 $ .46 $ .26 $ --
- ----------------------------------------------------------------------------------------------------------
Balance Sheet Data as of December 31:
Total assets $471,420 $287,209 $173,922 $140,651 $117,989
Notes and mortgages payable $242,644 $109,547 $118,557 $101,504 $ 64,769
Shareholder's equity $144,216 $119,405 $ 26,648 $ 17,904 $ 33,658
18 SELECTED FINANCIAL DATA
Management's Discussion and Analysis of
Financial Condition and Results of Operations
The Company was organized in December 1996 to combine the vacation ownership
resort acquisition, development and management businesses conducted by the
Company's corporate and partnership predecessors. The Company generates revenues
from the sale and financing of annual and alternate-year Vacation Ownership
Interests ("VOI's") at its resorts, which typically entitle the purchaser to
ownership of a fully-furnished unit for a one-week period, on either an annual
or alternate-year basis, in perpetuity. For purposes of the following
discussion, unless otherwise noted, sales of VOI's reflect sales of both annual
VOI's and alternate-year VOI's, each as a sale of a single VOI. The Company
generates additional revenues from resort operations, which include room rental
operations and auxiliary resort operations such as food and beverage sales, and
from management fees and telecommunications services provided by the Company at
its resorts.
The Company recognizes revenues attributable to sales of VOI's on an accrual
basis after the execution of a binding sales contract between the Company and
the purchaser and receipt by the Company of a down payment of at least 10% of
the sales price. In connection with the Embassy Vacation Resort at Myrtle Beach,
South Carolina, the Embassy Vacation Resort at Scottsdale, Arizona, and Lakeside
Terrace Condominiums at Avon, Colorado, the Company has sold or is selling, and
may in the future sell at other resorts, VOI's prior to completion of
construction. To the extent the Company sells VOI's prior to completion of
construction, the Company recognizes such sales in accordance with the
percentage of completion method. Under this method, costs associated with the
acquisition and development of vacation ownership resorts, including carrying
costs such as interest and taxes, and sales and marketing costs, are generally
capitalized and subsequently recorded as the related revenues are recognized.
The Company, through its predecessor corporations and partnerships, has operated
in the vacation ownership industry since 1980. In November 1991, Messrs. Gellein
and Adler, together with a third individual, acquired the Company from a
corporate entity that had purchased the Company in 1986. In May 1995, the
Company purchased the entire interest in the Company held by the third
individual, who was a shareholder/executive of the Company (the "Executive
Repurchase"). Also in 1995, the Company redeemed options (the "Option
Redemption") to purchase interests in the partnerships which operate Vistana
Resort Orlando and Vistana's Beach Club, which were held by two institutions
that had purchased receivables from the Company. Together, the Executive
Repurchase and the Option Redemption affected the financial results in that the
Company incurred additional debt to finance the Executive Repurchase and the
Option Redemption. Additionally, in connection with the Executive Repurchase,
the Company paid its former shareholder/executive for a five-year covenant not
to compete, which is being amortized through April 2000.
In February 1997, the Company completed its initial public offering (the
"Initial Offering") of common stock, using the majority of the $49.5 million net
proceeds to repay outstanding indebtedness. In September 1997, the Company
acquired the Success Companies and Points of Colorado ("Success and Points") in
a business combination accounted for as a purchase. Also, in December 1997, the
Company completed a secondary offering of common stock (the "Secondary
Offering") using all of the $41.5 million net proceeds to repay outstanding
indebtedness.
Results of Operations
The following discussion of results of operations relates to entities comprising
the Company on a consolidated basis. Results of operations only reflect
operations of entities in existence for each respective reporting year. The
following table sets forth certain consolidated operating information for the
entities comprising the Company for the three years ended December 31, 1998,
1997, and 1996.
1998 1997 1996
- --------------------------------------------------------------------------------
Statement of Operations:
As a percentage of Total Revenues
VOI sales 74.0% 69.4% 62.0%
Interest income 11.4% 13.3% 16.0%
Resort revenue 8.9% 11.6% 14.0%
Telecommunications revenue 3.9% 5.2% 7.3%
Other revenue 1.8% 0.5% 0.7%
---------------------------
Total revenues 100.0% 100.0% 100.0%
===========================
As a percentage of VOI Sales
VOI cost of sales (product cost) 22.3% 22.7% 24.3%
Sales and marketing expense 48.1% 45.2% 46.4%
Provision for doubtful accounts 7.4% 6.9% 7.1%
As a percentage of Interest Income
Interest expense--treasury 33.4% 37.5% 44.2%
As a percentage of Total Revenues
General and administrative expense 7.7% 8.2% 8.1%
Depreciation and amortization expense 2.7% 2.4% 2.6%
Interest expense--other 1.7% 1.2% 4.3%
Other expense 2.5% 2.1% 0.5%
Total costs and operating expenses 86.8% 84.6% 89.2%
As a percentage of Resort Revenues
Resort expenses/(1)/ 85.9% 82.2% 81.6%
As a percentage of Telecommunications Revenues
Telecommunications expenses/(1)/ 81.2% 81.5% 79.6%
Selected Operating Data:
Number of resorts at year-end 8 6 3
Number of VOI's sold - actual/(2)/ 18,137 10,260 5,794
Average price of VOI's sold - actual/(2)/ $ 9,734 $ 9,833 $10,366
Number of VOI's sold - annualized/(3)/ 14,769 8,747 4,877
Average sales price per VOI - annualized/(3)/ $11,954 $11,534 $12,316
Percentage of alternate unit week sales 37.1% 29.5% 31.7%
Number of VOI's in inventory at end of period/(4)/ 21,334 14,405 14,774
(1) Does not include interest and depreciation expenses.
(2) Includes sales of both annual and alternate-year VOI's.
(3) Includes sales of annual intervals plus sales of alternate year intervals
adjusted on an annualized basis.
(4) Inventory classified as annual VOI's.
MANAGEMENT'S DISCUSSION AND ANALYSIS 19
Management's Discussion and Analysis of Financial
Condition and Results of Operations
Comparison of the Year Ended
December 31, 1998 to the Year
Ended December 31, 1997
For the year ended December 31, 1998, the Company recognized total revenues of
$233.7 million compared to $145.4 million for 1997, an increase of $88.3 million
or 60.7%. This increase is primarily due to a $72.0 million, or 71.4%, increase
in sales of VOI's from $100.9 million during 1997 to $172.9 million during 1998.
VOI sales increased due to a 76.8% increase in the number of VOI's sold from
10,260 in 1997 to 18,137 in 1998, offset slightly by a 1.0% decrease in the
average sales price. Annualizing alternate year VOI sales, the number of VOI's
sold during the year ended December 31, 1998, increased 68.8%, to 14,769 from
8,747, and the average sales price per interval increased 3.6%, to $11,954 from
$11,534. The increase in VOI sales resulted from the contributions made by
Success and Points which were included in sales for all of 1998 and for
essentially only the fourth quarter in 1997, increased VOI sales at the
Company's Orlando area resorts and its resort at Myrtle Beach, and VOI sales at
the World Golf Village, Lakeside Terrace and Scottsdale resorts which are
included in revenues in 1998 but not in 1997. The decrease in average sales
price primarily resulted from an increasing product mix of resorts with lower
price points including Hampton Vacation Resort--Oak Plantation and certain of
the Success and Points resorts and sales of alternate year VOI's. The increase
in the number of VOI's sold was also the product of expanded sales and marketing
programs in Central Florida.
Interest income increased $7.2 million or 37.3% to $26.5 million from $19.3
million due to a 44.1% increase in the principal amount of net customer
mortgages receivable from $155.0 million to $223.3 million, and an increase in
the weighted average stated yield on customer mortgages receivable from 14.2% to
14.7%. Interest income includes discount amortization on customer mortgages
receivable of $1.6 million and $3.1 million recognized during the twelve month
periods ended December 31, 1998 and December 31, 1997, respectively, relating to
the repurchase of customer mortgages receivable. This discount resulted from a
1995 transaction in which the Company re-acquired customer mortgages receivable
(pursuant to a related clean-up call provision pertaining to the original
transaction) which had been previously sold in 1991, as well as recognition of a
discount on certain customer mortgages receivable repurchased in 1996 (pursuant
to a related clean-up call provision pertaining to the original transaction)
from an investment partnership. As of December 31, 1998, $0.8 million of total
unamortized discount remained and is expected to be amortized through 1999.
Resort revenue increased $3.8 million or 22.5% from $16.9 million to $20.7
million, primarily as a result of increased room rentals due to the increase in
rooms available and occupancy levels. Telecommunication revenues (guest
telephone charges relating to existing resorts and revenues from contracting
services provided to third parties) increased $1.6 million or 21.3% from $7.5
million in 1997 to $9.1 million in 1998 due to an increase in contract revenues
and higher resort occupancies.
Total costs and operating expenses increased $79.9 million or 65.0% from $122.9
million in 1997 to $202.8 million in 1998, an increase as a percentage of total
revenues from 84.6% in 1997 to 86.8% in 1998. VOI cost of sales (product cost),
as a percentage of VOI revenues, decreased from 22.7% in 1997 to 22.3% in 1998,
as a result of increased sales volumes, a broader product mix and increased
sales of alternate year VOI's. VOI cost of sales is expected to increase in
future periods as new resorts having higher land and construction costs comprise
a larger part of the Company's VOI sales. In 1998, this anticipated trend was
largely offset by an increase in the relative percentage of alternate year VOI
sales which carry a higher product margin. Alternate year unit week prices are
typically set at 60% to 65% of annual unit week prices. Sales and marketing
expenses increased 82.2% from $45.6 million in 1997 to $83.1 million in 1998,
principally due to the 71.4% increase in related VOI sales as well as costs
associated with the expansion of the Company's off-site international operations
and operating inefficiencies at newer resorts and adverse effects of seasonality
at the Company's Myrtle Beach resort (which opened in May 1998). As a percentage
of VOI sales, selling and marketing expenses increased from 45.2% in 1997 to
48.1% in 1998 primarily as a result of increased marketing costs and lower than
anticipated sales from the off-site operations of the Company's international
subsidiary, which was adversely affected by economic and weather conditions in
South and Central America and hurricane damage in the Caribbean basin. The
Company has closed several of its off-site offices in South and Central America
and is evaluating other action intended to reduce the sales and marketing costs
of its off-site international business. Certain of these remedial actions may
increase costs in the short term. Sales and marketing costs at the Company's
newer resorts are generally higher than at its mature properties, primarily as a
result of start-up costs and sales inefficiencies currently anticipated during
at least the first 12 to 24 months of new resort operations, as well as the
lower percentage of in-house VOI sales (which typically carry higher margins)
available at newer resorts.
The Company is currently developing or planning three proposed new resorts and
is evaluating other resort opportunities. Many of these proposed resorts are
located in areas where the Company has not previously conducted business. As
these new resorts move into sales and
20 MANAGEMENT'S DISCUSSION AND ANALYSIS
constitute a greater proportion of the Company's total revenues and expenses,
they will have an increasing impact on the Company's results of operations. If
the Company is unable to achieve the revenues, cost of sales, and sales and
marketing expenses targeted for these new resorts, the resulting differences
could have a material adverse effect on the Company's results of operations.
Loan portfolio expenses consist of interest expense-treasury and the provision
for doubtful accounts. Interest expense-treasury increased 23.6% to $8.9 million
in 1998 from $7.2 million in 1997, primarily as a result of increased levels of
debt secured by customer mortgages receivable offset by a lower average cost of
funds. Because a significant majority of the Company's indebtedness bears
interest at variable rates and the Company's customer mortgages receivable earn
interest at fixed rates, increases in short-term interest rates could have an
adverse effect on the net interest margin earned by the Company on its customer
mortgages receivable. Provision for doubtful accounts increased to 7.4% of VOI
sales in 1998 compared to 6.9% in 1997. The Company periodically monitors its
allowance for doubtful accounts to provide for future losses associated with any
defaults on customer mortgages receivable. Management believes that the
allowance is adequate for such future losses.
Resort and telecommunication expenses increased at a rate commensurate with that
of related revenues. General and administrative expenses increased $5.9 million
or 49.2% from $12.0 million for 1997 to $17.9 million for 1998, decreasing as a
percent of total revenues from 8.2% in 1997 to 7.7% in 1998. The decrease in
general and administrative expenses as a percentage of total revenues was
primarily the result of economies of scale relating to increased revenue levels.
Depreciation and amortization increased to 2.7% of total revenues in 1998
compared to 2.4% in 1997, primarily due to capital additions during the current
year for resort and sales facilities and information technology assets. Interest
expense-other increased as a percentage of total revenue from 1.2% in 1997 to
1.7% in 1998 due to increased borrowings secured by real estate and unsecured
borrowings. Interest expense-other excludes amounts capitalized of $3.2 million
in 1998 and $1.9 million in 1997.
Other income increased $3.8 million or 542.9% from $0.7 million in 1997 to $4.5
million in 1998 primarily as a result of the net sales of premium ticket
inventory from a marketing company in Central Florida acquired in the fourth
quarter of 1997. The increase in other expenses of $2.9 million or 96.7% from
$3.0 million to $5.9 million primarily reflects the costs associated with
operating the acquired company. Minority interest increased $1.8 million from
$0.5 million in 1997 to $2.3 million in 1998 reflecting an increased loss from
operations from consolidated ventures which are not wholly owned.
Operating income, excluding amounts for excess value recognized and minority
interest, increased $8.5 million or 37.9% to $30.9 million, or 13.2% of total
revenues, during 1998 from $22.4 million, or 15.4% of total revenues, during
1997.
Comparison of the Year Ended
December 31, 1997 to the Year
Ended December 31, 1996
For the year ended December 31, 1997, the Company recognized total revenues of
$145.4 million compared to $96.9 million for 1996, an increase of $48.5 million
or 50.1%. This increase is primarily due to a $40.8 million, or 67.9%, increase
in sales of VOI's from $60.1 million during 1996 to $100.9 million during 1997.
VOI sales increased due to a 77.1% increase in the number of VOI's sold from
5,794 in 1996 to 10,260 in 1997, reduced by a 5.1% decrease in the average sales
price. Annualizing alternate year VOI sales, the number of VOI's sold during the
year ended December 31, 1997, increased 79.4% to 8,747 from 4,877, and the
average sales price per interval decreased 6.4%, to $11,534 from $12,316. The
increase in VOI sales resulted from record sales levels at the Company's
flagship Vistana Resort in Orlando, Florida, and the addition of Success and
Points beginning September 16, 1997. The decrease in average sales price
primarily resulted from an increasing product mix of resorts with lower price
points including Hampton Vacation Resort--Oak Plantation and certain resorts
acquired in the Success and Points transaction. The increase in VOI's sold was
also the product of expanded sales and marketing programs, both in Central
Florida and internationally, and sales of VOI's at the Hampton Vacation Resort--
Oak Plantation which were included in sales for all of 1997 and for a limited
period in 1996.
Interest income increased $3.8 million or 24.5% to $19.3 million from $15.5
million due to a 54.7% increase in the principal amount of net customer
mortgages receivable from $100.2 million to $155.0 million, offset by a decline
in the weighted average stated yield on customer mortgages receivable from 14.4%
to 14.2%. Interest income includes discount amortization on customer mortages
receivable of $3.1 million and $2.8 million recognized during the twelve month
periods ended Decemeber 31, 1997 and December 31, 1996, respectively, relating
to the repurchase of customer mortgages receivable. This discount resulted from
a 1995 transaction in which the Company re-acquired customer mortgages
receivable (pursuant to a related clean-up call provision pertaining to the
original transaction) which had been previously sold in 1991, as well as
recognition of a discount on certain customer mortgages receivable repurchased
in 1996 (pursuant to a related clean-up call provision
MANAGEMENT'S DISCUSSION AND ANALYSIS 21
Management's Discussion and Analysis of
Financial Condition and Results of Operations
pertaining to the original transaction) from an investment partnership. As of
December 31, 1997, $2.5 million of total unamortized discount remained and is
expected to be amortized through 1999.
Resort revenue increased $3.3 million or 24.3% from $13.6 million to $16.9
million, primarily as a result of increased room rentals including the impact of
Hampton Vacation Resort--Oak Plantation, which is included for all of 1997 and
for a limited period in 1996. Telecommunication revenues (guest telephone
charges relating to the existing resorts and revenues from contracting services
provided to third parties) increased $0.4 million or 5.6% from $7.1 million in
1996 to $7.5 million in 1997.
Total costs and operating expenses increased $36.4 million or 42.1% from $86.5
million in 1996 to $122.9 million in 1997, but declined as a percentage of total
revenue from 89.2% in 1996 to 84.6% in 1997. VOI cost of sales, as a percentage
of VOI sales, decreased from 24.3% in 1996 to 22.7% in 1997, as a result of
current period sales at Vistana Resort of phases with relatively lower per unit
costs and at Hampton Vacation Resort--Oak Plantation of units having a lower
product cost. Sales and marketing expenses increased 63.4% from $27.9 million in
1996 to $45.6 million in 1997, principally due to the 67.9% increase in related
VOI sales. As a percentage of VOI sales, selling and marketing expenses
decreased from 46.4% in 1996 to 45.2% in 1997 primarily as a result of lower
sales and marketing costs at Vistana Resort due primarily to increased operating
efficiencies.
Loan portfolio expenses consist of interest expense-treasury and the provision
for doubtful accounts. Interest expense-treasury increased 4.4% to $7.2 million
in 1997 from $6.9 million in 1996 primarily as a result of increased borrowing
levels in the second half of 1997. Interest expense-treasury increased at a
lower rate than the increase in customer mortgages receivable, net, primarily
due to the repayment of debt during 1997 with proceeds from the Initial Offering
and Secondary Offering. Provision for doubtful accounts decreased to 6.9% of VOI
sales in 1997 compared to 7.1% in 1996 due primarily to the impact of Success
and Points which had a lower provision and loss rate than the Company's
historical levels. The Company periodically monitors its allowance for doubtful
accounts to provide for future losses associated with any defaults on customer
mortgages receivable and provides for additions to the allowance for loss on
receivables through its provision for doubtful accounts on an annual basis.
Management believes that the allowance is adequate for such future losses.
Because substantially all of the Company's indebtedness bears interest at
variable rates and the Company's customer mortgages receivable earn interest at
fixed rates, increases in short-term interest rates could have an adverse effect
on the net interest margin earned by the Company on its customer mortgages
receivable.
Resort and telecommunication expenses increased at a rate commensurate with that
of related revenues. General and administrative expenses increased $4.1 million
or 51.9% from $7.9 million for 1996 to $12.0 million for 1997, increasing as a
percent of total revenues from 8.1% in 1996 to 8.2% in 1997. The increase in
general and administrative expenses was primarily the result of (i) increased
revenue levels and commensurate business activities; (ii) the addition of a
number of senior managers and executives to build the management and
organizational infrastructure necessary to efficiently manage the Company's
future growth; (iii) the Company's expenses as a public company, including the
filing of periodic public reports; and (iv) added salary, travel and office
expenses attributable to the current and planned growth in the size of the
Company. Depreciation and amortization decreased to 2.4% of total revenues in
1997 compared to 2.6% in 1996, reflecting the added costs of depreciation from
capital additions being spread over a larger revenue base. Interest expense-
other decreased as a percentage of total revenue from 4.3% in 1996 to 1.2% in
1997 due to the early extinguishment of debt from funds provided by the Initial
Offering and the Secondary Offering. Interest expense-other excludes amounts
capitalized of $1.9 million in 1997 and $0.4 million in 1996.
Other income remained essentially flat at $0.7 million in 1997 and 1996. Other
expenses increased $2.6 million from $0.4 million in 1996 to $3.0 million in
1997 due to the addition of new resort operations and costs affiliated with the
transition as a public company. Minority interest was $0.5 million in 1997
reflecting a loss from consolidated ventures not wholly owned, including the
commencement of Vistana Resort at World Golf Village.
Operating income increased $12.0 million or 114.3% to $22.5 million, or 15.4% of
total revenues, during 1997 from $10.5 million, or 10.8% of total revenues,
during 1996.
During 1997, in connection with the Initial Offering and Secondary Offering, the
Company repaid approximately $81.2 million of debt. As a result of the early
extinguishment of debt, the Company recorded an extraordinary charge relating to
the write-off of previously capitalized fees and incurrence of prepayment
penalties totaling $1.4 million, net of related tax benefits of $0.8 million.
22 MANAGEMENT'S DISCUSSION AND ANALYSIS
Income Taxes
As the result of the transactions which occurred simultaneously with the Initial
Offering, the Company became subject to federal, state and foreign income taxes
during 1997 and was required to record a nonrecurring deferred tax liability of
$13.2 million for cumulative temporary differences between financial reporting
and tax reporting. In 1997, the Company also recorded an income tax expense
provision of $8.1 million, excluding the $0.8 million benefit relating to the
extraordinary item that was recorded net of tax. The provision for income taxes
for the year ended December 31, 1997 reflects the income tax expense from the
date of the Initial Offering through December 31, 1997.
The Company reports most of its sales of VOI's on the installment method for
federal income tax purposes. As a result, the Company does not recognize taxable
income on these sales until the installment payments have been received from the
Company's customers. In the quarter ended June 30, 1997, the Company became
subject to the federal alternative minimum tax ("AMT") as a result of the
deferred income, which results from the installment sales method. The Company
also began paying State of Florida AMT during that period. The Company currently
anticipates that it will continue to be subject to the federal AMT and will
continue to pay Florida AMT during future periods.
Under Section 453(l) of the Internal Revenue Code, interest may be imposed on
the amount of tax attributable to the installment payments on customer mortgages
receivable for the period beginning on the date of sale and ending on the date
the related tax is paid. If the Company is otherwise not subject to pay tax in a
particular year, no interest is imposed since the interest is based on the
amount of tax paid in that year. The Company has not included a provision for
any of this interest since it is not currently subject to tax; however, in the
future it may become so. The Company continues to monitor its tax provision and
may adjust it to provide for this interest in the future.
Liquidity and Capital Resources
The Company generates cash from operations from the sales and financing of
VOI's, resort operations, management activities and telecommunication services.
With respect to the sale of VOI's, the Company generates cash for operations
from (i) customer down payments and (ii) third party financing of customer
mortgages receivable in amounts typically equal to 90% of the related customer
mortgage receivable. The Company generates additional cash from the financing of
VOI's equal to the difference between the interest received on the customer
mortgages receivable and the interest paid on the notes payable secured by the
Company's pledge of such customer mortgages receivable (which averaged 8.4% at
December 31, 1998). As of December 31, 1998 the customer mortgages receivable
portfolio averaged a 14.7% stated rate of interest. Net cash provided by
operations decreased to $3.4 million for the twelve months ended December 31,
1998 from $9.5 million for the prior year due primarily to increased
construction activities relative to resort development. In addition, the
decrease was affected by increases in deferred financing fees incurred in
connection with increased borrowings, including the securitization transaction
described below, and increased levels of capitalized sales and marketing
materials. The impact of construction activities was principally offset by
increased levels of customer deposits and the allowance for doubtful accounts
which both reflect increased VOI sales and the growing customer mortgages
receivable portfolio. Land acquisitions and construction and development
activities for new and existing resorts are expected to require increased
amounts of cash during future periods.
Net cash used in investing activities for the twelve months ended December 31,
1998 and 1997 was $127.8 million and $75.0 million, respectively, principally
due to increased sales of VOI's, and the related increase in origination of
customer mortgages receivable and restricted cash levels associated with the
escrow of customer deposits. Additions to restricted cash also reflect the
accumulation of the reserve fund in connection with the securitization
transaction described below. Increased expenditures for land, property and
equipment, and resort and sales facilities also impacted the change.
Net cash provided by financing activities increased to $134.5 million during
1998 from $69.3 million in 1997, as a result of increased net borrowings
primarily from the financing of customer mortgages receivable, the
securitization, the financing of construction activities, and the acquisition of
land intended for development. Net cash provided by financing activities in 1997
was primarily due to the Initial Offering and Secondary Offering. In the Initial
Offering, which was completed in the first quarter of 1997, the Company issued
4.6 million shares of common stock resulting in approximately $49.5 million of
net proceeds. In the Secondary Offering, which was completed in the fourth
quarter of 1997, the Company issued 2 million shares of common stock resulting
in approximately $41.5 million of net proceeds. The net proceeds of the
Offerings were used by the Company to repay $81.2 million in outstanding debt
and related interest and prepayment penalties.
The Company requires funds to finance the acquisition and development of
vacation ownership resorts and related inventory, to finance customer mortgages
receivable
MANAGEMENT'S DISCUSSION AND ANALYSIS 23
Management's Discussion and Analysis of
Financial Condition and Results of Operations
originated from financing customer purchases of VOI's, and to fund working
capital. Historically, these funds have been principally provided by
indebtedness secured by a portion of the Company's land, construction in
progress and inventory of unsold VOI's, customer mortgages receivable and other
assets. As of December 31, 1998, the Company had $91.5 million outstanding under
its notes payable secured by its land, construction in progress and VOI
inventory, $133.3 million outstanding under its notes payable secured by
customer mortgages receivable and $17.8 million of other secured and unsecured
notes payable.
The Company's credit facilities (the "Credit Facilities'') provide for term
loans, of which $96.5 million were outstanding as of December 31, 1998, and
revolving lines of credit, of which $57.5 million were outstanding related to
notes secured by land, construction in progress and VOI inventory, and $73.6
million related to notes payable secured by customer mortgages receivable as of
December 31, 1998. At that date, total committed but unused available capacity
under the revolving lines of credit (assuming the availability of sufficient
receivables or other qualified assets) and term loans was $194.3 million and
$1.1 million, respectively. In addition, the Company has a $20.0 million
revolving unsecured line of credit which had a remaining capacity of $5.0
million as of December 31, 1998. As of December 31, 1998, the Company's term
loans and revolving lines of credit accrued interest at various rates between
6.06% and 9.75%, per annum. Approximately $75.0 million of the Company's
outstanding indebtedness at December 31, 1998 bears interest at variable rates
based on fixed spreads over specified reference rates. The Company bears the
risk of increases in interest rates with respect to this indebtedness.
As of December 31, 1998, the Company's scheduled principal payments on its long-
term indebtedness through 2003 (excluding payments on Credit Facilities secured
primarily by customer mortgages receivable, discussed below) were $43.7 million
in 1999, $29.5 million in 2000, $13.4 million in 2001, $17.4 million in 2002,
and $5.3 million in 2003 and thereafter.
The foregoing principal repayment obligations exclude amounts due on notes
payable secured by customer mortgages receivable including the Notes issued in
connection with the securitization transaction described below, as such notes do
not have fixed principal amortization dates. Rather, all collections of
principal and interest on the receivables serving as collateral for these notes
are paid to the lender on a monthly basis. Payments are first applied to
outstanding interest and then to principal. The total amount of customer
mortgages receivable pledged was $160.9 million and $125.1 million at December
31, 1998 and 1997, respectively.
The terms of some of the Credit Facilities impose certain operating and
financial restrictions upon the Company, including, without limitation, (i)
maintenance of a minimum tangible net worth by the Company or certain of its
operating subsidiaries; (ii) maintenance of certain financial ratios, including
the ratio of selling expenses to net VOI sales; (iii) limitations on cash
distributions by certain of the Company's operating subsidiaries to the amount
of the subsidiary's net income or net cash flow (subject to certain exceptions
for tax and other permitted distributions); (iv) subordination of certain
intercompany obligations; and (v) limitations on certain indebtedness. The
Company's Credit Facilities are generally established for fixed terms and are
also subject to early termination under certain events.
During the year ended December 31, 1998, the Company entered into (i) a $60.0
million revolving project finance facility that accrues interest at LIBOR plus
2.85%, (ii) a $40.0 million revolving project finance facility that accrues
interest at LIBOR plus 2.65%, and (iii) a $20.0 million receivables based
revolving credit facility that accrues interest at LIBOR plus 2.25%. The project
finance facilities provide 100% financing for land acquisition and construction
and development of approved resorts. During 1998, the Company also increased its
principal pre-securitization receivables warehouse facility from $70.0 million
to $100.0 million. This facility bears interest at LIBOR plus 1.0%.
In September 1998, the Company completed a private placement of $66.2 million in
principal amount of timeshare mortgage-backed notes (the "Notes"). The
outstanding balance of the Notes of $58.6 million as of December 31, 1998 is
included in the Credit Facilities referenced above and shown on the Company's
balance sheet at that date. The securitization was structured as two classes of
fixed-rate notes, with approximately $32.0 million of 5.89% notes being rated
`AAA,' and $34.2 million of 6.28% notes being rated `A,' by Duff & Phelps Credit
Rating Co. ("DCR"). The Notes are secured by approximately $71.1 million in
first mortgage liens on VOI's sold by Vistana subsidiaries in Florida and
Colorado. The weighted average cost of the Notes, including the yield on the
Notes and the cost of a letter of credit used to provide credit enhancement, is
approximately 6.30% per annum. The Notes were issued through a bankruptcy-remote
Vistana subsidiary, with no recourse back to Vistana for defaults experienced on
the underlying portfolio of receivables or for draws on the letter of credit.
The net proceeds of the securitization were used primarily to repay $60.2
million of outstanding debt secured by customer mortgages receivable and bearing
interest at LIBOR plus
24 MANAGEMENT'S DISCUSSION AND ANALYSIS
2.5% and LIBOR plus 1.0%.
The Company intends to pursue a growth-oriented strategy. Accordingly, the
Company may from time to time acquire, among other things, additional vacation
ownership resorts, additional land upon which vacation ownership resorts may be
expanded or developed and companies operating resorts or having vacation
ownership assets, management, or sales or marketing expertise commensurate with
the Company's operations in the vacation ownership industry. The Company is
currently considering the acquisition of several land parcels for development of
additional VOI inventory. The Company from time to time evaluates additional
acquisitions of operating companies and related assets, but presently has no
contracts or capital commitments relating to any such potential acquisitions.
In the future, the Company may negotiate additional or renewed credit
facilities, issue debt, or execute additional securitizations of its customer
mortgages receivable. Any debt incurred or issued by the Company may be secured
or unsecured, bear interest at fixed or variable rates, and be subject to terms
and conditions approved by management. The Company has historically enjoyed good
credit relationships and has been successful in establishing new relationships
and expanding existing credit facilities as its growth and opportunities have
necessitated. Management believes the Company will continue to be able to borrow
in this manner. However, adverse conditions in the capital or other financial
markets, adverse financial performance by the Company or its subsidiaries, or
the need for additional equity capital, could curtail or increase the cost of
the Company's access to debt.
The Company believes that the cash generated from operations and future
borrowings, including possible securitizations of customer mortgages receivable,
will be sufficient to meet its working capital and capital expenditure needs for
its current operations for the next 12 months. However, depending upon the
Company's growth opportunities, conditions in the capital and other financial
markets and other factors, the Company may from time to time consider the
issuance of debt, equity or other securities, the proceeds of which may be used
to finance acquisitions, to refinance debt or for general corporate purposes.
During future periods, continued access to external funding will be necessary
for the Company to acquire, develop, and sell additional VOI inventory and to
finance customer purchases of its VOI's and may be necessary to provide or
supplement general working capital. If the Company were unable to obtain credit
facilities or debt or equity financing in amounts, and on terms and conditions,
satisfactory for such purposes, such event would have a material adverse effect
on the Company's business and results of operations.
Inflation
Inflation and changing prices have not had a material impact on the Company's
revenues, operating income and net income during any of the Company's three most
recent fiscal years. Due to the current economic climate, the Company does not
expect that inflation and changing prices will have a material impact on the
Company's revenues, operating income or net income. To the extent inflationary
trends affect short-term interest rates, a portion of the Company's debt service
costs may be affected as well as the rates the Company charges on its customer
mortgages.
Seasonality
The Company's revenues are seasonal. Owner and guest activity at the Company's
resorts in the eastern United States are currently the greatest from February
through April and June through August. Owner and guest activity at the Company's
resorts in the western United States are currently the greatest from June 15 to
Labor Day and Christmas to Easter. As a result of this seasonality, the Company
currently anticipates its weakest operating results during the first quarter,
and its strongest operating results during the third quarter, of each calendar
year. However, as the Company opens new resorts and expands into new markets and
geographic locations it may experience increased or different seasonality
dynamics creating fluctuations in operating results that are different from
those experienced in the past.
Year 2000
The Company is devoting resources to minimize the risk of potential disruption
from the "year 2000 (`Y2K') problem." This problem results from computer
programs having been written using two digits (rather than four) to store date
information. Information technology ("IT") systems that have date-sensitive
software may recognize a date using "00" as the year 1900 rather than the year
2000, which could result in miscalculations and system failures. The problem
also extends to "non-IT" (operation and control) systems that rely on embedded
microchips that may be date sensitive. In addition, like other business
enterprises, the Company has a risk from Y2K failures on the part of its major
business counterparts, including financial institutions, suppliers,
distributors, licensees and manufacturers, as well as potential failures in
public and private infrastructure services, including electricity, water, gas,
transportation and communications. For example, disruptions in air travel could
adversely affect tour flow, vacation
MANAGEMENT'S DISCUSSION AND ANALYSIS 25
Management's Discussion and Analysis of
Financial Condition and Results of Operations
ownership sales, and resort occupancy and profitability.
In addressing the Y2K problem, the Company has classified its systems as
"critical," "important," or "non-critical." A "critical" system is one that, if
not operational, would cause the shutdown of all or a portion of a critical
business unit. These critical systems have been identified as sales and
marketing, mortgage servicing and processing, and payroll and employee benefits.
An "important" system is one that would cause an interruption to customer
service, such as the reservation system.
In 1989, through a conversion from one hardware platform to another, the Company
expanded the date field from two to four digits on all of the critical sales and
marketing software applications. This conversion and a subsequent rewrite of the
sales and marketing processes took into consideration all invalid date
processing functions including Y2K. These modules, totaling more than 400
software applications, included tour activity, sales and contract processing,
commissions, and statistical reporting.
In 1990, the Company rewrote the mortgage servicing and lender reporting
processes to improve functionality. In connection with this rewrite, the Company
took into consideration Y2K in conjunction with the overall data processing
conversion. This rewrite, totaling some 200 programs used in processing and
servicing mortgages, mortgage payment coupon processing, ACH systems, and credit
card systems, resulted in these system processes becoming Y2K compliant by the
end of 1991.
During 1997, in conjunction with its transition to a public company and to meet
the demands of its growing business, the Company began migrating to a Personal
Computer ("PC") environment. As part of the migration plan, the Company
developed minimum required standards for all IT solutions, including Y2K
compliance, and replaced all PC hardware and software that did not meet the new
Company-wide standard. During the summer of 1998, as a result of the Company's
significant growth, the major mainframe hardware, software, and operating
systems were replaced with larger systems to meet the increasing demands of the
business. In accordance with the Company's established standards, the new
systems were required to meet the standards of Y2K compliance. The migration
plan and major systems replacement were not implemented specifically to address
the Y2K issue but, rather, were the result of the Company's evolution in
enhanced automation during a period of significant growth.
During March of 1997, the Company formed a Y2K task force. Since this time,
policies and procedures have been created to review all new software and
hardware purchases and any new internal software development for Y2K compliance.
In the latter part of 1998, the payroll and employee benefit systems were
upgraded to accommodate the growing employee base and to incorporate hardware
and software applications that were Y2K compliant. The total costs associated
with this upgrade approximated $0.6 million, including the costs of software and
hardware as well as third-party costs affiliated with the implementation.
The Company has developed a seven-phase approach to resolving and monitoring Y2K
issues. All of these efforts are being coordinated through a task force chaired
by the Company's Vice President of Information Services, with individual members
from major business units.
The seven phases of the approach are as follows:
1. Inventory: inventory relevant items as to IT and non-IT items.
2. Assessment: classify items into critical, important, and non-critical.
3. Strategy: test, certify, replace or abandon relevant items.
4. Remediation: execute the strategy chosen for each item.
5. Testing and Certification: establish the test environment; test and
certify.
6. Contingency Planning: address any open issues expected in 1999.
7. Oversight Committee: complete final review of all items in the first six
phases.
Phase 1 - Inventory.
This is an ongoing process and has been in existence since 1997. This phase
entails maintaining an inventory of all hardware and software (including
business and operational applications, operating systems and third-party
products) that may be at Y2K risk, and identifying key third-party businesses
whose Y2K failures would most significantly impact the Company. The IT system
inventory process has been completed, including the inventories of key third-
party businesses and internal non-IT systems.
Phase 2 -Assessment.
Once each at-risk system has been identified, the Y2K task force assesses how
critical the system is to business operations and the potential impact of
failure, in order to establish priorities for repair or replacement. This
assessment has been completed for all IT systems and is ongoing as inventory
changes. This assessment process for internal non-IT systems and for key third-
party items is expected to be completed by March 1999.
Phase 3 - Strategy.
This is an ongoing process that involves the development
26 MANAGEMENT'S DISCUSSION AND ANALYSIS
of appropriate remedial strategies for both IT and non-IT systems. These
strategies may include repairing, testing and certifying, replacing or
abandoning particular systems. Selection of appropriate strategies is based upon
such factors as the assessments made in Phase 2, the type of system, the
availability of the Y2K-compliant replacement and cost. This phase has been
completed for all IT systems. For some non-IT embedded systems, strategy
development is continuing. At the Company's Orlando resort, the majority of
critical systems have been tested and certified. All ongoing development work
and enhancements to systems are tested and documented before being placed in
production.
Phase 4 - Remediation.
The remediation phase involves creating detailed project plans, marshalling
necessary resources and executing the strategies chosen. For IT systems, this
phase is approximately 90% complete for critical and important systems, and is
expected to be completed (including certification) by June 1999. For non-
critical systems, most corrections are expected to be completed by third quarter
1999. For those systems that are not expected to be reliably functional after
January 1, 2000, detailed manual workaround plans are expected to be completed
in advance of year end 1999.
Phase 5 - Testing and Certification.
This phase includes establishing a test environment, performing systems testing
(with third parties if necessary), and certifying the results. The certification
process entails having functional experts review the results, computer screens
and printouts against pre-established criteria to evaluate system compliance.
The Company expects all critical and important IT systems to be certified by
June 1999. Testing for non-IT systems has been initiated. The Company's target
for all critical and important non-IT systems is June 1999.
The Company has initiated written and telephonic communications with key third-
party businesses, as well as public and private providers of infrastructure
services, to ascertain and evaluate their efforts in addressing Y2K compliance.
It is anticipated that the majority of testing and certification with these
entities will occur in 1999.
Phase 6 - Contingency Planning.
This phase involves addressing any remaining open issues expected in 1999 and
early 2000. As a precautionary measure, the Company is currently developing
contingency plans for systems that are not expected to be Y2K compliant by the
Year 2000. A variety of automated as well as manual fallback plans are under
consideration.
Phase 7 - Oversight Committee.
This committee will review the work and progress of the Y2K task force before
year-end 1999, to determine any omissions or reclassifications that may have
changed due to the growth of the Company.
The conversion processes and rewriting of systems in the late 1980's and early
1990's, and the evolution toward greater automation in a PC environment, were
not performed specifically to address issues of Y2K compliance. Modifications
implemented in these processes which facilitated compliance with the Y2K issue
were a process step in the overall implementation plan and were performed to
accommodate business functionality, not solely Y2K compliance. Consequently, the
Company did not track, nor is it currently practicable to accumulate, specific
costs pertaining to adjustments for Y2K compliance. For the Company's activities
specifically targeting Y2K compliance, as of December 31, 1998, costs incurred
approximated $0.4 million, of which the majority was capitalized as newly
acquired software and the related implementation costs. Given the Company's
prior preparation and the status of overall Y2K compliance, the remaining Y2K
preparations are not expected to require the allocation of full-time resources
internally or externally. As a result, the estimated additional costs to address
Y2K compliance, including testing and certification, are not expected to require
significant incremental costs of internal resources or incurrence of third-party
expense. The Company intends to continue to use operating cash flow to fund all
of the costs remaining for Y2K preparedness.
Based on its efforts to date, the Company believes that the majority of both its
IT and non-IT systems, including all critical and important systems, will remain
fully operational after January 1, 2000. Accordingly, the Company does not
currently anticipate that internal systems failures will result in any material
adverse effect on its results of operations or financial condition. At this
time, the Company believes that its most likely "worst-case" scenario involves
potential disruptions in the areas in which the Company must rely on third
parties whose systems may not work properly after January 1, 2000. Although such
failures could affect important operations of the Company, either directly or
indirectly, in a significant manner, and have a material adverse effect on its
results of operations and financial condition, the Company cannot presently
estimate either the likelihood or the potential costs of such failures.
The nature and focus of the Company's efforts to address the Y2K issues may be
revised periodically as interim goals are achieved and new issues identified. In
addition, it is important to note that the description of the Company's efforts
involves estimates and projections with respect to activities required in the
future. These estimates and projections are subject to change as work continues,
and additional information is made available and such changes may be
substantial.
MANAGEMENT'S DISCUSSION AND ANALYSIS 27
Report of Management
The consolidated financial statements of Vistana, Inc. and subsidiaries have
been prepared by management and have been audited by independent accountants.
Management of the Company is responsible for the financial information and
representations contained in the consolidated financial statements and other
sections of this report. Management believes that the consolidated financial
statements have been prepared in conformity with generally accepted accounting
principles appropriate under the circumstances to reflect, in all material
respects, the substance of the events and transactions that should be included.
In preparing the consolidated financial statements, management necessarily made
informed estimates and judgments based on currently available information of the
effects of certain events and transactions.
In meeting its responsibility for the reliability of the consolidated financial
statements, management depends on the Company's internal control structure. This
internal control structure is designed to provide reasonable assurance that
assets are safeguarded and transactions are executed in accordance with
management's authorization and are properly recorded. In designing control
procedures, management recognizes that errors or irregularities may occur and
that estimates and judgments are required to assess and balance the relative
costs and expected benefits of the controls. Management believes that the
Company's internal control structure provides reasonable assurance that errors
or irregularities that could be material to the consolidated financial
statements are prevented or would be detected within a timely period by
employees in the normal course of performing their assigned functions.
The Board of Directors fulfills its oversight role for the accompanying
consolidated financial statements through its Audit Committee, which is composed
solely of directors who are not officers or employees of the Company. The
Committee meets with management and the independent accountants to review the
work of each, and to monitor the discharge by each of its responsibilities.
Management is responsible for the conduct of the Company's business in an
ethical, moral manner. Our commitment to ethics and integrity is a fundamental
part of the vision and values that are stressed at all levels of the Company.
/s/ Raymond L. Gellein
Raymond L. Gellein, Jr.
Chairman of the Board and Co-Chief Executive Officer
/s/ Jeffrey A. Adler
Jeffrey A. Adler
President and Co-Chief Executive Officer
/s/ Charles E. Harris
Charles E. Harris
Vice Chairman and Chief Financial Officer
28 REPORT OF MANAGEMENT
Independent Auditors' Report
The Board of Directors and Shareholders Vistana, Inc. and Subsidiaries:
We have audited the consolidated balance sheets of Vistana, Inc. and
subsidiaries (the "Company") as of December 31, 1998 and 1997 and the related
consolidated statements of income, shareholders' equity and cash flows for each
of the years in the three-year period ended December 31, 1998. These
consolidated financial statements are the responsibility of the Company's
management. Our responsibility is to express an opinion on these consolidated
financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the financial position of Vistana, Inc. and
subsidiaries as of December 31, 1998 and 1997 and the results of their
operations and their cash flows for each of the years in the three-year period
ended December 31, 1998, in conformity with generally accepted accounting
principles.
KPMG LLP
Orlando, Florida
February 10, 1999
INDEPENDENT AUDITORS' REPORT 29
Consolidated Balance Sheets
As of December 31, 1998 and 1997
(in thousands except share amounts)
1998 1997
- ----------------------------------------------------------------------------------------------------
Assets
Cash and cash equivalents $ 20,001 $ 9,878
Restricted cash 29,054 9,196
Customer mortgages receivable, net 223,275 155,048
Other receivables, net 8,053 4,953
Inventory of Vacation Ownership Interests 50,019 27,271
Construction in progress 30,922 17,026
---------------------
Total Vacation Ownership Interests 80,941 44,297
=====================
Prepaid expenses and other assets 24,408 15,021
Land held for development 23,874 13,840
Intangible assets, net 19,743 17,275
Property and equipment, net 42,071 17,701
---------------------
Total Assets $471,420 $287,209
=====================
Liabilities and Shareholders' Equity
Accounts payable and accrued liabilities $ 17,502 $ 9,276
Income taxes payable 424 1,927
Accrued compensation and benefits 10,883 9,847
Customer deposits 22,610 9,423
Deferred income taxes 25,753 17,535
Other liabilities 5,723 6,265
Notes and mortgages payable 242,644 109,547
----------------------
Total Liabilities 325,539 163,820
Minority interest 1,665 3,984
Shareholders' Equity
Common stock, $.01 par value: Authorized 100,000,000 shares
Issued and outstanding 21,224,172 and 21,007,630 shares at
December 31, 1998 and 1997, respectively 212 210
Additional paid-in capital 111,502 107,341
Retained earnings 32,502 11,854
----------------------
Total Shareholders' Equity 144,216 119,405
Total Liabilities and Shareholders' Equity $471,420 $287,209
=====================
See accompanying notes to consolidated financial statements.
30 CONSOLIDATED BALANCE SHEETS
Consolidated Statements of Income
For the Years Ended December 31, 1998, 1997, and 1996
(in thousands except per share data and share amounts) 1998 1997 1996
- ------------------------------------------------------------------------------------------------------------------------------------
Revenues:
Vacation Ownership Interest sales $ 172,872 $ 100,887 $ 60,063
Interest 26,538 19,296 15,546
Resort 20,735 16,921 13,587
Telecommunications 9,078 7,499 7,054
Other 4,499 749 686
------------------------------------------
Total revenues 233,722 145,352 96,936
------------------------------------------
Costs and operating expenses:
Vacation Ownership Interest cost of sales 38,622 22,898 14,595
Sales and marketing 83,138 45,616 27,877
Interest expense--treasury 8,852 7,240 6,865
Provision for doubtful accounts 12,792 6,971 4,271
Resort 17,821 13,913 11,089
Telecommunications 7,369 6,111 5,613
General and administrative 17,869 11,988 7,873
Depreciation and amortization 6,424 3,455 2,553
Interest expense--other 4,057 1,705 4,154
Other 5,896 3,009 443
Deferred executive incentive compensation -- -- 1,114
------------------------------------------
Total costs and operating expenses 202,840 122,906 86,447
------------------------------------------
Operating income 30,882 22,446 10,489
Excess value recognized 102 111 105
Minority interest 2,319 468 --
------------------------------------------
Income before income taxes and extraordinary item 33,303 23,025 10,594
Provision for income taxes 12,655 8,101 --
Non-recurring charge associated with the change of tax status -- 13,201 --
------------------------------------------
Income before extraordinary item 20,648 1,723 $ 10,594
Extraordinary item--early extinguishment of debt, net of tax -- (1,425) --
------------------------------------------
Net Income $ 20,648 $ 298 $ 10,594
==========================================
Per share data:
Basic
Income per share before extraordinary item $ 0.98 $ 0.09 --
Extraordinary item -- (0.07) --
------------------------------------------
Income per share $ 0.98 $ 0.02 --
------------------------------------------
Weighted average number of shares outstanding 21,120,472 18,344,545 --
==========================================
Diluted
Income per share before extraordinary item $ 0.96 $ 0.09 --
Extraordinary item -- (0.07) --
------------------------------------------
Income per share $ 0.96 $ 0.02 --
------------------------------------------
Weighted average number of shares outstanding 21,474,662 18,649,180 --
==========================================
Pro-forma share data (unaudited):
Income before income taxes -- $ 23,025 $ 10,594
Provision for income taxes -- 8,726 4,026
------------------------------------------
Pro-forma net income -- $ 12,874 $ 6,568
------------------------------------------
Pro-forma net income per share--basic -- $ 0.70 $ 0.46
------------------------------------------
Pro-forma weighted average number of shares outstanding--basic -- 18,344,545 14,175,000
------------------------------------------
Pro-forma net income per share--diluted -- $ 0.69 $ 0.46
------------------------------------------
Pro-forma weighted average number of shares outstanding--diluted -- 18,649,180 14,175,000
------------------------------------------
See accompanying notes to consolidated financial statements.
Consolidated Statements of Shareholders' Equity
Additional Equity of Total
For the Years Ended December 31, 1998, Common Stock Paid-In Retained Predecessor Shareholders'
1997 and 1996 (in thousands) Shares Amount Capital Earnings Entities Equity
- ------------------------------------------------------------------------------------------------------------------------------------
Balance at December 31, 1995 -- $ -- $ -- $ -- $ 17,904 $ 17,904
Distributions -- -- -- -- (1,850) (1,850)
Net income -- -- -- -- 10,594 10,594
----------------------------------------------------------------------------------------
Balance at December 31, 1996 -- $ -- $ -- $ -- $ 26,648 $ 26,648
Distributions -- -- -- -- (2,245) (2,245)
Net income from January 1, 1997
through the Formation Transactions -- -- -- -- 1,645 1,645
Deferred taxes recorded in connection
with Formation Transactions -- -- -- -- (13,201) (13,201)
Exchange of predecessor equity for stock in
connection with Formation Transactions 14,175 142 12,705 -- (12,847) --
Proceeds from Initial Offering
(net of offering costs) 4,625 46 49,419 -- -- 49,465
Acquisition of Success Companies and
Points of Colorado 207 2 3,772 -- -- 3,774
Proceeds from sale of common stock in
Secondary Offering (net of offering costs) 2,000 20 41,445 -- -- 41,465
Net income subsequent to
Formation Transactions -- -- -- 11,854 -- 11,854
----------------------------------------------------------------------------------------
Balance at December 31, 1997 21,007 $ 210 $ 107,341 $ 11,854 $ -- $ 119,405
Net Income -- -- -- 20,648 -- 20,648
Exercise of stock options 70 1 835 -- -- 836
Tax benefit of stock options exercised -- -- 209 -- -- 209
Stock issued pursuant to employee
stock purchase plan 39 -- 537 -- -- 537
Stock recorded as contingent consideration
in conjunction with a business acquisition 143 1 2,580 -- -- 2,581
----------------------------------------------------------------------------------------
Balance at December 31, 1998 21,259 $ 212 $ 111,502 $ 32,502 $ -- $ 144,216
----------------------------------------------------------------------------------------
See accompanying notes to consolidated financial statements.
Consolidated Statements of Cash Flows
For the Years Ended December 31, 1998, 1997 and 1996
(in thousands) 1998 1997 1996
- ------------------------------------------------------------------------------------------------------------------
Operating activities:
Net Income $ 20,648 $ 298 $ 10,594
Adjustments to reconcile net income
to net cash provided by operating activities:
Depreciation and amortization expense 6,424 3,455 2,553
Amortization of discount on customer mortgages receivable (1,648) (3,061) (2,757)
Provision for doubtful accounts 12,792 6,971 4,271
Minority interest (2,319) (468) --
Deferred income taxes 8,218 16,072 --
Changes in operating assets and liabilities, net of effect of acquisitions
Other receivables, net (3,100) 971 (1,306)
Construction in progress (46,678) (20,725) (359)
Prepaid expenses and other assets (11,307) (3,174) (7,508)
Accounts payable and accrued liabilities 8,226 4,805 (1,077)
Income taxes payable (1,503) 1,927 --
Accrued compensation and benefits 1,036 (30) 738
Customer deposits 13,187 4,331 2,645
Repurchase obligation -- -- (1,408)
Other liabilities (542) (1,861) 3,729
------------------------------------
Net cash provided by operating activities 3,434 9,511 10,115
------------------------------------
Investing activities:
Expenditures for property and equipment (27,411) (6,517) (2,513)
Business acquisition, net of cash acquired (1,141) (25,383) --
Customer mortgages receivable, net (79,371) (38,405) (16,550)
Repurchase of customer mortgages receivable -- -- (1,171)
Additions to restricted cash (19,858) (4,731) (603)
------------------------------------
Net cash used in investing activities (127,781) (75,036) (20,837)
------------------------------------
Financing activities:
Proceeds from notes and mortgages payable 325,114 116,601 53,628
Principal payments on notes and mortgages payable (192,017) (136,017) (46,908)
Net proceeds from public offerings -- 90,930 --
Proceeds from exercised stock options 836 -- --
Equity distributions/redemption -- (2,245) (1,850)
Proceeds from employee stock purchase plan 537 -- --
Minority interest -- -- 4,443
------------------------------------
Net cash provided by financing activities 134,470 69,269 9,313
------------------------------------
Net increase in cash and cash equivalents 10,123 3,744 (1,409)
Cash and cash equivalents, beginning of period 9,878 6,134 7,543
------------------------------------
Cash and cash equivalents, end of period $ 20,001 $ 9,878 $ 6,134
------------------------------------
Supplemental disclosure of cash flow information:
Cash paid during the period for interest $ 11,689 $ 9,446 $ 10,732
------------------------------------
Cash paid during the period for taxes $ 5,730 $ 3,526 $ --
------------------------------------
See accompanying notes to consolidated financial statements.
Notes to Consolidated Financial Statements
- --------------------------------------------------------------------------------
(1) Nature of Business
Vistana, Inc. and its consolidated subsidiaries (the "Company") generate
revenues from the sale and financing of Vacation Ownership Interests ("VOI's")
in its resort properties which typically entitle the buyer to ownership of a
fully-furnished unit for a one week period on an annual or an alternate-year
basis. The Company's principal operations consist of (1) constructing,
furnishing, marketing, selling and financing the sale of VOI's, and (2) managing
the operations of its resorts and related amenities. The Company sells VOI's to
both domestic and foreign purchasers. All contracts relating to the sale of
VOI's are denominated in U.S. dollars.
- --------------------------------------------------------------------------------
(2) Capital Transactions and Basis of Presentation
The Company became the parent for all of the operations of its predecessors in
connection with its initial public offering (the "Initial Offering") completed
on February 28, 1997. At the time of the Initial Offering each of the owners of
the predecessor entities (the "Principal Shareholders") transferred to the
Company all of the existing common stock and partnership interests owned by them
in exchange for 14.2 million shares (20 shares of the common stock of Vistana,
Inc. were outstanding at the time of the Initial Offering) of the Company (the
"Formation Transactions"). A total of 5.6 million shares of the common stock of
the Company were offered (4.6 million shares by the Company and 0.9 million
shares by the Principal Shareholders) to the public in the Initial Offering. In
addition, in connection with the Initial Offering and the Formation
Transactions, former equity holders of the Company's predecessor corporations
and limited partnerships received a distribution of approximately $2.6 million,
$0.3 million of which represented the balance of such holders' federal and state
income tax liability attributable to their ownership of such entities through
the date of the Initial Offering, and $2.3 million of which represented the
retained earnings of the Company's predecessor corporations and limited
partnerships for which such holders had previously paid income tax. The
Formation Transactions were accounted for as a reorganization of entities under
common control in a manner similar to a pooling of interests. Accordingly, the
net assets of the predecessor corporations and limited partnerships were
recorded at the predecessor entities' basis. The majority of the consolidated
subsidiaries were formed in 1991 by the principal shareholders to acquire and
own, either directly or indirectly, the assets and certain liabilities of the
predecessor operating entities from the previous owner. The consolidated
financial statements shown herein for the Company and its consolidated
subsidiaries for 1997 include the operations of its predecessors in interest.
On September 16, 1997, the Company completed the acquisition of entities
comprising The Success Companies, Success Developments, L.L.C. and Points of
Colorado, Inc. (the "Business Acquisition"). The purchase method of accounting
was followed in accounting for this transaction and, therefore, operating
results of the acquired entities are included in the Company's results from the
acquisition date.
Pro forma (unaudited) financial data presented on the face of the consolidated
statement of income for the year ended December 31, 1997 reflects the
elimination of the non-recurring charge for deferred taxes pertaining to the
predecessor entities relative to all years prior to 1997. Pro forma (unaudited)
financial data presented on the face of the consolidated statements of income
reflect results of the year ended 1996 as if the conversion of tax status to a C
corporation had occurred at the beginning of the period.
- --------------------------------------------------------------------------------
(3) Summary of Significant Accounting Policies
(a) Principles of Consolidation
The consolidated financial statements include the accounts of the Company and
certain wholly owned subsidiaries (both corporations and limited partnerships)
under common control. The consolidated financial statements also include the
accounts of two partnerships between one or more subsidiary companies and
unaffiliated third party partners wherein the Company exercises operational and
financial control over such partnerships. Interests of unaffiliated third party
partners in these partnerships are reflected as minority interests.
(b) Revenue Recognition
Greater than 90% of the VOI's sold by the Company generate installment
receivables secured by a mortgage on the related VOI. These customer mortgages
receivable are payable in monthly installments, including interest, with
maturities up to ten years. Sales are included in revenues when minimum down
payment requirements (at least 10%) have been met. A provision is recorded for
those contracts expected to rescind in the allowed statutory rescission period.
Product costs and direct selling expenses related to a VOI sale are recognized
at the time the sale is recognized. Product costs (also referred to as VOI cost
of sales) include the cost of land, professional fees, improvements to the
property, capitalized interest, and for certain projects, the cost of amenities
owned by the VOI owners. Product costs are allocated to each VOI based on the
total number and type of VOI's in the particular phase.
In 1997, the Company began pre-construction sales at its Embassy Vacation Resort
at Myrtle Beach and in 1998 at its Embassy Vacation Resort at Scottsdale, and
Lakeside
34 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Terrace Condominiums at Avon, Colorado. The Company recognized revenue related
to VOI sales at these resorts during the period of construction using the
percentage of completion method. Under this method, the portion of revenues
related to applicable costs (including construction and sales and marketing
costs) incurred, as compared to the total estimate of such costs, is recognized
as revenue in the period of sale. The remaining revenue is deferred and
recognized as the remaining costs are incurred. During 1998, construction was
completed at Myrtle Beach and Lakeside Terrace. As of December 31, 1998, only
Embassy Vacation Resort at Scottsdale was subject to percentage of completion
accounting.
Resort revenues are recognized on an accrual basis. Telecommunications revenues
are recognized when earned.
(c) Allowance for Losses on Customer Mortgages Receivable
The Company provides for estimated future losses to be incurred related to
uncollectible customer mortgages receivable. The Company evaluates such
receivables collectively for impairment due to their relative balances and
homogenous nature. The allowance is based on the collection history of the
receivables and is net of anticipated cost recoveries of the underlying VOI's.
Management believes that all such allowances are adequate.
(d) Inventory of VOI's and Land Held for Development
Inventory of VOI's and related construction in progress are carried at cost,
which is lower than fair value less cost to sell. The recoverability of
inventory is determined on an individual project basis, which is based on each
resort location. Land held for development is carried at the lower of cost or
fair value less cost to sell.
(e) Resort and Sales Facilities
In connection with the development of a resort property, the Company constructs
guest registration facilities and on-site sales and marketing facilities
("Resort and Sales Facilities"). The Company retains ownership and control over
these facilities. The facilities are capitalized as fixed assets and depreciated
on a straight-line basis over a period consistent with the useful life applied
to similar assets, typically 30 years.
The Company does not retain ownership or unilateral control over certain
recreational assets developed in connection with the construction of a resort
property, including the swimming pool and exercise facilities. These assets are
included in cost of sales over the period of project sell-out.
(f) Customer Deposits
Until a VOI contract qualifies as a sale, all payments received are accounted
for as deposits. If a contract is canceled after the applicable statutory
period, deposits forfeited are credited to income.
(g) Intangible Assets
The Company reevaluates the recoverability of intangible assets as well as the
amortization periods to determine whether an adjustment to carrying value or a
revision to estimated useful lives is appropriate. The primary indicators of
recoverability are a significant event or change in the environment in which the
business operates, and current and forecasted undiscounted operating cash flows.
(h) Fair Market Value of Financial Instruments
The carrying amount reported in the consolidated balance sheets for cash and
cash equivalents, restricted cash, other receivables, accounts payable and
accrued liabilities approximates fair market value due to the immediate or
short-term maturity of these financial instruments. The approximate fair value
of customer mortgages receivable exceeds book value by the amount of the
unamortized discount on customer mortgages receivable purchased. The carrying
amount of notes and mortgages payable approximates fair market value. Interest
rates on variable rate notes and mortgages payable reprice frequently.
(i) Income Taxes
Income taxes are accounted for under the asset and liability method. Deferred
tax assets and liabilities are recognized for the future tax consequences
attributable to differences between the financial statements carrying amounts of
existing assets and liabilities and their respective tax bases and operating
loss and tax-credit carry forwards. Deferred tax assets and liabilities are
measured using enacted tax rates expected to apply to taxable income in the
years in which those temporary differences are expected to be recovered or
settled. The effect on deferred tax assets and liabilities of a change in tax
rates is recognized in income in the period that includes the enactment date.
(j) Use of Estimates
The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make a number of estimates and
assumptions that affect the amounts reported in the consolidated financial
statements and accompanying notes. Actual results could differ from those
estimates and assumptions.
(k) Cash and Cash Equivalents, and Restricted Cash
Cash and cash equivalents consist of all highly liquid investments purchased
with an original maturity of three months or less. Cash and cash equivalents
consist of cash and money market funds.
Notes to Consolidated Financial Statements
Restricted cash consists of: (1) deposits received on sales of VOI's that are
held in escrow until the applicable statutory rescission period has expired and
the related customer mortgage has been recorded, (2) worker's compensation
funds, and (3) funds associated with the securitization including the reserve
funds (see Note 11).
(l) Interest Rate Swap Agreements
The Company only uses derivative financial instruments on a limited basis and
does not use them for trading purposes. Derivative financial instruments are
used to manage well-defined interest rate risks. The differential to be paid or
received under the terms of the interest rate swap agreements is accrued as
interest rates change and is recognized over the life of the applicable interest
rate swap agreements. The Company does not engage in speculative or profit
motivated hedging activities. As of December 31, 1998 and 1997, the Company had
no derivative financial instruments outstanding.
(m) Reclassifications
Certain prior year amounts have been reclassified to conform with the 1998
presentation.
(n) Effect of New Accounting Pronouncements
In April 1998, the Accounting Standards Executive Committee ("AcSEC") of the
American Institute of Certified Public Accountants ("AICPA") issued Statement of
Position 98-5, "Reporting on the Costs of Start-up Activities" (SOP 98-5). SOP
98-5 is applicable for all nongovernmental entities and requires that costs of
start-up activities, including organization costs, be expensed as incurred.
Except for certain specified investment companies, SOP 98-5 is effective for
financial statements for fiscal years beginning after December 15, 1998, with
earlier application permitted. The Company's current accounting policy is to
capitalize pre-opening costs and amortize them generally over a one-year period.
The effect of initially applying the provisions of SOP 98-5 will be reported as
a change in accounting principle at the beginning of the period of adoption and
thereafter all such costs will be expensed as incurred. Amounts capitalized as
pre-opening costs as of December 31, 1998, were approximately $980,000. The
Company will adopt SOP 98-5 in the first quarter of 1999.
In 1997, the AICPA began a project addressing the accounting for all real estate
timeshare transactions. The proposed guidance is currently in the drafting
stage of the promulgation process. The Company is unable to assess the possible
impact, if any, this proposed guidance may have on financial results.
(o) Concentrations of Risk
Any adverse change in economic conditions or significant price increases or
adverse events related to the travel and tourism industry, such as the cost and
availability of fuel and air travel, could have a material adverse effect on the
Company's business. Such conditions or increases may also adversely affect the
future availability and cost of financing for the Company or its customers and
result in a material adverse effect on the Company's business and financial
results. In addition, adverse changes in general economic conditions may
adversely affect the Company's ability to collect on its customer mortgages
receivable. Adverse changes in the Company's collection history could result in
increased provisions for loss and curtail or increase the cost of the Company's
financing, any of which could have a material adverse effect on the Company's
business and financial results.
- --------------------------------------------------------------------------------
(4) Customer Mortgages Receivable, Net
As of December 31, customer mortgages receivable, net consisted of:
(in thousands) 1998 1997
- ------------------------------------------------------------
Customer mortgages receivable, gross $243,263 $170,147
Less:
Unamortized discount on customer
mortgages receivable purchased (830) (2,478)
Unamortized excess value
over consideration -- (27)
Allowance for doubtful accounts (19,158) (12,594)
--------------------
Customer mortgages receivable, net $223,275 $155,048
--------------------
As of December 31, 1998 and 1997, customer mortgages receivable, gross, from
buyers not residing in the United States or Canada were approximately $42.2
million and $34.5 million, respectively, with buyers within no foreign country
aggregating more than 5% of gross outstanding customer mortgages receivable.
Stated interest rates on customer mortgages receivable outstanding at December
31, 1998 range from 00.0% to 17.9% per annum (averaging approximately 14.7% per
annum). Interest is not imputed on customer mortgages receivable with less than
a market interest rate because such amounts are immaterial.
The activity in the customer mortgages receivable allowance for doubtful
accounts is as follows:
(in thousands) 1998 1997 1996
- -----------------------------------------------------------------
Balance, beginning of year $12,594 $10,191 $ 9,009
Provision for doubtful accounts 12,792 6,971 4,271
Allowance relating to customer
mortgages receivable purchased -- -- 588
Allowance relating to customer
mortgages receivable for
businesses acquired -- 1,076 --
Customer mortgages
receivable charged off (6,228) (5,644) (3,677)
-----------------------------
Balance, end of year $19,158 $12,594 $10,191
-----------------------------
During 1996 and 1995, under the clean-up call provisions of the related
transactions, the Company repurchased the remaining amount of customer mortgages
receivable
36 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
previously sold and effectively liquidated the entities. The Company
repurchased gross customer mortgages receivable of $20.3 million and recorded
discounts, which amounted to $10.4 million. These discounts are being amortized
over the estimated remaining collection period of the purchased customer
mortgages receivable. Amortization of the discount during 1998, 1997, and 1996
was $1.6 million, $3.1 million and $2.8 million, respectively, and is included
in interest income.
- -------------------------------------------------------------------------------
(5) Property and Equipment, Net
As of December 31, property and equipment, net consisted of:
(in thousands) 1998 1997
- -----------------------------------------------------------------
Land and land improvements $ 4,900 $ 2,753
Buildings and building improvements 24,880 11,595
Furniture, fixtures and equipment 18,699 9,510
-------------------
Subtotal 48,479 23,858
-------------------
Less accumulated depreciation (10,710) (7,508)
-------------------
Subtotal 37,769 16,350
Construction in progress 4,302 1,351
-------------------
Property and equipment, net $ 42,071 $17,701
===================
Property and equipment are recorded at cost. Resort and Sales Facilities as of
December 31, 1998 totalled $13.3 million. Depreciation of property and equipment
is computed over the applicable estimated useful lives (between 3 and 30 years)
of the assets using the straight-line method.
- --------------------------------------------------------------------------------
(6) Prepaid Expenses and Other Assets
As of December 31, prepaid expenses and other assets consisted of:
(in thousands) 1998 1997
- -------------------------------------------------------------
Prepaid licensing fee $ 4,605 $ 5,075
Deferred financing fees 4,823 1,981
Other prepaid expenses 5,280 4,067
Prepaid business registration costs 1,819 1,453
Ticket inventory and sales and
marketing materials 7,881 2,445
-----------------
Total prepaid expenses and other assets $24,408 $15,021
=================
The licensing fee pertains to the partnership involving Vistana WGV, Ltd. and is
being amortized over ten years and is included in depreciation and amortization
in the consolidated statement of income. Deferred financing fees related to
notes and mortgages payable are capitalized and amortized over the lives of the
respective debt on a straight-line basis. Amortization expense related to
deferred financing fees was $2.0 million, $1.0 million, and $0.7 million in
1998, 1997, and 1996, respectively, and is included in amortization and
depreciation expense in the consolidated statements of income.
- --------------------------------------------------------------------------------
(7) Joint Ventures and Other Agreements
Vistana WGV, Ltd. ("WGV")
In June of 1996, the Company entered into a partnership agreement providing for
the Company to serve as general partner with operating and financial control
over the WGV partnership as well as own a 37.5% interest therein. WGV is
developing the first phase of a 408-unit resort near St. Augustine, Florida. WGV
has entered into various licensing, servicing fee and royalty arrangements based
upon stipulated percentages of sales of VOI's or gross rental revenue from
operations of unoccupied units at the resort. In 1996 a $5.1 million licensing
fee was paid by WGV to an unaffiliated partner for the use of names and logos.
This fee has been capitalized and will be amortized over the projected sales
period currently estimated at ten years. WGV is contingently liable, along with
other developers at the project, for annual debt service shortfalls, up to a
specified amount, related to bond funding for a related convention center
development. Under certain defined circumstances, the Company has the right to
acquire the interest of the other unaffiliated partners as well as such
unaffiliated partners having the right to require the Company to purchase their
ownership interests. WGV has been included in the consolidated financial
statements.
Oak Plantation Joint Venture ("OPJV")
In June 1996, the Company acquired a 66.7% ownership interest and became
managing joint venturer for OPJV. Subsequently, OPJV converted a 242 unit multi-
family property in Kissimmee, Florida into a VOI resort, Hampton Vacation
Resort-Oak Plantation. The Company acquired its ownership interest in OPJV
without payment of cash in a purchase transaction. The fair value of the assets
acquired and the liabilities assumed each aggregated approximately $12.2
million, which included a liability of $1.9 million which was paid in January
1997 to an unaffiliated partner for the early termination of a consulting
service arrangement. Under certain defined circumstances, the Company has the
right to acquire the interest of the other unaffiliated partners as well as such
unaffiliated partners having the right to require the Company to purchase their
ownership interests. OPJV has been included in the consolidated financial
statements.
Promus Agreement
In December 1996, the Company and Promus Hotels, Inc. entered into a five-year
agreement (the "Promus Agreement") to jointly acquire, develop, market and
operate vacation ownership resorts in North America under Promus' Embassy
Vacation Resort, Hampton Vacation Resort and Homewood Vacation Resort brands. As
of December 31, 1998, the Company was Promus'
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 37
Notes to Consolidated Financial Statements
exclusive joint venture partner for the acquisition, development and operation
of vacation ownership resorts in North America and also had the option of
operating vacation ownership resorts on a franchise basis. At such date, the
Promus Agreement precluded the Company from acquiring or developing vacation
ownership resorts with any other multi-hotel brand, but preserved its ability to
develop vacation ownership resorts in combination with non-hotel brands, to
acquire or develop vacation ownership resorts under the Vistana name (other than
in certain selected markets agreed to by the parties), and to develop vacation
ownership resorts with unique, non-multi-hotel brand hotel properties. As of
December 31, 1998, the Company and Promus had not entered into any development
or project for which the joint venture component of the Promus Agreement would
be initiated. As of December 31, 1998, the Company was operating the Hampton
Vacation Resort - Oak Plantation and the Embassy Vacation Resort at Myrtle Beach
as franchised resorts pursuant to the Promus Agreement. At the same date, the
Company was constructing and conducting pre-opening sales at Embassy Vacation
Resort at Scottsdale, a franchised resort pursuant to the Promus Agreement.
Proposed Sun International Joint Venture
In November 1997, the Company entered into an agreement to form a 50/50 joint
venture with a subsidiary of Sun International Hotels, Limited ("Sun") to
design, develop, sell and manage a vacation ownership resort adjacent to Sun's
Atlantis Resort and Casino on Paradise Island in The Bahamas. In connection with
the proposed joint venture, the Company would be required to make an initial
cash equity investment of approximately $7.8 million for the initial phase of
the project. As of December 31, 1998, the Company and Sun had not yet entered
into the definitive joint venture agreement relating to the resort, and no
material activity had occurred for which amounts have been included in the
consolidated financial statements.
- -------------------------------------------------------------------------------
(8) Acquisition Transactions
On September 16, 1997, the Company completed the acquisition of entities
comprising The Success Companies, Success Developments, L.L.C. and Points of
Colorado, Inc. ("Success and Points"). The Company acquired the entire equity
interest in the acquisition for a purchase price of approximately $24.0 million
in cash, 0.2 million shares of Company common stock and contingent consideration
of 0.4 million shares of Company common stock. The net assets acquired totalled
$11.6 million. The purchase method of accounting was followed in accounting for
this transaction. Delivery of the contingent shares is dependent upon Success
and Points achieving certain operating results for calendar years 1998 through
2000. Management of the Company has determined that the contingent consideration
is an additional cost of the acquisition. During the year ended December 31,
1998, approximately 0.14 million shares were recorded and/or issued relative to
the achievement of the required results. The goodwill associated with the
acquisition, incurred to date, is being amortized on a straight-line basis over
20 years. During the year ended December 31, 1998, approximately $3.0 million of
non-cash additions to goodwill were recorded, the majority of which was related
to the issuance of contingent shares of Company common stock to the selling
parties based on the achievement of certain quarterly operating results. For the
year ended December 31, 1997, only the results of operations of Success and
Points from September 16, 1997 through year-end 1997 are included in the
accompanying consolidated statements of income.
The following unaudited pro forma summary presents the combined results of
operations of the Company and Success and Points, as if the acquisition had
occurred at the beginning of 1997 and 1996, respectively. The pro forma amounts
also give effect to certain adjustments which reflect: (1) the Company's Initial
Offering and the conversion of tax status as if each event had occurred at the
beginning of each period, and (2) in 1997 the exclusion of non-recurring charges
related to deferred taxes pertaining to the predecessor entities and
extraordinary items pertaining to extinguishments of debt. This pro forma
summary does not necessarily reflect the results of operations as they would
have been if the businesses had constituted a single entity during such periods
and is not necessarily indicative of results which may be obtained in the
future. The pro forma presentation of the Success and Points acquisition without
effect for the aforementioned adjustments would reflect net income of $1.4
million and $6.9 million or $0.07 and $0.48 per share for the years ended
December 31, 1997 and 1996, respectively.
(Pro forma unaudited)
Years ended December 31,
(in thousands except per share amounts) 1997 1996
- ----------------------------------------------------------------
VOI sales $117,420 $ 74,125
Interest income 21,144 16,629
Total revenue 164,655 112,885
Cost of VOI sales 27,213 17,946
Sales and marketing 52,727 33,844
Provision for doubtful accounts 7,249 4,456
Interest expense--treasury 9,032 8,066
Operating income 24,866 16,019
Net income 15,776 9,997
Earnings per share--diluted $0.81 $0.53
On November 3, 1997, the Company entered into and completed an agreement to
purchase the assets of two
related guest service and marketing companies (the "Acquired Companies") for
$1.8 million in cash and approximately $3.2 million in contingent cash payments.
Payment of the contingent consideration is conditioned on the Acquired Companies
achieving certain operating results in each of the calendar years 1998 through
2000. Management of the Company has determined that the contingent consideration
is an additional cost of the acquisition. No amounts were paid or recognized in
1998 relative to the contingent consideration. The purchase method of accounting
was followed in accounting for this transaction. The goodwill associated with
the acquisition is being amortized on a straight-line basis over 10 years. For
the year ended December 31, 1997, only the results of operations of the Acquired
Companies from November 3, 1997 through year-end 1997 are included in the
accompanying consolidated statements of income.
- --------------------------------------------------------------------------------
(9) Intangibles
Intangible assets consist of goodwill and a covenant not to compete, totaling
$19.7 million and $17.3 million as of December 31, 1998 and 1997, respectively.
In connection with the Success and Points acquisition and the acquisition of the
Acquired Companies completed during 1997, consideration paid exceeded the
estimated value of the assets acquired (including estimated liabilities assumed
as part of the transaction) by approximately $16.7 million. As of December 31,
1998, an additional $3.0 million of goodwill had been recorded relating
primarily to the recognition of contingent consideration. The excess of
investment over net asset values at acquisition is being amortized on a
straight-line basis over 20 years for Success and Points and 10 years for the
Acquired Companies. The amount of excess consideration paid over net asset value
amortized was $0.8 million and $0.2 million in 1998 and 1997, respectively. The
covenant not to compete with a former shareholder/executive of the Company is
being amortized over the five-year term of the agreement. Amortization expense
related to the covenant not to compete was $0.4 million in 1998, 1997, and 1996.
In connection with the acquisition by the Company in 1991 from the Seller, the
estimated value of the assets acquired exceeded the consideration paid
(including the estimated liabilities assumed as part of the transaction) by $3.4
million. Accordingly, the excess value over consideration paid has been
allocated on a pro-rata basis to reduce the recorded value of long-term assets
originally acquired from the Seller, principally customer mortgages receivable.
This excess value over consideration paid is being amortized into income over
the life of those assets. The amount of excess value over consideration paid
amortized into income was $0.1 million in 1998, 1997 and 1996, with a remaining
unamortized balance as of December 31, 1998 and 1997 of $0.6 million and $0.7
million, respectively.
- --------------------------------------------------------------------------------
(10) Repurchase Obligations
Changes in repurchase obligations during the year ended December 31, 1996 were
as follows:
(in thousands)
Balances, beginning of year $ 3,003
Loss on customer mortgages receivable
repurchased under recourse provisions (1,408)
Remaining balance of estimated losses on
repurchase obligations relating to customer
mortgages receivable repurchased (1,595)
---------
Balances, end of year --
=========
As of December 31, 1998 and 1997, there were no outstanding customer mortgages
receivable sold for which the Company had a recourse obligation.
- --------------------------------------------------------------------------------
(11) Receivable Securitization
In September 1998, the Company completed the private placement of $66.2 million
in principal amount of timeshare mortgage-backed notes (the "Notes"). The
securitization was structured as two classes of fixed-rate notes, with
approximately $32.0 million of 5.89% notes being rated `AAA,' and $34.2 million
of 6.28% notes being rated `A,' by Duff & Phelps Credit Rating Co. ("DCR"). The
Notes are secured by approximately $71.1 million in first mortgage liens on
VOI's sold by Vistana subsidiaries in Florida and Colorado. Credit enhancement
for the `AAA' rated notes is provided by subordination of the `A' rated notes,
7% overcollaterization, a letter of credit (approximately $8.5 million at
execution) from Dresdner Bank AG (rated `AA' by DCR), and a reserve account that
grows from 0% to 5% of the pool balance derived from the excess interest spread
earned. The `A' rated notes are credit enhanced by the overcollaterization,
letter of credit, and reserve account. The weighted average cost of the Notes,
including the yield on the Notes and the cost of the letter of credit, is
approximately 6.30% per annum. The Notes were issued through a bankruptcy-remote
Vistana subsidiary. The securitization was treated as an on balance sheet
financing for accounting purposes. Consequently, the principal balance of the
Notes is included in notes and mortgages payable and the customer mortgages
receivable securing the Notes are included in the customer mortgages receivable.
The buildup of the reserve account is being treated as restricted cash. The
balance in the reserve account, once fully funded, and the letter of credit
level (subject to certain restrictions) will decrease at a rate commensurate
with the amortization of the receivable pool. The balance in the reserve account
totalled $2.4 million as of December 31, 1998. No gain on sale will be
recognized as a result of the transaction. The net proceeds of the
securitization were used primarily to repay $60.2 million of outstanding debt
secured by customer mortgages receivable and bearing interest at LIBOR plus 2.5%
and LIBOR plus 1.0%.
Notes to Consolidated Financial Statements
(12) Notes and Mortgages Payable
As of December 31, notes and mortgages payable and remaining availability under
related loan facilities and lines of credit (assuming the availability of
sufficient receivables or other qualified assets) consisted of:
(in thousands) 1998 1997
- -----------------------------------------------------------------------------------------------------------------------
Notes Payable Secured by Customer Mortgages Receivable
Notes payable bearing interest at prime plus 2.0% per annum (9.75% at December 31, 1998).
Remaining availability under these lines of credit was $35.2 million at December 31, 1998. $ 25,080 $ 34,791
Notes payable bearing interest at LIBOR plus 2.5% (7.65% at December 31, 1998).
Remaining availability under these lines of credit was $17.6 million at December 31, 1998. 7,354 39,942
Note payable bearing fixed interest at 11.34% per annum. -- 4,191
Note payable bearing interest at prime plus 1.5% (10.0% per annum at December 31, 1997). -- 278
Note payable bearing interest at LIBOR plus 2.65% (7.71% at December 31, 1998).
Remaining availability under this line of credit was $3.8 million at December 31, 1998. 16,220 --
Note payable bearing interest at LIBOR plus 1% (6.06% at December 31, 1998).
Remaining availability under this line of credit was $73.9 million at December 31, 1998. 26,051 --
Notes payable bearing fixed interest at 6.1% per annum (see Note 11). 58,560 --
--------------------
Subtotal of notes secured by customer mortgages receivable $133,265 $ 79,202
====================
Notes Payable and Mortgage Obligations Secured by Real Estate
Term note payable bearing interest at prime plus 2.0%.
Remaining availability at December 31, 1998 was $4.4 million. Matures on June 25, 2001. $ 13,851 $ 17,167
Construction mortgage note payable bearing interest at prime plus 2.0%.
Remaining availability at December 31, 1998 was $1.1 million. Matures on July 24, 2001. 22,098 6,591
Notes payable bearing interest at LIBOR plus 3.25% (8.13% per annum at December 31, 1998).
Remaining availability at December 31, 1998 was $0.3 million. Matures on July 31, 2002. 12,353 1,930
Mortgage loan bearing fixed interest at 8.2% per annum at December 31, 1998.
Matures on June 15, 2001. 1,998 1,839
Construction mortgage notes payable bearing interest at LIBOR plus 2.85%
(7.91% at December 31, 1998).
Remaining availability at December 31, 1998 was $32.2 million. Matures on July 9, 2006. 27,848 --
Construction mortgage notes payable bearing interest at LIBOR plus 2.65%.
Remaining availability at December 31, 1998 was $26.6 million. Matures on October 9, 2005. 13,384 --
--------------------
Subtotal of notes and mortgages secured by real estate $ 91,532 $ 27,527
====================
Other Notes and Mortgage Loan Payable
Note payable (working capital loan) bearing interest at prime plus 2%.
Remaining availability at December 31, 1998 was $0.3 million. Matures on June 25, 2001. $ 2,240 $ 2,228
Unsecured note payable bearing interest at LIBOR plus 2.25% (7.31% at December 31, 1998).
Remaining availability at December 31, 1998 was $5.0 million. Matures on November 30, 2000. 15,000 --
Capital lease obligations 607 590
--------------------
Total notes and mortgages payable $242,644 $109,547
====================
During the year ended December 31, 1998, the Company entered into two revolving
project finance facilities: (i) a $60.0 million facility that provides a three-
year borrowing term followed by a five-year provision for repayment and bears
interest at LIBOR plus 2.85% per annum, and (ii) a $40.0 million facility that
provides a three-year borrowing term followed by a maximum repayment term of
four years and bears interest at LIBOR plus 2.65%. Both project finance
facilities provide 100% financing for land acquisition and construction and
development of approved resorts. The Company also entered into a $20.0 million
receivables based revolving credit facility that provides a three-year borrowing
term followed by a seven-year provision for repayment and bears interest at
LIBOR plus 2.25%. During 1998, the Company also increased its principal pre-
securitization receivables warehouse facility from $70.0 million to $100.0
million. This facility bears interest at LIBOR plus 1.0%.
As of December 31, 1998, the Company had loan facilities secured by customer
mortgages receivable with available but unused capacity (assuming the
availability of
40 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
sufficient receivables) of up to $130.5 million. These various facilities bear
interest at rates which include prime plus 2%, as well as LIBOR plus 1.0%, 2.5%
and 2.65%, and fixed interest of 6.1%.
In addition, as of December 31, 1998, the Company had remaining availability of
up to $64.6 million for facilities secured by real estate. These facilities
bear interest at variable rates which include Prime plus 2%, LIBOR plus 2.65%,
2.85% and 3.25% and fixed interest of 8.2%.
As part of financing the development of units for WGV and OPJV, the joint
venturers have agreed to pay its lenders, upon fulfillment of its obligations,
incentive fees. The incentive fees are being recognized over the term of the
respective debt as an adjustment to interest expense using the effective
interest method. The debt associated with the incentive fees had outstanding
balances of $13.9 million, $22.1 million, and $2.2 million at December 31, 1998.
In addition, upon formation, WGV entered into an agreement with one of the
limited partners whereby WGV could borrow up to $1.6 million. No amounts were
outstanding under this agreement as of December 31, 1998.
Scheduled principal payments on notes and mortgages where there are agreed upon
scheduled repayments subsequent to December 31, 1998 are as follows (in
thousands):
Year ended December 31:
- --------------------------------------------------
1999 43,747
2000 29,520
2001 13,418
2002 17,378
2003 and thereafter 5,316
The foregoing principal repayment obligations exclude amounts due on notes
payable secured by customer mortgages receivable including the Notes issued in
connection with the securitization transaction, as such notes do not have fixed
principal amortization dates. Rather, all collections of principal and interest
on the receivables serving as collateral for these notes are paid to the lender
on a monthly basis. Payments are first applied to outstanding interest and then
to principal. The total amount of customer mortgages receivable pledged was
$160.9 million and $125.1 million at December 31, 1998 and 1997, respectively.
(13) Extraordinary Items
During the first and fourth quarters of 1997, in connection with the Initial
Offering and Secondary Offering, the Company repaid certain indebtedness early
and, as a result, recognized extraordinary after-tax charges of $0.8 million and
$0.6 million, or $0.05 per share and $0.03 per share, respectively. The interest
rates on the indebtedness extinguished ranged between 10.3% and 11.9% per annum,
and 8.2% and 11.0% per annum, respectively. The extraordinary charges consisted
of the following amounts:
1997
First Fourth
(in thousands) Quarter Quarter
- -------------------------------------------------------------
Write-off of related unamortized
financing costs $ 863 $ 696
Prepayment penalties 455 272
Extraordinary charge before tax benefit 1,318 968
Income tax benefit (493) (368)
Net extraordinary charge $ 825 $ 600
- -------------------------------------------------------------
(14) Income Taxes
Upon completion of the Initial Offering, the Company became subject to federal
and state income taxes from the effective date of the sale of the common stock.
In addition, the Company was required to provide a deferred tax liability for
cumulative temporary differences between financial reporting and tax reporting
in its consolidated statements of income for the period following the effective
date of the Initial Offering. Such deferred taxes are based on the cumulative
temporary differences at the date of the Initial Offering and totalled $13.2
million.
Prior to February 28, 1997, the predecessor entities were taxed either as a C
corporation taxable at the corporate level, as an S corporation taxable at the
shareholder level, or as a partnership taxable at the partner level.
Accordingly, the table below summarizes the unaudited pro forma provision for
income taxes that would have been reported had the Company been treated as a C
corporation rather than as individual partnerships and limited liability
companies for federal income tax purposes for the year ended December 31, 1996.
For the year ended December 31, 1997, the Company's actual income tax provision
is presented for the period subsequent to February 28, 1997.
Year ended December 31,
(in thousands) 1998 1997 1996
Pro forma
(unaudited)
- ----------------------------------------------------------
Current:
Federal $ 3,774 $3,426 $2,500
State 663 584 220
--------------------------
4,437 4,010 2,720
==========================
Deferred:
Federal 7,457 3,495 1,071
State 761 596 235
--------------------------
8,218 4,091 1,306
--------------------------
Provision for income taxes 12,655 $8,101 $4,026
==========================
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 41
Notes to Consolidated Financial Statements
A reconciliation between the statutory provision for income taxes and the
provision for income taxes is shown as follows for the year ended December 31:
Year ended December 31,
(in thousands) 1998 1997 1996
Pro forma
(unaudited)
- ----------------------------------------------------------------------
Income tax at federal statutory rate $11,660 $7,456 $3,905
State tax, net of federal benefit 926 762 300
Amortization of goodwill 128 26 --
Other (59) (143) (179)
------------------------------
Provision for income taxes $12,655 $8,101 $4,026
==============================
Deferred income taxes reflect the net tax effects of temporary differences
between the carrying amounts of assets and liabilities for financial reporting
purposes and the amounts used for income tax purposes. The significant
components of the net deferred tax liabilities were as follows for the year
ended December 31:
Year ended December 31,
(in thousands) 1998 1997
- -----------------------------------------------------------
Deferred tax assets:
Allowance for doubtful accounts $ 9,193 $ 5,211
Purchase discounts 519 1,217
Alternative minimum tax credit 9,786 5,453
Fixed assets and intangibles 698 967
Net operating loss carryforward 12,264 5,093
Accrued compensation and benefits 88 1,666
Other accruals 300 1,714
Other 393 826
-------------------
Total deferred tax assets $ 33,241 $ 22,147
Deferred tax liabilities:
Deferred revenue (installment sales) $ 58,097 $ 38,764
VOI and other inventory 302 338
Other 595 580
-------------------
Total deferred tax liabilities 58,994 39,682
-------------------
Net deferred tax liabilities $(25,753) $(17,535)
===================
At December 31, 1998, the Company had net operating loss carryforwards of
approximately $32.0 million for federal tax purposes, which expire between 2008
and 2013. In addition, the Company had approximately $9.8 million in alternative
minimum tax credit carryforwards.
Under Section 453(l) of the Internal Revenue Code, interest may be imposed on
the amount of tax attributable to the installment payments on customer mortgages
receivable for the period beginning on the date of sale and ending on the date
the related tax is paid. If the Company is otherwise not subject to pay tax in a
particular year, no interest is imposed since the interest is based on the
amount of tax paid in that year. The Company has not included a provision for
this interest, as it is not currently subject to the tax; however, in the future
it may become so. The Company continues to monitor its tax provision and may
adjust it to provide for this interest in the future.
(15) Shareholders' Equity
The Company is authorized to issue 100 million shares of common stock, par value
of $.01 per share. At the time of the Initial Offering the Company issued a
total of 4.6 million shares of common stock at a price of $12 per share. The
majority of the approximately $49.5 million net proceeds from the Initial
Offering were used to repay approximately $39.7 million of outstanding
indebtedness, including $0.6 million of accrued interest and prepayment
penalties.
On December 4, 1997, the Company completed a Secondary Offering of 2.0 million
shares of common stock at a price of $22 per share. The Company used all of the
$41.5 million net proceeds to repay outstanding indebtedness, including $0.3
million of accrued interest and prepayment penalties.
The Company is authorized to issue 5.0 million shares of preferred stock, par
value $.01 per share. As of December 31, 1998 and 1997, none of the authorized
shares had been issued.
(16) Stock Option and Employee Stock Purchase Plans
The Company adopted SFAS No. 123, "Accounting for Stock-Based Compensation" in
1997 by accounting for employee stock-based compensation under APB Opinion No.
25 and providing pro forma equivalent information in a footnote disclosure.
Stock Option Plan
The Vistana, Inc. Stock Plan (the "Stock Plan") was adopted by the Company's
shareholders in December 1996, prior to the Initial Offering, and amended by the
Company's shareholders in April 1998. As amended, the Stock Plan covers up to
2.5 million shares of common stock and permits the Company to grant to
employees, directors, officers, and consultants of the Company and its
subsidiaries and affiliates: (i) incentive stock options ("ISOs"); (ii) non-
qualified stock options ("NSOs"); (iii) stock appreciation rights; (iv) phantom
stock awards; and (v) restricted stock. The Stock Plan is administered by the
Compensation Committee of the Board of Directors, which also selects the
individuals who receive grants under the plan. As of December 31, 1998, the only
grants that had been made under the Stock Plan were NSOs.
The exercise price, term, and vesting schedule for options granted under the
Stock Plan are set by the Compensation Committee, subject to certain
limitations. Under the Stock
42 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Plan, the exercise price of an ISO may not be less than the fair market value of
the shares of common stock at the date of grant (110% if the ISO is granted to a
greater than 10% shareholder), and the term of an option may not exceed 10 years
(5 years if an ISO is granted to a greater than 10% shareholder). Unless
otherwise specified by the Compensation Committee (which from time to time has
approved vesting schedules for employees ranging from 24 to 48 months), options
become 25% vested after 12 months from the date of grant and thereafter vest pro
rata in arrears over 36 months. Vesting is accelerated in the event of a change
in control of the Company. Options generally terminate at, or shortly after, the
termination of the option holder's employment. Each of the Company's non-
employee directors received NSOs under the Stock Plan upon joining the Board of
Directors. The Stock Plan provides for the automatic grant of 5,000 additional
NSOs per year to certain non-employee directors after the options previously
granted to the director have vested.
The following table summarizes the status of the Company's Stock Plan:
December 31, 1998 December 31, 1997
- -------------------------------------------------------------------------------------------------------------------------------
Weighted Average Weighted Average
Fixed Option Shares Exercise Price Shares Exercise Price
- -------------------------------------------------------------------------------------------------------------------------------
Outstanding options beginning of year 2,080,750 $14.08 535,000 $11.00
Granted: 157,000 $19.52 1,654,000 $14.94
Exercised: 73,875 $12.00 -- --
Forfeited: 75,750 $12.25 108,250 $12.00
Outstanding at year end: 2,088,125 $14.63 2,080,750 $14.08
Exercisable at year end: 802,479 $13.47 178,750 $11.25
Weighted average fair value of options granted during the year $ 8.42 $ 6.44
The following table summarizes the status of the Stock Plan
for options outstanding and exercisable at December 31, 1998:
Options Outstanding Options Exercisable
------------------------------------------------------------------------------------------------------------
Weighted
Average
Outstanding at Remaining Weighted Options Weighted
Range of December 31, Contractual Average Exercisable at Average
Exercise Prices 1998 Life Exercise Price December 31, 1998 Exercise Price
------------------------------------------------------------------------------------------------------------
$11.00 535,000 8 $11.00 267,500 $11.00
$11.88 - $13.13 861,125 9 12.04 359,457 12.00
$17.50 - $17.75 375,000 9 17.56 106,564 17.56
$20.25 - $25.50 317,000 9 24.34 68,958 24.34
------------------------------------------------------------------------------------------------------------
Total 2,088,125 $14.63 802,479 $13.47
------------------------------------------------------------------------------------------------------------
The Company has adopted the disclosure-only provisions of SFAS No. 123.
Therefore, no compensation expense has been recognized for the Stock Plan. Had
compensation cost for the Stock Plan been accounted for based on the fair value
at the grant date, consistent with provisions of SFAS No. 123, the Company's net
income and net income per share would have been reduced to the pro forma amounts
below:
December 31,
(in thousands except per share amounts) 1998 1997
- --------------------------------------------------------------
Net income--as reported $20,648 $ 298
Net income--pro forma $19,828 $ (983)
Net income per diluted share--as reported $ .96 $ 0.02
Net income per diluted share--pro forma $ .92 $(0.05)
The effects of applying SFAS No. 123 for the presentation of pro forma
disclosures are not necessarily indicative of the effects on reported net income
for future years.
The fair value of options granted in both 1998 and 1997 were estimated using the
Black-Scholes option pricing model as of the date of grant with the following
assumptions: expected lives of 6 years; expected volatility of 35%; expected
dividend yield of 0%; and a range of risk-free interest rates between 4.80% and
5.02% for 1998 and 5.81% and 6.88% for 1997.
In connection with the Initial Offering, the Principal Shareholders granted
certain executive officers and other employees of and a consultant to the
Company (i) immediately exercisable options to purchase an aggregate
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 43
Notes to Consolidated Financial Statements
of 1.4 million shares of common stock at an exercise price equal to $12 per
share, and (ii) an option, which vests on February 10, 2001, to purchase an
aggregate of 0.04 million shares of common stock at an exercise price equal to
$12 per share. Subsequent to the Initial Offering, the Principal Shareholders
granted certain executive officers (i) an option, which vests over a period of
four years, to purchase 0.4 million shares of common stock at an exercise price
equal to $24.62 per share, and (ii) an option, which vests over a period of four
years, to purchase an aggregate of 0.04 million shares of common stock at an
exercise price equal to $24.25 per share. All of these options will terminate
ten years after the date of grant, subject to certain exceptions. The shares
covered by these options were outstanding as of December 31, 1998.
Employee Stock Purchase Plan
Effective October 1, 1997, the Company adopted the Vistana, Inc. Employee Stock
Purchase Plan (the "Purchase Plan") to assist employees in acquiring a stock
ownership interest in the Company and to encourage employees to remain in the
employ of the Company. The Purchase Plan meets the requirements of an "employee
stock purchase plan" pursuant to section 423 of the Internal Revenue Code. A
maximum of 1.0 million shares of common stock is reserved for issuance under the
Purchase Plan. As of December 31, 1998, approximately 39,000 shares had been
issued under the Purchase Plan.
(17) Earnings Per Share
Basic earnings per share ("EPS") excludes dilution and is computed by dividing
income available to common shareholders by the weighted average number of common
shares outstanding for the period. Diluted EPS reflects the potential dilution
that could occur if securities or other contracts to issue Common Stock were
exercised and shared in the earnings of the Company. For the year ended December
31, 1998 and 1997, approximately 0.4 million and 0.3 million net shares,
respectively, relative to options granted were considered dilutive after giving
effect for taxes and the application of the treasury stock method and were
included in the respective diluted EPS calculations. An additional 0.1 million
and 0.08 million net shares, respectively, were considered anti-dilutive and
therefore excluded from the respective diluted EPS calculations. Contingent
shares recorded but not issued were considered outstanding for purposes of
computing diluted EPS.
(18) 401(k) Plan
The Company has established a qualified retirement plan, with a salary deferral
feature designed to qualify under Section 401 of the Code (the "401(k) Plan").
Employees of the Company are eligible to participate in the 401(k) Plan if they
meet certain requirements concerning minimum age and period of credited service.
The 401(k) Plan allows participants to defer up to 15% of their compensation on
a pre-tax basis subject to certain maximum amounts. The 401(k) Plan allows the
Company discretionary matching contributions up to a maximum of 6% of the
participant's compensation per year. The Company has historically matched
participant contributions in an amount equal to 25 cents for each dollar of
participant contributions and expects to continue to do so. The expense
recognized was $0.3 million in 1998, and $0.2 million in each of 1997 and 1996.
(19) Stay-On Agreements
In 1992, the Company entered into stay-on agreements (which were amended and
expanded in 1995) with certain senior management executives who were not owners
of the Company. In order to receive payment under the agreements the executives
were required to remain in the employ of the Company through December 31, 1996.
The agreements provided that these executives would be entitled to receive, on a
deferred basis, an aggregate of 3% (amended in 1995 to 10%) of the cumulative
pretax income of the Company during the period of employment, before
determination of the deferred executive incentive compensation amounts.
The expense associated with these agreements was recognized in amounts totaling
$1.1 million for the year ended December 31, 1996. No expense was recognized in
1997 or 1998. Amounts payable under these agreements totalled $1.7 million and
$3.1 million as of December 31, 1998 and 1997, respectively, and are included in
accrued compensation and benefits in the accompanying consolidated balance
sheets. Payment of this obligation is being made in annual installments over a
three-year period beginning in 1997. In 1998, approximately $1.4 million, of
installment payments were made. As the senior executives subject to the stay-on
agreements entered into employment agreements with the Company in 1997, no
future expense amounts will be incurred in connection with the stay-on
provisions.
(20) Commitments and Contingencies
The Company is, from time to time, party to certain litigation which relates to
matters arising in the ordinary course of business. Management believes that
such litigation is not expected to have a material impact on the financial
position or results of operations of the Company.
44 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(21) Quarterly Financial Information
(Unaudited)
Summarized quarterly financial information for the years ended December 31, 1998
and 1997 is presented below (in thousands except share amounts):
Net income for the first quarter of 1997 includes a non-recurring charge of
$13.2 million related to the recognition of deferred taxes in connection with
the Company's change in tax status. In addition, financial results in 1997
include the results of Success and Points from the September 16, 1997
acquisition date.
Three months ended in 1998 March June September December
31 30 30 31
- -----------------------------------------------------------------------------------------------------------------------
VOI sales $ 33,535 $ 42,596 $ 51,354 $ 45,387
Interest Income 6,085 6,154 6,943 7,356
Total revenue 47,186 57,551 67,439 61,546
VOI cost of sales 7,048 9,372 11,942 10,260
Sales and marketing 16,945 20,192 23,430 22,571
Interest expense-treasury 2,188 2,083 2,352 2,229
Provision for doubtful accounts 2,482 3,144 3,807 3,359
Interest expense-other 373 442 1,487 1,755
--------------------------------------------------------------
Net Income $ 3,479 $ 5,190 $ 6,409 $ 5,570
==============================================================
Per share data:
Net Income-diluted .16 .24 .30 .26
==============================================================
Weighted average shares
outstanding-diluted 21,630 21,630 21,384 21,297
==============================================================
Three months ended in 1997 March June September December
31 30 30 31
- ----------------------------------------------------------------------------------------------------------------------
VOI sales $ 18,246 $ 21,837 $ 28,632 $ 32,172
Interest Income 4,445 4,480 4,617 5,754
Total revenue 28,302 32,193 39,712 45,143
VOI cost of sales 4,217 5,060 6,326 7,295
Sales and marketing 8,581 9,705 12,229 15,100
Interest expense-treasury 1,774 1,355 1,729 2,382
Provision for doubtful accounts 1,282 1,526 1,909 2,254
Interest expense-other 760 310 283 352
--------------------------------------------------------------
Net Income (loss) before extraordinary item (10,405) 3,431 4,543 4,154
Extraordinaary item, net of tax (825) -- -- (600)
==============================================================
Net Income (loss) $(11,230) $ 3,430 $ 4,543 $ 3,554
==============================================================
Per share data:
Income (loss) before extraordinary item $ (0.66) $ 0.18 $ 0.23 $ 0.20
==============================================================
Extraordinary item, net of tax (0.05) -- -- (.03)
==============================================================
Net (loss) income-diluted (0.71) 0.18 0.23 0.17
==============================================================
Weighted average shares
outstanding-diluted 15,819 18,800 19,592 20,418
==============================================================
Notes to Consolidated Financial Statements
(22) Interest Rate Swap Agreements
The Company entered into interest rate swap agreements to reduce the impact of
changes in interest rates on certain of its floating rate term debt. At December
31, 1996, the Company had two outstanding interest rate swap agreements with a
commercial bank, having a total notional principal amount of $14.5 million.
These interest rate swap agreements effectively fixed the Company's interest
rates on its $9.8 million floating rate note due June 30, 2000 and on its $4.7
million floating rate note due December 29, 2000, to 9.69% per annum and 11.69%
per annum, respectively. In 1997, in connection with the Initial Offering, the
remaining swap agreements were terminated.
(23) Supplemental Disclosures of Non-cash Operating and Investing Activities
(in thousands) 1998 1997 1996
- -------------------------------------------------------------------------------------------------------
Supplemental schedule of
non-cash operating activities:
Transfers from construction in
progress to inventory of VOI's $51,485 $14,512 $9,397
========================
Transfers from land held for
development to inventory of VOI's $ 2,462 $ 866 $ 986
========================
Interest capitalized $ 3,186 $ 1,874 $ 434
========================
Transfers from construction in
progress to fixed assets $12,794 $ 1,701 $ 53
========================
During 1996, pursuant to clean-up call provisions, the Company purchased certain
customer mortgages receivables previously sold. A summary of the impact of these
transactions on non-cash investing activities is as follows:
(in thousands) 1996
- ---------------------------------------------------------
Contractual balance of customer mortgages
receivable acquired $ 9,804
Allowance for doubtful accounts assigned to
customer mortgages receivable acquired (588)
Remaining balance of estimated losses on
repurchase obligations relating to customer
mortgages receivable repurchased 1,595
Investment in limited partnership (5,059)
Cash paid upon repurchase (1,170)
-------
Discount on purchase of
customer mortgages receivable $ 4,582
-------
46 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(24) Business Segment Information
Effective January 1, 1998, the Company adopted SFAS No. 131, "Disclosures about
Segments of an Enterprise and Related Information." SFAS No. 131 establishes
new standards for reporting information about business segments and related
disclosures about products and services, geographic areas and major customers.
The Company is engaged in two operating segments, timeshare development and
resort operations. The Company's reportable segments offer different products
or services and are managed separately because each requires different operating
strategies and management expertise. The operations of the timeshare
development segment consist of constructing, furnishing, marketing, selling, and
financing the sale of VOI's. The resort operations segment manages the
operations of the resorts and related amenities. The accounting policies of the
segments are as described in Note 3.
The table below presents information related to the Company's business segments
for 1998, 1997, and 1996
(in thousands) Revenue from Additions to Depreciation
External Operating Total Long-Lived and
Customers Income (1) Assets Assets Amortization
- ---------------------------------------------------------------------------------------------------------------------
1998
Timeshare Development $203,909 $27,813 $446,041 $18,266 $5,110
Resort Operations 20,735 1,823 21,273 7,912 945
- ---------------------------------------------------------------------------------------------------------------------
Total Segments 224,644 29,636 467,314 26,178 6,055
Other 9,078 1,246 4,106 1,233 369
- ---------------------------------------------------------------------------------------------------------------------
Total Company $233,722 $30,882 $471,420 $27,411 $6,424
1997
Timeshare Development $120,932 $19,129 $275,089 $ 6,229 $2,484
Resort Operations 16,921 1,834 9,545 165 675
- ---------------------------------------------------------------------------------------------------------------------
Total Segments 137,853 20,963 284,634 6,394 3,159
Other 7,499 1,483 2,575 123 296
- ---------------------------------------------------------------------------------------------------------------------
Total Company $145,352 $22,446 $287,209 6,517 3,455
1996
Timeshare Development $ 76,295 $7,712 $162,089 $ 768 $2,105
Resort Operations 13,587 1,400 8,165 1,435 243
- ---------------------------------------------------------------------------------------------------------------------
Total Segments 89,882 9,112 170,254 2,203 2,348
Other 7,054 1,377 3,668 310 205
- ---------------------------------------------------------------------------------------------------------------------
Total Company $ 96,936 $10,489 $173,922 $ 2,513 $2,553
(1) Total Company operating income equals income before taxes and extraordinary
item as shown on the Company's consolidated statements of income.
The table below presents information related to geographic areas in which the
Company operated in 1998, 1997, and 1996.
1998 1997 1996
- ---------------------------------------------------
Revenue(1)
United States $206,898 $108,435 $ 76,503
Foreign 26,824 36,917 20,433
- ---------------------------------------------------
Total Revenue $233,722 $145,352 $ 96,936
Total Assets
United States $467,228 $285,048 $172,992
Foreign 4,192 2,161 930
- ---------------------------------------------------
Total Assets $471,420 $287,209 $173,922
(1) Revenues attributed to geographic area are based on residence of customer.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 47
Directors and Officers
- --------------------------------------------------------------------------------
Board of Directors
Jeffrey A. Adler /1/
President and
Co-Chief Executive Officer
Vistana, Inc.
James G. Brocksmith, Jr.
Consultant
Naples, Florida
Raymond L. Gellein, Jr./1/
Chairman of the Board and
Co-Chief Executive Officer
Vistana, Inc.
Laurence S. Geller /2,3/
Chief Executive Officer
Strategic Hotel Capital
Incorporated
Chicago, Illinois
Charles E. Harris
Vice Chairman and
Chief Financial Officer
Vistana, Inc.
Steven J. Heyer /2,3/
President and Chief Operating
Officer
Turner Broadcasting System, Inc.
Atlanta, Georgia
1 Member of Nominating Committee
2 Member of Audit Committee
3 Member of Compensation Committee
- --------------------------------------------------------------------------------
Corporate Officers
Raymond L. Gellein, Jr.
Chairman of the Board and
Co-Chief Executive Officer
Jeffrey A. Adler
President and
Co-Chief Executive Officer
Charles E. Harris
Vice Chairman and
Chief Financial Officer
Carol Lytle
Senior Vice President
James A. McKnight
Senior Vice President,
Construction and Development
Susan Werth
Senior Vice President,
General Counsel and Secretary
Alvin White, Jr.
Senior Vice President, Human
Resources
David N. Matheson
Vice President, Public Relations
Mark E. Patten
Vice President and
Chief Accounting Officer
- --------------------------------------------------------------------------------
Additional Vice Presidents
Lisa M. Cassin
Treasury Operations
Rex Davidson
VCH Communications, Inc.
William J. Newcome
Information Systems
Joel J. Pope
Resort Operations
Sergio D. Rivera
Administration
William F. Schabot
Facilities Management and
Purchasing
Julie R. Smith
VCH Portfolio Services Inc.
Paulette J. Temple
Vistana Resort Orlando
Joy D. Theiss
Human Resources
Thorp S. Thomas
Property Management Services
- --------------------------------------------------------------------------------
Vistana East, Inc.
Carol Lytle
President and Co-Chief Executive
Officer
William J. McLaughlin
President and Co-Chief Executive
Officer
Jeff L. Carter
Vice President, Sales
Karen S. Friend
Vice President
Sharon McLaughlin
Vice President
Robyn Ryan
Vice President
Brian F. Tolan
Vice President, Marketing
Martin J. Tolan
Vice President, Marketing
- --------------------------------------------------------------------------------
Vistana West, Inc. and Affiliates
Donald J. Dubin
Co-President
Larry D. Doll
Co-President
David E. Bruce
Exec. Vice President
James Danz
Vice President
Gary DuFresne
Vice President
Anne Kingsley
Vice President
Paula S. Matson
Vice President
Ronald R. Sharp
Treasurer
Marc B. Preston
Controller
Vistana International, Inc.
Alain J. A. Grange
President and Chief Executive
Officer
48 DIRECTORS AND OFFICERS