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IILG > SEC Filings for IILG > Form 10-Q on 8-Aug-2013All Recent SEC Filings

Show all filings for INTERVAL LEISURE GROUP, INC.

Form 10-Q for INTERVAL LEISURE GROUP, INC.


8-Aug-2013

Quarterly Report


Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations

Cautionary Statement Regarding Forward-Looking Information

This quarterly report on Form 10-Q contains "forward-looking statements" within the meaning of the Private Securities Litigation Reform Act of 1995. The use of words such as "anticipates," "estimates," "expects," "intends," "plans" and "believes," and similar expressions or future or conditional verbs such as "will," "should," "would," "may" and "could" among others, generally identify forward-looking statements. These forward-looking statements include, among others, statements relating to: our future financial performance, our business prospects and strategy, anticipated financial position, liquidity and capital needs and other similar matters. These forward-looking statements are based on management's current expectations and assumptions about future events, which are inherently subject to uncertainties, risks and changes in circumstances that are difficult to predict.

Actual results could differ materially from those contained in the forward-looking statements included in this quarterly report for a variety of reasons, including, among others: adverse trends in economic conditions generally or in the vacation ownership, vacation rental and travel industries; adverse changes to, or interruptions in, relationships with third parties; lack of available financing for, or insolvency of developers; consolidation of developers; decreased demand from prospective purchasers of vacation interests; travel-related health concerns; changes in our senior management; regulatory changes; our ability to compete effectively and successfully add new products and services; our ability to successfully manage and integrate acquisitions; impairment of assets; the restrictive covenants in our revolving credit facility; adverse events or trends in key vacation destinations; business interruptions in connection with our technology systems; ability of managed homeowners associations to collect sufficient maintenance fees; third parties not repaying advances or extensions of credit; and our ability to expand successfully in international markets and manage risks specific to international operations. Certain of these and other risks and uncertainties are discussed in our filings with the SEC, including in Item 1A "Risk Factors" of our 2012 Annual Report on Form 10-K and in Part II of this report. In light of these risks and uncertainties, the forward looking statements discussed in this report may not prove to be accurate. Accordingly, you should not place undue reliance on these forward looking statements, which only reflect the views of our management as of the date of this report. Except as required by applicable law, we do not undertake to update these forward-looking statements.

GENERAL

The following Management Discussion and Analysis provides a narrative of the results of operations and financial condition of ILG for the three and six months ended June 30, 2013. This section should be read in conjunction with the consolidated financial statements and accompanying notes included in this report as well as our 2012 Annual Report on Form 10-K, which have been prepared in accordance with U.S. generally accepted accounting principles ("GAAP"). This discussion includes the following sections:


Management Overview


Results of Operations


Financial Position, Liquidity and Capital Resources


Critical Accounting Policies and Estimates


ILG's Principles of Financial Reporting


Reconciliations of Non-GAAP Measures


MANAGEMENT OVERVIEW

General Description of our Business

ILG is a leading global provider of membership and leisure services to the vacation industry. We operate in two operating segments: Membership and Exchange and Management and Rental. Membership and Exchange offers leisure and travel-related products and services to owners of vacation interests and others primarily through various membership programs, as well as related services to resort developer clients. Management and Rental provides hotel, condominium resort, timeshare resort and homeowners association management, and rental services to both vacation property owners and vacationers.

Membership and Exchange Services

Interval, the principal business comprising our Membership and Exchange segment, has been a leader in the membership and exchange services industry since its founding in 1976. As of June 30, 2013, Interval's primary operation is the Interval Network, a quality global vacation ownership membership exchange network with:


a large and diversified base of participating resorts consisting of approximately 2,800 resorts located in over 75 countries, including both leading independent resort developers and branded hospitality companies; and


approximately 1.8 million vacation ownership interest owners enrolled as members of the Interval Network.

Interval typically enters into multi-year contracts with developers of vacation ownership resorts, pursuant to which the resort developers agree to enroll all purchasers of vacation interests at the applicable resort as members of an Interval exchange program. In return, Interval provides enrolled purchasers with the ability to exchange the use and occupancy of their vacation interest at the home resort (generally for a period of one week) for the right to occupy accommodations at a different resort participating in an Interval exchange network. Through Interval's Getaways, members may rent resort accommodations for a fee without relinquishing the use of their vacation interest. In addition, Interval offers sales, marketing and operational support, consulting and back-office services, including reservation servicing, to certain resort developers participating in the Interval Network, upon their request and for additional consideration.

The Membership and Exchange segment earns most of its revenue from (i) fees paid for membership in the Interval Network and (ii) Interval Network transactional and service fees paid primarily for exchanges, Getaways, reservation servicing, and related transactions collectively referred to as "transaction revenue."

Management and Rental Services

We also provide management and rental services to hotels as well as condominium and timeshare resorts and their homeowners associations through Aston, Vacation Resorts International, or VRI, and Trading Places International, or TPI. Such vacation properties and hotels are not owned by us. Aston is based in Hawaii and concentrates largely on hotel and condominium resort management primarily in Hawaii, as well as vacation property rental and related services (including common area and owner association management services for condominium projects). TPI provides property management, vacation rental and homeowners association management services to timeshare resorts in the United States, Canada and Mexico. On February 28, 2012, we acquired VRI, a non-developer provider of resort and homeowners association management services to the shared ownership industry.


As of June 30, 2013, the businesses that comprise our Management and Rental segment provided management and rental services at over 200 vacation properties, resorts and club locations in North America as well as more limited management services to certain additional properties.

Revenue from the Management and Rental segment is derived principally from fees for hotel, condominium resort, timeshare resort and homeowners association management and rental services. Management fees consist of a base management fee and, in some instances for hotels or condominium resorts, an incentive management fee which is generally a percentage of operating profits or improvement in operating profits. Service fee revenue is based on the services provided to owners including reservations, sales and marketing, property accounting and information technology services either internally or through third party providers. A majority of Aston's hotel and condominium resort management agreements provide that owners receive either specified percentages of the revenue generated under our management or guaranteed dollar amounts. In these cases, the operating expenses for the rental operation are paid from the revenue generated by the rentals, the owners are then paid their contractual percentages or amounts, and the Management and Rental segment either retains the balance (if any) as its management fee or makes up the deficit.

International Operations

International revenue decreased in the three and six months ended June 30, 2013 by 2.9% and 0.7%, respectively, compared to the same periods in 2012. As a percentage of our total revenue, international revenue decreased in the three and six months ended June 30, 2013 to 17.5% and 18.2%, respectively, from 19.0% and 19.4% compared to the same periods in 2012. The decrease in international revenue as a percentage of total revenue is largely attributable to the February 2012 acquisition of VRI which operates entirely in the United States.

Other Factors Affecting Results

Membership and Exchange

The consolidation of resort developers driven by bankruptcies and the lack of receivables financing has resulted in a decrease in the flow of new members from point of sale to our exchange networks. While access to receivables financing has recovered, financing standards for consumers remain higher than those required several years ago. Additionally, a high proportion of sales by developers are to their existing owners, which does not result in new members to the Interval Network.

Our 2013 results to-date continue to be negatively affected by a shift in the percentage mix of our membership base from traditional, direct renewal members to corporate members who are renewed directly by the respective developer and tend to have a lower propensity to transact with us. Membership mix as of June 30, 2013 included 60.7% traditional and 39.3% corporate members, compared to 62.9% and 37.1%, respectively, as of June 30, 2012. Consequently, where possible, we structure our corporate membership arrangements to include reservation servicing and/or other revenue streams to mitigate the anticipated lower transaction propensity.

Management and Rental

Our Management and Rental segment results are susceptible to variations in economic conditions, particularly in its largest market, Hawaii. According to the Hawaii Tourism Authority, visitor arrivals by air in Hawaii increased 4.1% and 5.6% for the three and six months ended June 30, 2013, respectively, compared to the same periods in the prior year. The increase in visitors correlates with an overall increase of 9.5% and 12.0% in revenue per available room ("RevPAR") in Hawaii for the three and six months ended June 30, 2013 compared to the same periods in 2012. The increases in RevPAR in Hawaii were driven by higher average daily rates.


As of the latest forecast (May 2013), the Hawaii Department of Business, Economic Development and Tourism forecasts increases of 4.3% in visitors to Hawaii and 5.6% in visitor expenditures in 2013 over 2012.

Business Acquisition

On February 28, 2012, we acquired VRI, a non-developer provider of resort and homeowners association management services to the shared ownership industry. VRI was consolidated into our financial statements as of the acquisition date and the financial effect of this acquisition was not material to our consolidated financial statements; however, the year-over-year comparability for the six month period ending June 30, 2013 was affected as further discussed in our Results of Operations section.

Correction of an Immaterial Prior Period Item

During the current quarter, we identified an immaterial net understatement of membership revenue, related membership expenses, and income for the period commencing January 1, 2011 through March 31, 2013. In accordance with ASC 250, "Accounting Changes and Error Corrections," we assessed the materiality of the net understatement, both quantitatively and qualitatively, and concluded it is not material to any of our previously issued or current year financial statements. The out of period correction of this item resulted in the recognition of $4.1 million of membership revenue and $0.6 million of certain membership expenses in the three and six month periods ended June 30, 2013. Consequently, operating income and net income for the three and six months ended June 30, 2013 was increased by $3.5 million and $2.1 million, respectively, or $0.04 of diluted earnings per share.

Outlook

The vacation ownership industry remains in a period of transition that resulted in the bankruptcy, restructuring and consolidation of developers as well as continued modifications to their business models. We expect additional consolidation and reorganizations within the industry. Additionally, we anticipate continued margin compression and increased competition in our membership and exchange business.

For the Management and Rental segment, we expect Aston's RevPAR to continue to show year-over-year improvement as its largest market, Hawaii, continues its tourism recovery and benefits from increases in airlift into the island chain; however, increases in the cost of a Hawaiian vacation may negatively impact visitor arrivals and temper growth.

In August 2013, Interval Leisure Group and its subsidiary, VRI Europe Limited, entered into a definitive agreement with CLC World Resorts and Hotels
(CLC). VRI Europe Limited will purchase the European shared ownership management business of CLC, for approximately 56 million (or approximately $85.6 million) in cash (subject to adjustment for working capital, actual 2013 results and other specified items) and issuance to CLC of shares totaling 24.5% of VRI Europe Limited. The closing is expected to take place on or prior to November 1, 2013 subject to satisfaction of the following conditions and regulatory requirements: (1) the transfer of certain licenses in Europe, (2) the warranties and covenants of the sellers have not been breached or other occurrence, in each case that could have a material adverse effect on the business and (3) other customary closing conditions. In connection with this arrangement, ILG will issue a convertible secured loan for approximately $14.4 million to CLC which matures in five years with interest payable monthly. Subsequent to the closing of this transaction, we expect the year-over-year comparability of the results of our operations to be affected.


RESULTS OF OPERATIONS

Revenue

For the three months ended June 30, 2013 compared to the three months ended
June 30, 2012

                                                  Three Months Ended June 30,
                                                2013         % Change       2012
                                                     (Dollars in thousands)
     Membership and Exchange
     Transaction revenue                      $   50,174           2.2 %  $  49,082
     Membership fee revenue                       36,819          13.2 %     32,535
     Ancillary member revenue                      1,811           3.8 %      1,744

     Total member revenue                         88,804           6.5 %     83,361
     Other revenue                                 6,713           5.5 %      6,365

     Total Membership and Exchange revenue        95,517           6.5 %     89,726

     Management and Rental
     Management fee and rental revenue            14,172           4.1 %     13,615
     Pass-through revenue                         15,294          (0.2 )%    15,327

     Total Management and Rental revenue          29,466           1.8 %     28,942

     Total revenue                            $  124,983           5.3 %  $ 118,668

Revenue for the three months ended June 30, 2013 increased $6.3 million, or 5.3%, from the comparable period in 2012. Membership and Exchange segment revenue increased $5.8 million, or 6.5%, and Management and Rental segment revenue increased $0.5 million, or 1.8%, in the quarter compared to 2012.

Membership and Exchange

The $5.8 million increase in Membership and Exchange segment revenue during the second quarter of 2013 includes a correction of an immaterial prior period net understatement amounting to $4.1 million (the "prior period item") as discussed in Note 2 of the accompanying notes to our consolidated financial statements.

Excluding the impact of the prior period item, Membership and Exchange revenue increased $1.7 million, or 1.9%, in the second quarter of 2013 compared to 2012. This increase is primarily driven by an increase in transaction revenue of $1.1 million, as well as an increase in other revenue of $0.3 million. The rise in transaction revenue is mainly related to higher revenue from exchanges and Getaways of $0.7 million and increases in other transaction related fees and reservation servicing revenue of $0.3 million and $0.1 million, respectively. Higher transaction revenue from exchanges and Getaways was due to a 1.7% increase in average fee per transaction, partially offset by slight decreases in exchange and Getaway transaction volumes. Lower transaction volume is related to the continued shift in percentage mix of the membership base from traditional to corporate, which reduced transaction propensity. Other revenue consists primarily of revenue generated from non-Interval Network activities and other membership programs.

Total active members in the Interval Network at June 30, 2013 decreased 2.1% to approximately 1.82 million members as compared to approximately 1.86 million members at June 30, 2012. Despite the decrease in total active members, greater adoption of Platinum and Club Interval products bolstered year-over-year membership fee revenue during the period. Overall Interval Network average revenue per member was $48.59 for the second quarter of 2013 which was 7.7% higher over the prior


year. Excluding the impact of the prior period item, average revenue per member in the current quarter increased 2.8% over the prior year.

Management and Rental

The increase of $0.6 million, or 4.1%, in management fee and rental revenue was primarily driven by higher fee income earned from managed hotel and condominium resort properties at Aston of $0.4 million, or 6.5%, in the second quarter of 2013 due to a 9.9% increase in RevPAR to $129.17 driven by an 11.2% higher average daily rate, partly offset by a 1.2% drop in occupancy rates during the quarter compared to prior year.

Pass-through revenue represents reimbursed compensation and other employee-related costs directly associated with managing properties that are included in both revenue and expenses and that are passed on to the property owners or homeowners association without mark-up. Pass-through revenue for the second quarter of 2013 was consistent with the prior year.

For the six months ended June 30, 2013 compared to the six months ended June 30,

2012

                                                   Six Months Ended June 30,
                                                 2013        % Change      2012
                                                     (Dollars in thousands)
      Membership and Exchange
      Transaction revenue                      $  111,322          1.0 % $ 110,233
      Membership fee revenue                       70,183          7.8 %    65,134
      Ancillary member revenue                      3,736           NM       3,735

      Total member revenue                        185,241          3.4 %   179,102
      Other revenue                                12,371          7.3 %    11,531

      Total Membership and Exchange revenue       197,612          3.7 %   190,633

      Management and Rental
      Management fee and rental revenue            31,617         21.4 %    26,048
      Pass-through revenue                         30,635          6.6 %    28,726

      Total Management and Rental revenue          62,252         13.7 %    54,774

      Total revenue                            $  259,864          5.9 % $ 245,407

Revenue for the six months ended June 30, 2013 increased $14.5 million, or 5.9%, from the comparable period in 2012. Membership and Exchange segment revenue increased $7.0 million, or 3.7%, in the period compared to the prior year and Management and Rental segment revenue increased $7.5 million, or 13.7%, from 2012.

Membership and Exchange

Membership and Exchange revenue increased $7.0 million, or 3.7%, in first six months of 2013 compared to 2012 which includes $4.1 million relating to the prior period item. Excluding the impact of the prior period item, Membership and Exchange revenue increased $2.9 million, or 1.5%, in the 2013 period compared to 2012. This increase is primarily driven by increases in transaction revenue of $1.1 million and membership fee revenue of $1.0 million, coupled with a rise in other revenue of $0.8 million. The rise in transaction revenue is mainly related to higher revenue from exchanges and Getaways of $0.6 million and increases in other transaction related fees and reservation servicing revenue of $0.3 million and $0.1 million, respectively. Higher transaction revenue from exchanges and Getaways was due to a 1.3% increase in average fee per transaction, partially offset by a 0.7% decrease in exchange and Getaway transaction volume. Lower transaction volume is related to the continued


shift in percentage mix of the membership base from traditional to corporate, which reduced transaction propensity. Other revenue consists primarily of revenue generated from non-Interval Network activities and other membership programs. Excluding the prior period item, the increase of $1.0 million in membership fee revenue in 2013 compared to 2012 is mainly a result of greater adoption of Platinum and Club Interval products which has bolstered year-over-year membership fee revenue.

The increase in other revenue for the current period is primarily attributable to an increase in non-member vacation rentals coupled with stronger sales from our other membership programs outside of the Interval Network and higher sales of marketing materials. Overall Interval Network average revenue per member was $101.39 in 2013, which was higher by 4.1% over the prior year period. Excluding the impact of the prior period item, average revenue per member in 2013 increased 1.8% over 2012.

Management and Rental

The increase of $5.6 million, or 21.4%, in management fee and rental revenue includes $4.3 million of incremental VRI management fee revenue subsequent to our February 2012 acquisition. Fee income earned from managed hotel and condominium resort properties at Aston increased $1.1 million, or 8.1%, in the first half of 2013 due to a 12.9% increase in RevPAR to $147.39 driven by a 13.0% higher average daily rate during the six month period compared to prior year.

The increase in pass-through revenue of $1.9 million, or 6.6%, in the first half of 2013 is principally related to our acquisition of VRI.

Cost of Sales

For the three months ended June 30, 2013 compared to the three months ended
June 30, 2012

                                                        Three Months Ended June 30,
                                                      2013         % Change       2012
                                                          (Dollars in thousands)
Membership and Exchange                             $   22,780           0.3 %  $ 22,720
Management and Rental
Management fee and rental expenses                       5,347           2.6 %     5,214
Pass-through expenses                                   15,294          (0.2 )%   15,327

Total Management and Rental cost of sales               20,641           0.5 %    20,541

Total cost of sales                                 $   43,421           0.4 %  $ 43,261

As a percentage of total revenue                          34.7 %        (4.7 )%     36.5 %
As a percentage of total revenue excluding prior
period item                                               35.8 %        (1.7 )%     36.5 %
As a percentage of total revenue excluding
pass-through revenue                                      39.6 %        (5.4 )%     41.9 %
Gross margin                                              65.3 %         2.7 %      63.5 %
Gross margin excluding prior period item                  64.2 %         1.0 %      63.5 %
Gross margin without pass-through
revenue/expenses                                          74.4 %         1.9 %      73.0 %

Cost of sales consists primarily of compensation and other employee-related costs (including stock-based compensation) for personnel engaged in servicing members of the Membership and Exchange segment and providing services to property owners and/or guests of the Management and Rental segment's managed vacation properties, as well as cost of rental inventory used primarily for Getaways included within the Membership and Exchange segment.

Cost of sales in the second quarter of 2013 increased $0.2 million from 2012, consisting of an increase of $0.1 million each from our Membership and Exchange and Management and Rental segments. Overall gross margin, adjusted to exclude the impact of the prior period item, increased by 62 basis points to 64.2% this quarter compared to 2012.


Gross margin for the Membership and Exchange segment in the second quarter of 2013, adjusted to exclude the impact of the prior period item, was relatively consistent when compared to the prior year. Cost of sales for this segment was relatively in-line with the prior periods, increasing $0.1 million, or 0.3%.

Cost of sales for our Management and Rental segment was relatively consistent with the prior period. Gross margin for this segment increased by 92 basis points to 29.9% in the second quarter of 2013 compared to 2012. Our Management and Rental segment has lower gross margins than our Membership and Exchange segment largely due to the effect of pass-through revenue. Excluding the effect of pass-through revenue, gross margin for this segment increased by 57 basis points to 62.3% during the quarter compared to the prior year.

For the six months ended June 30, 2013 compared to the six months ended June 30,

2012

                                                         Six Months Ended June 30,
                                                       2013        % Change       2012
                                                           (Dollars in thousands)
Membership and Exchange                              $  48,237           0.8 %  $ 47,846
Management and Rental
Management fee and rental expenses                      10,925          15.2 %     9,480
Pass-through expenses                                   30,635           6.6 %    28,726

Total Management and Rental cost of sales               41,560           8.8 %    38,206

Total cost of sales                                  $  89,797           4.4 %  $ 86,052

As a percentage of total revenue                          34.6 %        (1.5 )%     35.1 %
As a percentage of total revenue excluding prior
. . .
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