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INTERVAL LEISURE GROUP, INC. - 10-Q - Management's Discussion and Analysis of Financial Condition and Results of Operations(Edgar Glimpses Via Acquire Media NewsEdge) 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 or 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; the effects of our significant indebtedness and our compliance with the terms thereof; 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; loss of the management contract for one of Aston's largest managed properties; and our ability to expand successfully in international markets and manage risks specific to international operations. Certain of these and other risks and uncertainties are discussed in our filings with the SEC, including in Item 1A "Risk Factors" of our Annual Report on Form 10-K for the fiscal year ended December 31, 2011 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 nine months ended September 30, 2012. This section should be read in conjunction with the consolidated financial statements and accompanying notes included in this report as well as our 2011 Annual Report on Form 10-K, which have been prepared in accordance with accounting principles generally accepted in the United States of America ("GAAP"). This discussion includes the following sections: º • º Management Overview º • º Results of Operations º • º Financial Position, Liquidity and Capital Resources º • º Critical Accounting Policies and Estimates º • º ILG's Principles of Financial Reporting º • º Reconciliation of EBITDA and Adjusted EBITDA 29 -------------------------------------------------------------------------------- MANAGEMENT OVERVIEWGeneral 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. Our principal operating segment, Membership and Exchange, offers travel and leisure 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, our other business segment, 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 September 30, 2012, Interval's primary operation is the Interval Network, a quality global vacation ownership membership exchange network with: º • º a large and diversified base of participating resorts consisting of approximately 2,700 resorts located in over 75 countries, including both leading independent resort developers and branded hospitality companies; and º • º approximately 1.9 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 ("VRI") and Trading Places International ("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 timeshare resort and homeowners association management services as well as vacation rentals. On February 28, 2012, we acquired VRI, the largest independent provider of resort and homeowners association management services to the shared ownership industry. 30 -------------------------------------------------------------------------------- As of September 30, 2012, 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 remained relatively flat in the three months ended September 30, 2012 and increased approximately 2.1% in the nine months ended September 30, 2012 compared to the same periods in 2011. As a percentage of our total revenue, international revenue decreased to 13.7% and 14.5% in the three and nine months ended September 30, 2012, respectively, from 15.0% and 15.6% for the three and nine months ended September 30, 2011, respectively. The decreases as a percentage of total revenue are attributable to higher U.S. revenue mainly due to our newly acquired VRI business. 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 improved, financing standards for consumers remain higher than those required several years ago. Developers are continuing to modify their business models whereby a high proportion of sales are to their existing owners, which does not result in new members to the Interval Network. In addition, our 2012 results 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. Consequently, we work to structure our corporate membership arrangements such that there is a reservation servicing component which partly offsets the anticipated lower transaction propensity. Management and Rental Our Management and Rental segment results are susceptible to variations in economic conditions, particularly in its primary market, Hawaii. According to the Hawaii Tourism Authority, visitor arrivals by air in Hawaii have increased 8.4% and 9.2% for the three and nine months ended September 30, 2012, respectively, compared to the same periods in the prior year. This is consistent with Aston's managed properties in Hawaii experiencing increases in occupancy, leading to overall increases of 18.0% and 16.7% in revenue per available room ("RevPAR") in Hawaii for the three and nine months ended September 30, 2012 compared to the same periods in 2011, respectively. These increases in RevPAR in Hawaii were driven by both higher average daily rates and occupancy. 31 -------------------------------------------------------------------------------- As of the latest forecast (August 2012), the Hawaii Department for Business, Economic Development and Tourism forecasts increases of 8.6% in visitors to Hawaii and 15.2% in visitor expenditures in 2012 over 2011. Additionally, our third quarter and year-to-date 2012 results include the results of operations from VRI for the months subsequent to our February 28, 2012 acquisition. Liquidity On June 21, 2012, we entered into an amended and restated credit agreement which provides, among other things, a $500 million revolving credit facility, as further discussed in Note 5 of the interim consolidated financial statements included in this report. The interest rate on the amended credit agreement is based on (at our election) either LIBOR plus a predetermined margin that ranges from 1.25% to 2.25%, or the Base Rate, as defined, plus a predetermined margin that ranges from 0.25% to 1.25%, in each case based on ILG's leverage ratio. On September 4, 2012, we redeemed all of our 9.5% senior notes at 100% of the principal amount plus accrued and unpaid interest to the redemption date, at which time the senior notes were no longer deemed to be outstanding and our obligations under the indenture, as previously supplemented, terminated. Additionally, the extinguishment of our senior notes resulted in a non-cash, pre-tax loss on extinguishment of debt of $17.9 million during the third quarter of 2012 principally pertaining to the acceleration of the original issue discount and the write-off of the related unamortized deferred debt issuance costs. This non-cash charge is presented as a separate line item within other income (expense) in our consolidated statements of income for the three and nine months ended September 30, 2012. Outlook Throughout 2012, the vacation ownership industry remained 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 into 2013. Additionally, we anticipate margin compression and increased competition in our membership and exchange business resulting from developers' proprietary clubs. For the Management and Rental segment, we expect Aston's RevPAR to continue to show year-over-year improvement as its primary market, Hawaii, continues its tourism recovery; however, increases in airfare may negatively impact visitor arrivals from the mainland and temper growth. Additionally, our comparative results for the remainder of 2012 will be favorably impacted by the inclusion of the results of operations from VRI subsequent to our acquisition. Lastly, during the second quarter of 2012, the ownership and debt structure of one of Aston's largest managed properties was restructured. This caused Aston's management agreement for the property to be modified, Aston's compensation to be reduced and the remaining term to be shortened, with short-term renewals at the option of the new property owner. Consequently, during the second and third quarter we assessed the impact of these modifications on our Management and Rental operating segment to determine whether an interim impairment test of long-lived assets and goodwill and other indefinite-lived intangible assets is warranted as of September 30, 2012. The result of these assessments did not indicate that assets might be impaired and, therefore, an interim impairment test was not warranted at this time. 32 -------------------------------------------------------------------------------- RESULTS OF OPERATIONSRevenue For the three months ended September 30, 2012 compared to the three months ended September 30, 2011 Three Months Ended September 30, 2012 % Change 2011 (Dollars in thousands) Membership and Exchange Transaction revenue $ 46,588 (0.5 )% $ 46,836 Membership fee revenue 32,518 1.0 % 32,196 Ancillary member revenue 1,808 (14.7 )% 2,119 Total member revenue 80,914 (0.3 )% 81,151 Other revenue 5,178 2.1 % 5,071 Total Membership and Exchange revenue 86,092 (0.2 )% 86,222 Management and Rental Management fee and rental revenue 15,117 78.2 % 8,484 Pass-through revenue 15,986 33.1 % 12,007 Total Management and Rental revenue 31,103 51.8 % 20,491 Total revenue $ 117,195 9.8 % $ 106,713 Revenue for the three months ended September 30, 2012 increased $10.5 million, or 9.8%, from the comparable period in 2011. Management and Rental segment revenue increased $10.6 million, or 51.8%, in the quarter compared to the prior year. Membership and Exchange segment revenue was relatively in-line with the prior year, decreasing $0.1 million. Membership and Exchange Total active members in the Interval Network at September 30, 2012 increased to approximately 1.86 million members as compared to approximately 1.79 million members at September 30, 2011, an increase of 3.6%. This led to an increase of $0.3 million, or 1.0%, in membership fee revenue during the period, partly offset by lower average membership fee revenue per member. On the other hand, transaction revenue was lower by $0.2 million primarily due to a $1.0 million decrease in revenue from exchanges and Getaways, resulting from a 3.9% decrease in exchange and Getaway transaction volume during the quarter compared to 2011 which was partly offset by a 1.6% increase in average fee per transaction. However, this decrease in transaction revenue also was partly offset by higher reservation servicing and other transaction related fees of $0.4 million and $0.3 million, respectively. Lower transaction volume and higher reservation servicing revenue are related to a shift in the percentage mix of our membership base from traditional to corporate members. Overall Interval Network average revenue per member was $43.54 in the third quarter of 2012, a decrease of 3.6% from $45.15 in the prior year. Management and Rental The increase of $6.6 million, or 78.2%, in management fee and rental revenue includes $5.5 million of incremental VRI management fee revenue and an increase of $0.5 million contribution from TPI primarily related to the addition of new property management contracts subsequent to the start of the third quarter of 2011. Fee income earned from managed hotel and condominium resort properties at Aston increased $0.6 million, or 8.3%, during the quarter compared to the prior year 33 -------------------------------------------------------------------------------- quarter due to an 18.9% increase in RevPAR to $134.45 driven by an 11.3% higher average daily rate and a 6.8% improvement in occupancy rates in the third quarter. Additionally, this segment reported an increase of $4.0 million, or 33.1%, in reimbursed compensation and other employee-related costs directly associated with managing properties that are included in both revenue and expenses and that are passed on to the property owners or homeowners association without mark-up ("pass-through revenue"). The increase in pass-through revenue is mostly related to our acquisition of VRI and, to a lesser extent, increases at Aston and TPI related to higher occupied room nights and new property management contracts, respectively. For the nine months ended September 30, 2012 compared to the nine months ended September 30, 2011 Nine Months Ended September 30, 2012 % Change 2011 (Dollars in thousands) Membership and Exchange Transaction revenue $ 156,822 3.9 % $ 150,865 Membership fee revenue 97,652 0.4 % 97,307 Ancillary member revenue 5,542 (6.1 )% 5,900 Total member revenue 260,016 2.3 % 254,072 Other revenue 16,709 4.9 % 15,929 Total Membership and Exchange revenue 276,725 2.5 % 270,001 Management and Rental Management fee and rental revenue 41,165 69.9 % 24,229 Pass-through revenue 44,712 27.7 % 35,020 Total Management and Rental revenue 85,877 44.9 % 59,249 Total revenue $ 362,602 10.1 % $ 329,250 Revenue for the nine months ended September 30, 2012 increased $33.4 million, or 10.1%, from the comparable period in 2011. Membership and Exchange segment revenue increased $6.7 million, or 2.5%, in the period compared to the prior year and Management and Rental segment revenue increased $26.6 million, or 44.9%, from 2011. Membership and Exchange The increase of $6.7 million in Membership and Exchange segment revenue in 2012 is primarily due to increases in transaction revenue and other revenue of $6.0 million and $0.8 million, respectively. The rise in transaction revenue for the nine month period is the result of a strong first-half of 2012 which returned higher revenue from exchanges and Getaways by $2.4 million and increases in reservation servicing and other transaction related fees of $1.6 million and $2.0 million, respectively. Higher transaction revenue from exchanges and Getaways was due to a 5.7% increase in average fee per transaction, partially offset by a 3.7% decrease in exchange and Getaway transaction volume. Lower transaction volume is related to a shift in the percentage mix of our membership base from traditional to corporate members. Membership fee revenue during the first nine months of 2012 was relatively consistent with 2011. The increase in other revenue in the nine month period is primarily attributable to the membership and exchange related activities of TPI and the inclusion of VRI subsequent to our acquisition in February 2012. Overall Interval Network average revenue per member of $141.00 for 2012 is in-line with $140.61 of the prior year. 34 -------------------------------------------------------------------------------- Management and Rental The increase of $16.9 million, or 69.9%, in management fee and rental revenue includes $12.9 million of incremental VRI management fee revenue and a $1.9 million contribution from TPI largely related to the addition of new property management contracts. Fee income earned from managed hotel and condominium resort properties at Aston increased $2.1 million, or 11.2% in 2012 due to an 18.5% increase in RevPAR to $131.84 driven by a 10.0% higher average daily rate and a 7.7% improvement in occupancy rates during the nine months ended September 30, 2012. The increase of $9.7 million, or 27.7%, in pass-through revenue is mostly related to our acquisition of VRI and, to a lesser extent, increases at Aston and TPI attributable to higher occupied room nights and new property management contracts, respectively. Cost of Sales For the three months ended September 30, 2012 compared to the three months ended September 30, 2011 Three Months Ended September 30, 2012 % Change 2011 (Dollars in thousands) Membership and Exchange $ 20,538 5.0 % $ 19,565 Management and Rental Management fee and rental expenses 5,217 66.4 % 3,136 Pass-through expenses 15,986 33.1 % 12,007 Total Management and Rental cost of sales 21,203 40.0 % 15,143 Total cost of sales $ 41,741 20.3 % $ 34,708 As a percentage of total revenue 35.6 % 9.5 % 32.5 % As a percentage of total revenue excluding pass-through revenue 41.2 % 12.5 % 36.6 % Gross margin 64.4 % (4.6 )% 67.5 % Gross margin without pass-through revenue/expenses 74.6 % (1.9 )% 76.0 % 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 third quarter of 2012 increased $7.0 million from 2011, consisting of an increase of $1.0 million from our Membership and Exchange segment and $6.1 million from our Management and Rental segment. Overall gross margin decreased 4.6% to 64.4% this quarter compared to 2011, primarily due to increased gross profit contribution from our lower-margin Management and Rental segment relative to total ILG gross profit. Gross margin for the Membership and Exchange segment decreased by 1.5% as compared to the prior year. Cost of sales for this segment increased $1.0 million primarily due to an increase of $0.8 million in compensation and other employee related costs. This increase mainly pertained to our call center and related member servicing activities which, coupled with increases of $0.2 million in membership fulfillment related expenses and $0.3 million in telecommunications costs related to member servicing , were in part attributable to an increase in the number of active members in our Interval Network resulting from the affiliation of two corporate accounts during the first half of 2012. These increases were partly offset by a $0.2 million decrease in cost of purchased inventory during the 35-------------------------------------------------------------------------------- quarter. The lower cost of purchased inventory was attributable mainly to a decrease in the average cost per unit of this purchased inventory, partly offset by a higher proportion of purchased inventory utilized during the quarter. The increase of $6.1 million in cost of sales from the Management and Rental segment was primarily attributable to an increase of $4.0 million in segment pass-through revenue coupled with an increase of $1.8 million in other incremental expenses related to VRI. Gross margin for this segment increased 22.0% to 31.8% in the third quarter of 2012 compared to 2011. The Management and Rental segment has lower gross margins than our Membership and Exchange segment largely due to the pass-through revenue. Excluding the effect of pass-through revenue, gross margin for this segment increased 3.9% to 65.5% during the third quarter compared to prior year. For the nine months ended September 30, 2012 compared to the nine months ended September 30, 2011 Nine Months Ended September 30, 2012 % Change 2011 (Dollars in thousands) Membership and Exchange $ 68,384 8.5 % $ 63,027 Management and Rental Management fee and rental expenses 14,697 54.4 % 9,517 Pass-through expenses 44,712 27.7 % 35,020 Total Management and Rental cost of sales $ 59,409 33.4 % $ 44,537 Total cost of sales $ 127,793 18.8 % $ 107,564 As a percentage of total revenue 35.2 % 7.9 % 32.7 % As a percentage of total revenue excluding pass-through revenue 40.2 % 10.0 % 36.6 % Gross margin 64.8 % (3.8 )% 67.3 % Gross margin without pass-through revenue/expenses 73.9 % (2.0 )% 75.3 % Cost of sales increased $20.2 million from 2011, consisting of an increase of $5.4 million from our Membership and Exchange segment and $14.9 million from our Management and Rental segment. Overall gross margin decreased 3.8% to 64.8% in the first nine months of 2012 compared to 2011, primarily due to increased gross profit contribution from our lower-margin Management and Rental segment relative to total ILG gross profit. Gross margin for the Membership and Exchange segment decreased by 1.8% during first nine months of 2012 compared to the prior year. Cost of sales for this segment increased $5.4 million primarily due to an increase of $3.0 million in compensation and other employee related costs and $0.8 million in the cost of purchased inventory. The increase in compensation and other employee related costs mainly pertained to our call center and related member servicing activities which, coupled with an increase of $1.5 million in membership fulfillment related expenses, were in part attributable to an increase in the number of active members in our Interval Network resulting from the affiliation of two corporate accounts during the first half of 2012. The increase in the cost of purchased inventory was due to a higher proportion of purchased inventory utilized during 2012, partly offset by a decrease in the average cost per unit of this purchased inventory. The increase of $14.9 million in cost of sales from the Management and Rental segment was primarily attributable to an increase of $9.7 million in segment pass-through revenue coupled with an increase of $4.4 million in other incremental expenses related to VRI and an increase of $0.5 million in compensation and other employee related costs at TPI. Gross margin for this segment increased 24.1% to 30.8% in the first nine months of 2012 compared to 2011. Excluding the effect of pass-through 36-------------------------------------------------------------------------------- revenue, gross margin for this segment increased 5.9% to 64.3% during 2012 compared to the prior year. Selling and marketing expense For the three months ended September 30, 2012 compared to the three months ended September 30, 2011 Three Months Ended September 30, 2012 % Change 2011 (Dollars in thousands) Selling and marketing expense $ 13,282 (0.4 )% $ 13,341 As a percentage of total revenue 11.3 % (9.3 )% 12.5 % As a percentage of total revenue excluding pass-through revenue 13.1 % (6.8 )% 14.1 % Selling and marketing expense consists primarily of advertising and promotional expenditures and compensation and other employee-related costs (including stock-based compensation) for personnel engaged in sales and sales support functions. Advertising and promotional expenditures primarily include printing costs of directories and magazines, promotions, tradeshows, agency fees, marketing fees and related commissions. Selling and marketing expense in the third quarter 2012 remained relatively flat compared to 2011, decreasing $0.1 million, or 0.4%. As a percentage of total revenue and total revenue excluding pass-through revenue, sales and marketing expense decreased 9.3% and 6.8%, respectively, during the third quarter of 2012 compared to the prior year. For the nine months ended September 30, 2012 compared to the nine months ended September 30, 2011 Nine Months Ended September 30, 2012 % Change 2011 (Dollars in thousands) Selling and marketing expense $ 41,323 0.3 % $ 41,215 As a percentage of total revenue 11.4 % (9.0 )% 12.5 % As a percentage of total revenue excluding pass-through revenue 13.0 % (7.2 )% 14.0 % Selling and marketing expense in 2012 remained relatively flat compared to 2011, increasing $0.1 million, or 0.3%. As a percentage of total revenue and total revenue excluding pass-through revenue, sales and marketing expense decreased 9.0% and 7.2%, respectively, during the first nine months of 2012 compared to the prior year. General and administrative expense For the three months ended September 30, 2012 compared to the three months ended September 30, 2011 Three Months Ended September 30, 2012 % Change 2011 (Dollars in thousands) General and administrative expense $ 26,626 14.5 % $ 23,256 As a percentage of total revenue 22.7 % 4.3 % 21.8 % As a percentage of total revenue excluding pass-through revenue 26.3 % 7.1 % 24.6 % 37 -------------------------------------------------------------------------------- General and administrative expense consists primarily of compensation and other employee-related costs (including stock-based compensation) for personnel engaged in finance, legal, tax, human resources, information technology and executive management functions, as well as facilities costs, fees for professional services and other company-wide benefits. General and administrative expense in the third quarter 2012 increased $3.4 million from 2011, primarily due to an increase of $2.6 million in overall compensation and other employee-related costs as well as other incremental expenses of $0.9 million from VRI, an unfavorable variance of $1.1 million in our estimated accrual for European Union ("EU") Value Added Tax ("VAT"), primarily due to the $1.1 million change in estimate recorded in the third quarter of 2011, and an unfavorable variance of $0.3 million in operating currency impact resulting from foreign currency remeasurements of operating assets and liabilities denominated in a currency other than the functional currency. These changes were partly offset by a favorable net change of $1.8 million in the estimated fair value of contingent consideration related to an acquisition, primarily due to the $1.2 million unfavorable change in estimate recorded in the third quarter of 2011 compared to a $0.7 million favorable change in estimate recorded in the current quarter. The $2.6 million increase in overall compensation and other employee-related costs was primarily due to $1.6 million of incremental compensation and other employee-related expenses from VRI, an increase in health and welfare insurance expense of $1.0 million due to higher self-insured claim activity in the quarter, as well as increases in other employee-related costs. These higher employee-related costs were partly offset by a decrease of $0.5 million in non-cash compensation expense mainly due to awards granted at spin-off, vesting fully during the third quarter of 2012. As a percentage of total revenue and total revenue excluding pass-through revenue, general and administrative expense increased 4.3% and 7.1%, respectively, during the third quarter of 2012 compared to the prior year. For the nine months ended September 30, 2012 compared to the nine months ended September 30, 2011 Nine Months Ended September 30, 2012 % Change 2011 (Dollars in thousands) General and administrative expense $ 79,032 10.2 % $ 71,731 As a percentage of total revenue 21.8 % NM 21.8 % As a percentage of total revenue excluding pass-through revenue 24.9 % 2.0 % 24.4 % General and administrative expense increased $7.3 million from 2011, primarily due to an increase of $6.7 million in overall compensation and other employee-related costs, other incremental expenses of $2.1 million from VRI and certain other miscellaneous increases primarily at Aston, partly offset by a favorable net change of $1.8 million in the estimated fair value of contingent consideration related to an acquisition. The $6.7 million increase in overall compensation and other employee-related costs was primarily due to $3.8 million of incremental compensation and other employee-related expenses from VRI, an increase of $1.2 million in health and welfare insurance expense due to higher self-insured claim activity in 2012, and various other increases in compensation and employee-related costs. These higher employee-related costs were partly offset by a decrease of $0.3 million in non-cash compensation expense mainly due to awards granted at spin-off, vesting fully during the third quarter of 2012. As a percentage of total revenue, general and administrative expense was in-line with the prior year and was higher by 2.0% as a percentage of total revenue excluding pass-through revenue. 38-------------------------------------------------------------------------------- Amortization Expense of Intangibles For the three and nine months ended September 30, 2012 compared to the three and nine months ended September 30, 2011 Three Months Ended Nine Months Ended September 30, September 30, 2012 % Change 2011 2012 % Change 2011 (Dollars in thousands) (Dollars in thousands) Amortization $ 6,669 (2.4 )% $ 6,830 $ 21,001 2.7 % $ 20,448 As a percentage of total revenue 5.7 % (11.1 )% 6.4 % 5.8 % (6.7 )% 6.2 % As a percentage of total revenue excluding pass-through revenue 6.6 % (8.6 )% 7.2 % 6.6 % (4.9 )% 6.9 % Amortization expense of intangibles for the third quarter of 2012 decreased $0.2 million from the comparable period in 2011 primarily due certain intangible assets amortizing fully during and prior to the third quarter of 2012, partly offset by the incremental amortization expense pertaining to intangible assets resulting from the acquisition of VRI. Amortization expense of intangibles for the nine months ended September 30, 2012 increased $0.6 million from 2011 primarily due to the incremental amortization expense pertaining to intangible assets resulting from the acquisition of VRI, partly offset by certain intangible assets amortizing fully during and prior to the third quarter of 2012. Depreciation Expense For the three and nine months ended September 30, 2012 compared to the three and nine months ended September 30, 2011 Three Months Ended Nine Months Ended September 30, September 30, 2012 % Change 2011 2012 % Change 2011 (Dollars in thousands) (Dollars in thousands) Depreciation $ 3,311 (0.2 )% $ 3,319 $ 9,839 (1.7 )% $ 10,006 As a percentage of total revenue 2.8 % (9.2 )% 3.1 % 2.7 % (10.7 )% 3.0 % As a percentage of total revenue excluding pass-through revenue 3.3 % (6.7 )% 3.5 % 3.1 % (9.0 )% 3.4 % Depreciation expense for the three and nine months ended September 30, 2012 was relatively consistent with the comparable periods in 2011, decreasing slightly by 0.2% and 1.7%, respectively. Operating Income For the three months ended September 30, 2012 compared to the three months ended September 30, 2011 Three Months Ended September 30, 2012 % Change 2011 (Dollars in thousands) Membership and Exchange $ 23,411 (6.6 )% $ 25,052 Management and Rental 2,155 941.1 % 207 Total operating income $ 25,566 1.2 % $ 25,259 As a percentage of total revenue 21.8 % (7.8 )% 23.7 % As a percentage of total revenue excluding pass-through revenue 25.3 % (5.3 )% 26.7 % 39 -------------------------------------------------------------------------------- Operating income in the third quarter was relatively consistent with the prior year, increasing slightly by $0.3 million or 1.2%, and was comprised of a decrease of $1.6 million from our Membership and Exchange segment and an increase of $1.9 million from our Management and Rental segment. Operating income for our Membership and Exchange segment decreased $1.6 million to $23.4 million in the third quarter 2012 from 2011 due to lower segment operating results, partly offset by the positive contributions from VRI's membership and exchange activities and a favorable net change of $0.9 million in the estimated fair value of contingent consideration related to an acquisition. The increase in operating income of $1.9 million at our Management and Rental segment is primarily due to improved operating results at Aston during the quarter, incremental contributions from VRI and a favorable net change of $0.9 million in the estimated fair value of contingent consideration related to an acquisition. For the nine months ended September 30, 2012 compared to the nine months ended September 30, 2011 Nine Months Ended September 30, 2012 % Change 2011 (Dollars in thousands) Membership and Exchange $ 79,076 1.0 % $ 78,304 Management and Rental 4,538 NM (18 ) Total operating income $ 83,614 6.8 % $ 78,286 As a percentage of total revenue 23.1 % (3.0 )% 23.8 % As a percentage of total revenue excluding pass-through revenue 26.3 % (1.1 )% 26.6 % Operating income for the first nine months of 2012 increased $5.3 million from the comparable period in 2011, consisting of increases of $0.8 million from our Membership and Exchange segment and $4.6 million from our Management and Rental segment. Operating income for our Membership and Exchange segment increased $0.8 million to $79.1 million in 2012 from 2011 due to the positive contributions from the membership and exchange activities of TPI and VRI and a favorable net change of $0.9 million in the estimated fair value of contingent consideration related to an acquisition, largely offset by lower segment operating results. The increase in operating income of $4.6 million at our Management and Rental segment is primarily due to improved operating results at Aston and TPI during the first nine months of 2012, coupled with the incremental contribution from VRI and a favorable net change of $0.9 million in the estimated fair value of contingent consideration related to an acquisition. Adjusted Earnings Before Interest, Taxes, Depreciation and Amortization Adjusted Earnings Before Interest, Taxes, Depreciation and Amortization ("Adjusted EBITDA") is a non-GAAP measure and is defined in "ILG's Principles of Financial Reporting." 40 -------------------------------------------------------------------------------- For the three months ended September 30, 2012 compared to the three months ended September 30, 2011 Three Months Ended September 30, 2012 % Change 2011 (Dollars in thousands) Membership and Exchange $ 33,701 (7.1 )% $ 36,262 Management and Rental 4,409 112.0 % 2,080 Total Adjusted EBITDA $ 38,110 (0.6 )% $ 38,342 As a percentage of total revenue 32.5 % (9.5 )% 35.9 % As a percentage of total revenue excluding pass-through revenue 37.7 % (7.0 )% 40.5 % Adjusted EBITDA in the third quarter 2012 was relatively in-line with the prior year, decreasing slightly by $0.2 million, or 0.6%, consisting of a decrease of $2.6 million from our Membership and Exchange segment and an increase of $2.3 million from our Management and Rental segment. Adjusted EBITDA from our Membership and Exchange segment decreased $2.6 million to $33.7 million in 2012 from $36.3 million in 2011. The decline in this segment's Adjusted EBITDA is primarily due to a continuing contraction in gross margin in part driven by a shift in percentage mix of the membership base from traditional to corporate members, who have a lower propensity to transact with us and a reduced membership fee. Additionally, the segment's results were negatively affected by increased health and welfare insurance expense resulting from higher self-insured claim activity in the quarter and an unfavorable variance of $1.1 million in our estimated accrual for EU VAT. Such was partly offset by incremental contributions from VRI and a favorable net change of $0.9 million in the estimated fair value of contingent consideration related to an acquisition. Adjusted EBITDA from our Management and Rental segment increased $2.3 million to $4.4 million in 2012 from $2.1 million in 2011. The improvement in Adjusted EBITDA in this segment is primarily due to higher gross profit of $4.6 million delivered mainly as a result of the inclusion of VRI in our results of operations, improvement in Aston's RevPAR during the quarter, new property management contracts gained at TPI subsequent to the start of the third quarter of 2011, as well as the favorable net change of $0.9 million in the estimated fair value of contingent consideration related to an acquisition. This was partly offset by an increase of $2.5 million in general and administrative expense due to the inclusion of VRI's general and administrative expenses and, to a lesser extent, various other increases within Aston's general and administrative expenses. For the nine months ended September 30, 2012 compared to the nine months ended September 30, 2011 Nine Months Ended September 30, 2012 % Change 2011 (Dollars in thousands) Membership and Exchange $ 111,863 (0.1 )% $ 111,935 Management and Rental 11,324 100.6 % 5,645 Total Adjusted EBITDA $ 123,187 4.8 % $ 117,580 As a percentage of total revenue 34.0 % (4.9 )% 35.7 % As a percentage of total revenue excluding pass-through revenue 38.8 % (3.0 )% 40.0 % Adjusted EBITDA for the first nine months of 2012 increased $5.6 million from 2011, or 4.8%, driven by an increase of $5.7 million from our Management and Rental segment, while our Membership and Exchange segment was in-line with prior year, decreasing slightly by $0.1 million. 41 -------------------------------------------------------------------------------- Adjusted EBITDA from our Membership and Exchange segment of $111.9 million was relatively in-line with prior year. Adjusted EBITDA for this segment reflects a strong first half of 2012 that was subsequently impacted by margin compression in the third quarter, as previously discussed, due to a shift in percentage mix of the membership base which has negatively affected transaction propensity and average membership fee per member. Additionally, the segment experienced higher overall compensation and employee-related costs, particularly driven by rising health and welfare insurance expense due to higher self-insured claim activity in the period. Such was partly offset by the inclusion of VRI's results, the favorable contribution from the membership and exchange activities of TPI, as well as a favorable net change of $0.9 million in the estimated fair value of contingent consideration related to an acquisition. Adjusted EBITDA from our Management and Rental segment increased $5.7 million to $11.3 million in 2012 from $5.6 million in 2011. The improvement in Adjusted EBITDA in this segment is primarily driven by higher gross profit of $11.8 million delivered mainly from the inclusion of VRI in our results of operations, improvement in Aston's RevPAR during the year, new property management contracts gained at TPI subsequent to the start of the third quarter 2011, in addition to a favorable net change, between the third quarter of 2011 and 2012, of $0.9 million in the estimated fair value of contingent consideration related to an acquisition. This was partly offset by higher general and administrative expenses of $5.9 million due to the inclusion of VRI's general and administrative expenses in our results and, to a lesser extent, various other increases within Aston and TPI's general and administrative expenses. Other income (expense), net For the three months ended September 30, 2012 compared to the three months ended September 30, 2011 Three Months Ended September 30, 2012 % Change 2011 (Dollars in thousands) Interest income $ 535 23.6 % $ 433 Interest expense (6,485 ) (26.0 )% (8,762 ) Other income (expense), net (915 ) (136.8 )% 2,488 Loss on extinguishment of debt (17,925 ) NM - Interest income increased $0.1 million in the third quarter 2012 compared to 2011 primarily as a result of interest earned on loans issued in periods subsequent to the third quarter 2011. Interest expense primarily relates to interest and amortization of debt costs related to our senior notes, which were extinguished on September 4, 2012, and our amended and restated revolving credit facility entered into on June 21, 2012. The senior notes were initially recorded with an original issue discount of $23.5 million, of which $0.5 million and $0.6 million were amortized in the third quarter of 2012 and 2011, respectively. Lower interest expense during the quarter is primarily due to (1) the extinguishment of our term loan on June 21, 2012, compared to the then outstanding principal balance on our term loan during the third quarter of 2011, (2) our senior notes being outstanding only through September 4, 2012 and (3) the prevailing interest rates on our revolving credit facility compare favorably against the extinguished indebtedness. Other income (expense), net primarily relates to net gains and losses on foreign currency exchange related to cash held in certain countries in currencies other than their local currency. Non-operating foreign exchange net loss was $0.9 million for the third quarter 2012 compared to a net gain of $2.5 million in 2011. The unfavorable fluctuations during the third quarter of 2012 were principally driven by U.S. dollar positions held at September 30, 2012 affected by the weaker dollar compared to the Mexican peso. The favorable fluctuations during the third quarter of 2011 were principally driven by U.S. dollar positions held at September 30, 2011 affected by the stronger dollar compared to the Mexican and Colombian pesos. 42 -------------------------------------------------------------------------------- Additionally, in connection with the redemption of our senior notes on September 4, 2012, we recognized a loss of $17.9 million in the third quarter 2012 on the early extinguishment of this debt resulting from the acceleration of related unamortized debt issuance costs and remaining original issue discount. This loss is presented as a separate line item within other income (expense) in our consolidated statements of income for the three months ended September 30, 2012. For the nine months ended September 30, 2012 compared to the nine months ended September 30, 2011 Nine Months Ended September 30, 2012 % Change 2011 (Dollars in thousands) Interest income $ 1,538 87.6 % $ 820 Interest expense (23,874 ) (11.1 )% (26,868 ) Other income (expense), net (2,408 ) NM 758 Loss on extinguishment of debt (18,527 ) NM - Interest income increased $0.7 million in the first nine months of 2012 compared to 2011 primarily as a result of interest earned on loans issued in periods subsequent to the third quarter 2011. Interest expense primarily relates to interest and amortization of debt costs on the term loan and senior notes, which were extinguished on June 21, 2012 and September 4, 2012, respectively, and our amended and restated revolving credit facility entered into on June 21, 2012. The senior notes were initially recorded with an original issue discount of $23.5 million of which $1.8 million and $1.9 million were amortized in the first nine months of 2012 and 2011, respectively. Lower interest expense during the 2012 is primarily due to (1) the extinguishment of our term loan on June 21, 2012, compared to the then outstanding principal balance on our term loan during third quarter 2011, (2) our senior notes being outstanding only through September 4, 2012, and (3) the prevailing interest rates on our revolving credit facility compare favorably against the extinguished indebtedness. Other income (expense), net primarily relates to net gains and losses on foreign currency exchange related to cash held in certain countries in currencies other than their local currency. Non-operating foreign exchange net loss was $2.1 million for the third quarter 2012 compared to a net gain of $1.0 million in 2011. The unfavorable fluctuations during 2012 were principally driven by U.S. dollar positions held at September 30, 2012 affected by the weaker dollar compared to the Mexican and Colombian peso. The favorable fluctuations during 2011 were principally driven by U.S. dollar positions held at September 30, 2011 affected by the stronger dollar compared to the Mexican peso, partly offset by a weaker dollar compared to the Colombian peso. Additionally, in connection with the repayment of our term loan on June 21, 2012 and the redemption of our senior notes on September 4, 2012, we recognized a loss of $18.5 million for the nine months ended September 30, 2012 on the early extinguishment of this indebtedness resulting from the acceleration of related unamortized debt issuance costs and the remaining original issue discount on the senior notes. This loss is presented as a separate line item within other income (expense) in our consolidated statements of income for the nine months ended September 30, 2012. Income Tax Provision For the three months ended September 30, 2012 compared to the three months ended September 30, 2011 For the three months ended September 30, 2012 and 2011, ILG recorded income tax provisions for continuing operations of $0.6 million and $8.0 million, respectively, which represent effective tax rates of 80.5% and 41.1%, respectively. The higher effective tax rate for the three months ended September 30, 2012 was primarily attributable to a reduced income before income taxes, driven by the loss on the extinguishment of debt related to the redemption of the senior notes, which magnified the 43 -------------------------------------------------------------------------------- impact of other income tax items, the most significant of which related to the effect of changes in tax laws in the U.K., as discussed further below, that were enacted during the third quarter of 2012. For the three months ended September 30, 2011, the tax rate is higher than the federal statutory rate of 35% due principally to state and local income taxes partially offset by foreign income taxed at lower rates. During the three months ended September 30, 2011, the effective tax rate increased due to other income tax items, the most significant related to the effect of changes in tax laws in the U.K., that were enacted during the third quarter of 2011. For the nine months ended September 30, 2012 compared to the nine months ended September 30, 2011 For the nine months ended September 30, 2012 and 2011, ILG recorded income tax provisions for continuing operations of $14.9 million and $20.9 million, respectively, which represent effective tax rates of 37.0% and 39.4%, respectively. These tax rates are higher than the federal statutory rate of 35% due principally to state and local income taxes partially offset by foreign income taxed at lower rates. During the nine months ended September 30, 2012, the effective tax rate decreased due to other income tax items, the most significant of which related to the tax impact of ILG's redemption of the senior notes offset by the effect of changes in tax laws in the U.K., as discussed further below, that were enacted during the third quarter of 2012. During the nine months ended September 30, 2011, the effective tax rate increased due to other income items, the most significant related to the effect of changes in tax laws in the U.K. that were enacted during the third quarter of 2011. As of September 30, 2012 and December 31, 2011, ILG had unrecognized tax benefits of $0.8 million and $0.9 million, respectively. During the three months ended September 30, 2012, the unrecognized tax benefits increased by approximately $0.1 million as a result of other income tax items, primarily related to certain tax credits. During the nine months ended September 30, 2012, the unrecognized tax benefits decreased by a net amount of approximately $0.1 million as a result of the expiration of the statute of limitations related to foreign taxes during the first quarter of 2012, partly offset by other income tax items in the third quarter of 2012. Additionally, during the first quarter of 2012, ILG acquired VRI, a domestic S corporation for income tax purposes. During the tax due diligence review of the S corporation status of VRI, a number of potential issues emerged that required a private letter ruling for assurance of VRI's S corporation status for the period prior to the acquisition. The ruling requested inadvertent termination relief if any of the identified issues inadvertently terminated VRI's S corporation election. VRI submitted the ruling request to the Internal Revenue Service ("IRS") on February 29, 2012. During the third quarter of 2012, the private letter ruling was received from the IRS granting VRI inadvertent termination relief. Accordingly, no adjustment was required to be made to the financial statements. ILG recognizes interest and, if applicable, penalties related to unrecognized tax benefits in income tax expense. There were no material accruals for interest for the three and nine months ended September 30, 2012. During the nine months ended September 30, 2012, interest and penalties decreased by approximately $0.2 million during the first quarter of 2012 as a result of the expiration of the statute of limitations related to foreign taxes. As of September 30, 2012, ILG had accrued $0.6 million for interest and penalties. ILG believes that it is reasonably possible that its unrecognized tax benefits could decrease by approximately $0.3 million within twelve months of the current reporting date due primarily to the expiration of the statute of limitations related to foreign taxes and settlements with taxing authorities on other income tax items. An estimate of other changes in unrecognized tax benefits cannot be made, but is not expected to be significant. By virtue of previously filed separate company and consolidated tax returns with IAC, ILG is routinely under audit by federal, state, local and foreign taxing authorities. These audits include questioning the timing and the amount of deductions and the allocation of income among various tax 44 -------------------------------------------------------------------------------- jurisdictions. Income taxes payable include amounts considered sufficient to pay assessments that may result from examination of prior year returns; however, the amount paid upon resolution of issues raised may differ from the amount provided. Differences between the reserves for tax contingencies and the amounts owed by ILG are recorded in the period they become known. Under a Tax Sharing Agreement, IAC indemnifies ILG for all consolidated tax liabilities and related interest and penalties for the pre-spin period. The IRS is also currently examining ILG's federal consolidated tax return for the short period following the spin-off and ended December 31, 2008. The statute of limitations for the short period following the spin-off and ended December 31, 2008 has been extended to June 30, 2013. This examination is expected to be completed prior to the expiration of the extended statute of limitations in 2013. Additionally during the third quarter of 2012, the State of Florida completed its examination of ILG's consolidated state tax return for the short period following the spin-off and ended December 31, 2008 as well as for the tax year ended December 31, 2009. During 2011, the U.K. Finance Act of 2011 was enacted, which further reduced the U.K. corporate income tax rate to 26%, effective April 1, 2011 and 25%, effective April 1, 2012. The impact of the U.K. rate reduction to 26% and 25%, which reduced our U.K. net deferred tax asset and increased income tax expense, was reflected in the reporting period when the law was enacted. During the third quarter of 2012, the U.K. Finance Act of 2012 was enacted which further reduced the U.K. corporate income tax rate to 24%, effective April 1, 2012 and 23%, effective April 1, 2013. The impact of the U.K. rate reduction to 24% and 23% has been reflected in the current reporting period. It reduced our U.K. net deferred tax asset and increased income tax expense by approximately $0.4 million. The change in the corporate tax rate initially negatively impacts income tax expense as the future benefit expected to be realized from our U.K. net deferred tax assets decreases; however, going forward, the lower corporate tax rate will decrease income tax expense and favorably impact our effective tax rate. A further U.K. rate reduction to 22% is expected to be included in a future U.K. Finance Bill. The future corporate income tax rate reduction is expected to have a similar impact on our financial statements, as outlined above, however the actual impact will be dependent on our deferred tax position at that time. FINANCIAL POSITION, LIQUIDITY AND CAPITAL RESOURCES As of September 30, 2012, we had $137.7 million of cash and cash equivalents and restricted cash and cash equivalents, including $90.5 million of U.S. dollar equivalent or denominated cash deposits held by foreign subsidiaries which are subject to changes in foreign exchange rates. Of this amount, $61.6 million is held in foreign jurisdictions, principally the U.K. Earnings of foreign subsidiaries, except Venezuela, are permanently reinvested. Additional tax provisions would be required should such earnings be repatriated to the U.S. Cash generated by operations is used as our primary source of liquidity. We believe that our cash on hand along with our anticipated operating future cash flows and availability under our $500 million revolving credit facility, which may be increased to up to $700 million subject to certain conditions, are sufficient to fund our operating needs, quarterly cash dividend, capital expenditures, development and expansion of our operations, debt service, investments and other commitments and contingencies for at least the next twelve months. However, our operating cash flow may be impacted by macroeconomic factors outside of our control. Cash Flows Discussion Net cash provided by operating activities decreased to $64.1 million in the nine months ended September 30, 2012 from $76.9 million in the same period of 2011. The decrease of $12.7 million from 2011 was principally due to higher income taxes paid related to the timing of certain income tax payments. 45 -------------------------------------------------------------------------------- Net cash used in investing activities of $42.6 million in the nine months ended September 30, 2012 primarily related to the VRI acquisition, net of cash acquired, of $40.0 million, disbursements totaling $9.5 million for additional investments in loans receivable, and capital expenditures of $10.4 million primarily related to IT initiatives, all partly offset by the early repayments of existing loans receivable totaling $17.0 million. Interest on the loans receivable are due monthly or quarterly and in some instances may be paid in kind. As of September 30, 2012, an additional $2.8 million is available to be drawn in connection with our financing receivables. In the nine months ended September 30, 2011, net cash used in investing activities was $31.7 million resulting from disbursements totaling $16.2 million for loans to third parties, capital expenditures of $9.9 million, primarily related to IT initiatives, and the acquisition of certain management agreements by our Management and Rental segment for $5.6 million. On June 21, 2012, we entered into an amended and restated credit agreement which, among other things (1) provides for a $500 million revolving credit facility in place of the existing senior secured credit facility which consisted of a $50 million revolving facility and a term loan facility with an original principal amount of $150 million, (2) extends the maturity of the credit facility to June 21, 2017, (3) provides for an interest rate on borrowings, commitment fees and letter of credit fees based on ILG and its subsidiaries' consolidated leverage ratio, and (4) may be increased to up to $700 million, subject to certain conditions. As of September 30, 2012, $290.0 million of borrowings were outstanding under the revolving credit facility, with $210.0 million available to be drawn. On September 4, 2012, we redeemed all of our $300 million senior notes, issued on August 19, 2008, at a redemption price equal to 100% of the principal amount plus accrued and unpaid interest, amounting to $314.5 million. We funded the redemption through the use of $290.0 million, drawn on our $500 million revolving credit facility, and cash on hand. Net cash used in financing activities of $89.4 million in the nine months ended September 30, 2012 was primarily due to the redemption of our senior notes, principal payments of $56.0 million on the term loan, of which we paid $51.0 million from cash on-hand in June 2012 to fully extinguish the term loan, cash dividends totaling $17.0 million, payments of debt issuance costs of $3.9 million in connection with entering into our amended and restated credit agreement in June 2012, and vesting of restricted stock units, net of withholding taxes. These uses of cash were partially offset by proceeds of the $290.0 million drawn on our revolving credit facility to fund the redemption, proceeds from excess tax benefits from stock-based awards and the exercise of stock options. In the nine months ended September 30, 2011, net cash used in financing activities of $34.3 million was principally due to repurchases of our common stock at market prices totaling $17.6 million, including commissions, which settled during the quarter, as well as voluntary principal prepayments on the term loan totaling $15.0 million, and vesting of restricted stock units, net of withholding taxes, all partially offset by excess tax benefits from stock-based awards and proceeds from the exercise of stock options. Any principal amounts outstanding under the revolving credit facility are due at maturity. The interest rate on the amended credit agreement is based on (at our election) either LIBOR plus a predetermined margin that ranges from 1.25% to 2.25%, or the Base Rate as defined in the amended credit agreement plus a predetermined margin that ranges from 0.25% to 1.25%, in each case based on the Borrower's leverage ratio. As of September 30, 2012, the applicable margin was 1.75% per annum for LIBOR revolving loans and 0.75% per annum for Base Rate loans. The revolving credit facility has a commitment fee on undrawn amounts that ranges from 0.25% to 0.375% based on the Borrower's leverage ratio and as of September 30, 2012 the commitment fee was 0.275%. The revolving credit facility has various financial and operating covenants that place significant restrictions on us, including our ability to incur additional indebtedness, to incur additional liens, issue redeemable stock and preferred stock, pay dividends or distributions or redeem or repurchase capital stock, prepay, redeem or repurchase debt, make loans and investments, enter into agreements that 46 -------------------------------------------------------------------------------- restrict distributions from our subsidiaries, sell assets and capital stock of our subsidiaries, enter into certain transactions with affiliates and consolidate or merge with or into or sell substantially all of our assets to another person. The revolving credit facility requires us to meet certain financial covenants requiring the maintenance of a maximum consolidated leverage ratio of consolidated debt, less credit given for foreign cash, over consolidated Earnings Before Interest, Taxes, Depreciation and Amortization ("EBITDA"), as defined in the Amended Credit Agreement, of 3.50 through December 31, 2013 and 3.25 thereafter. Additionally, we are required to maintain a minimum consolidated interest coverage ratio of consolidated EBITDA over consolidated interest expense, as defined in the Amended Credit Agreement, of 3.0. As of September 30, 2012, ILG was in compliance in all material respects with the requirements of all applicable financial and operating covenants and our consolidated leverage ratio and consolidated interest coverage ratio under the Amended Credit Agreement were 1.70 and 5.41, respectively. In March 2012, May 2012 and August 2012, our Board of Directors declared a quarterly dividend of $0.10 per share for shareholders of record on April 2, 2012, June 12, 2012 and September 6, 2012, respectively. On each of April 18, 2012, June 26, 2012 and September 20, 2012, a cash dividend of $5.7 million was paid. We currently expect to declare and pay quarterly dividends of similar amounts. We have funding commitments that could potentially require our performance in the event of demands by third parties or contingent events. At September 30, 2012, guarantees, surety bonds and letters of credit totaled $35.2 million. Guarantees represent $32.6 million of this total and primarily relate to the Management and Rental segment's hotel and resort management agreements of Aston, including those with guaranteed dollar amounts, and accommodation leases supporting the Aston management activities, entered into on behalf of the property owners for which either party may terminate such leases upon 60 days prior written notice to the other. In addition, certain of the Management and Rental segment's hotel and resort management agreements of Aston provide that owners receive specified percentages of the revenue generated under Aston management. In these cases, the operating expenses for the rental operations are paid from the revenue generated by the rentals, the owners are then paid their contractual percentages, and the Management and Rental segment either retains the balance (if any) as its management fee or makes up the deficit. Although such deficits are reasonably possible in a few of these agreements, as of September 30, 2012 amounts are not expected to be significant, individually or in the aggregate. Aston also enters into agreements, as principal, for services purchased on behalf of property owners for which it is subsequently reimbursed. As such, Aston is the primary obligor and may be liable for unreimbursed costs. As of September 30, 2012, amounts pending reimbursements are not significant. Subsequent Event In November 2012, our Board of Directors declared a $0.10 per share dividend payable December 18, 2012 to shareholders of record on December 4, 2012. Based on the number of shares of common stock outstanding as of September 30, 2012, at a dividend of $0.10 per share, the anticipated cash outflow would be $5.7 million in the fourth quarter of 2012. 47-------------------------------------------------------------------------------- Contractual Obligations and Commercial Commitments Contractual obligations and commercial commitments at September 30, 2012 are as follows: Payments Due by Period More Up to than Contractual Obligations Total 1 year 1 - 3 years 3 - 5 years 5 years (Dollars in thousands) Debt principal(a) $ 290,000 $ - $ - $ 290,000 $ - Debt interest(a) 30,351 6,384 12,856 11,111 - Purchase obligations(b) 30,107 8,234 11,715 7,758 2,400 Unused commitment on loans receivable and other advances 2,868 2,868 - - - Operating leases 58,116 11,740 18,228 12,432 15,716 Total contractual obligations $ 411,442 $ 29,226 $ 42,799 $ 321,301 $ 18,116 -------------------------------------------------------------------------------- º (a) º Debt principal and debt interest represent principal and interest to be paid on our revolving credit facility based on the balance outstanding as of September 30, 2012. In addition, also included are certain fees associated with our revolving credit facility based on the unused borrowing capacity and outstanding letters of credit balances, if any, as of September 30, 2012. Interest on the revolving credit facility is calculated using the prevailing rates as of September 30, 2012. º (b) º The purchase obligations primarily relate to future guaranteed purchases of rental inventory, operational support services, marketing related benefits and membership fulfillment benefits. Amount of Commitment Expiration Per Period More Total Amounts Less than thanOther Commercial Commitments(c) Committed 1 Year 1 - 3 Years 3 - 5 Years 5 Years (In thousands) Guarantees, surety bonds and letters of credit $ 35,220 $ 12,191 $ 15,082 $ 5,835 $ 2,112 -------------------------------------------------------------------------------- º (c) º Commercial commitments include minimum revenue guarantees related to Aston's hotel and resort management agreements, Aston's accommodation leases entered into on behalf of the property owners, and funding commitments that could potentially require performance in the event of demands by third parties or contingent events, such as under a letter of credit extended or under guarantees. Included in other liabilities, both current and long-term, as presented in our consolidated balance sheet as of September 30, 2012, are certain unconditional recorded contractual obligations. These obligations and the future periods in which such obligations are expected to settle in cash are as follows (in thousands): Twelve Month Period Ending September 30, 2013 $ 2,982 2014 3,857 2015 - 2016 - 2017 - Thereafter - Total $ 6,839 48 -------------------------------------------------------------------------------- Recent Accounting Pronouncements Refer to Note 2 in the consolidated financial statements for a description of recent accounting pronouncements. Seasonality Refer to Note 1 in the consolidated financial statements for a discussion on the impact of seasonality. CRITICAL ACCOUNTING POLICIES AND ESTIMATES The preparation of financial statements in conformity with GAAP requires management to make estimates, judgments and assumptions that affect the amounts reported in our consolidated financial statements and accompanying notes. On an ongoing basis, we evaluate our estimates which are based on historical experience and various other judgments and assumptions that we believe are reasonable under the circumstances. Actual outcomes could differ from those estimates. We have discussed those estimates that we believe are critical and required the use of significant judgment and use of estimates that could have a significant impact on our financial statements in our 2011 Annual Report on Form 10-K. There have been no material changes to our critical accounting policies in the interim period. ILG'S PRINCIPLES OF FINANCIAL REPORTINGDefinition of ILG's Non-GAAP Measure Earnings Before Interest, Taxes, Depreciation and Amortization ("EBITDA") is defined as net income attributable to common stockholders excluding, if applicable: (1) interest income and interest expense, (2) income taxes, (3) depreciation expense, and (4) amortization expense of intangibles. Adjusted EBITDA is defined as EBITDA excluding, if applicable: (1) non-cash compensation expense, (2) goodwill and asset impairments and (3) other non-operating income and expense. Our presentation of Adjusted EBITDA and EBITDA may not be comparable to similarly-titled measures used by other companies. We believe these measures are useful to investors because they represent the consolidated operating results from our segments, excluding the effects of any non-cash expenses. We also believe these non-GAAP financial measures improve the transparency of our disclosures, provide a meaningful presentation of our results from our business operations, excluding the impact of certain items not related to our core business operations and improve the period-to-period comparability of results from business operations. Adjusted EBITDA and EBITDA have certain limitations in that they do not take into account the impact of certain expenses to our statement of operations; including for Adjusted EBITDA, non-cash compensation. We endeavor to compensate for the limitations of these non-GAAP measures presented by also providing the comparable GAAP measure with equal or greater prominence and descriptions of the reconciling items, including quantifying such items, to derive the non-GAAP measure. We report Adjusted EBITDA and EBITDA as supplemental measures to results reported pursuant to GAAP. These measures are among the primary metrics by which we evaluate the performance of our businesses, on which our internal budgets are based and by which management is compensated. We believe that investors should have access to the same set of tools that we use in analyzing our results. These non-GAAP measures should be considered in addition to results prepared in accordance with GAAP, but should not be considered a substitute for or superior to GAAP results. We provide and encourage investors to examine the reconciling adjustments between the GAAP and non-GAAP measures which are discussed below. 49-------------------------------------------------------------------------------- Pro Forma Results We will only present Adjusted EBITDA and/or EBITDA on a pro forma basis if we view a particular transaction as significant in size or transformational in nature. For the periods presented in this report, there are no transactions that we have included on a pro forma basis. Non-Cash Expenses That Are Excluded From ILG's Non-GAAP Measure (as applicable) Amortization expense of intangibles is a non-cash expense relating primarily to acquisitions. At the time of an acquisition, the intangible assets of the acquired company, such as customer relationships, purchase agreements and resort management agreements are valued and amortized over their estimated lives. We believe that since intangibles represent costs incurred by the acquired company to build value prior to acquisition, they were part of transaction costs. Depreciation expense is a non-cash expense relating to our property and equipment and is recorded on a straight-line basis to allocate the cost of depreciable assets to operations over their estimated service lives. Non-cash compensation expense consists principally of expense associated with the grants, including unvested grants assumed in acquisitions, of restricted stock, restricted stock units and stock options. These expenses are not paid in cash, and we will include the related shares in our future calculations of diluted shares of stock outstanding. Upon vesting of restricted stock and restricted stock units and the exercise of certain stock options, the awards will be settled, at our discretion, on a net basis, with us remitting the required tax withholding amount from our current funds. Goodwill and asset impairments are non-cash expenses relating to adjustments to goodwill and long-lived assets whereby the carrying value exceeds the fair value of the related assets, and are infrequent in nature. Other non-operating income and expense consists principally of foreign currency translations of cash held in certain countries in currencies other than their functional currency, in addition to any gains or losses on extinguishment of debt. RECONCILIATION OF EBITDA AND ADJUSTED EBITDA The following tables reconcile EBITDA and Adjusted EBITDA to operating income for our operating segments, and to net income attributable to common stockholders in total, for the three and 50-------------------------------------------------------------------------------- nine months ended September 30, 2012 and 2011 (in thousands). The noncontrolling interest relates to the Management and Rental segment. For the Three Months Ended September 30, 2012 Membership Management and and Exchange Rental Consolidated Adjusted EBITDA $ 33,701 $ 4,409 $ 38,110 Non-cash compensation expense (2,311 ) (253 ) (2,564 ) Other non-operating expense, net (915 ) - (915 ) Loss on extinguishment of debt (17,925 ) - (17,925 ) EBITDA 12,550 4,156 16,706 Amortization expense of intangibles (4,968 ) (1,701 ) (6,669 ) Depreciation expense (3,011 ) (300 ) (3,311 ) Less: Other non-operating expense, net 915 - 915 Less: Loss on extinguishment of debt 17,925 - 17,925 Operating income $ 23,411 $ 2,155 25,566 Interest income 535 Interest expense (6,485 ) Other non-operating expense, net (915 ) Loss on extinguishment of debt (17,925 ) Income tax provision (624 ) Net income 152 Net income attributable to noncontrolling interest (3 ) Net income attributable to common stockholders $ 149 |