Monday, July 07, 2008

Timeshare Operator Silverleaf Resorts to Interest Income for Profitability

Homebuilders may be grabbing the headlines, but the economic slowdown and recent deterioration of the sub-prime mortgage markets has adversely impacted the operating outlook of timeshare operators, too. Texas-based Silverleaf Resorts (SVLF-$2.17), which offers annual one-week vacation ownership with certain exchange privileges, is resorting to novelty accounting to boost sales.

The company reported a 13.4% increase in net income for the first-quarter ended March 31, on
Vacation Interval sales increase of 22 percent to $65.1 million.

Sharon K. Brayfield, President, said, "Our product remains well received despite the slowdown in the economy. The growth in net income for the quarter translates into a business that is fundamentally healthy."

The 10Q Detective begs to differ—net income being more akin to phantom profits.

The business model of Silverleaf is dependent on collecting interest income from aspiring vacation homebuyers for its alleged profitability. Net income of $7.45 million rests on a foundation of $14.5 million in interest income.

Upgrades to existing owners comprised 58.5% of aggregate sales, up from 56.4% last year.

Vacation Interval sales to new customers increased 16.2% to $27.0 million.

Customer Financing

Management looks to be reaching out to more buyers with marginal credit histories, for approximately 22.7% of closings in the first-quarter were made to customers with FICO Credit Bureau scores below 600 (up from 21.2% last year).

Silverleaf provides financing of up to 90 percent of the purchase price of the Vacation Intervals, which are collateralized by the interest in the said property rentals. As testimony to the higher credit risk in dealing with timeshare buyers, the average yield on outstanding notes receivable at March 31, 2008, was 16.4 percent (with a weighted average maturity of seven years).

The company considers accounts more than 60 days past due to be delinquent. As of March 31, 2008, $4.2 million, or 1.4% of notes receivable, net of accounts charged off, were considered delinquent. However, the delinquency rate climbs to 9.9% when one includes payment concessions and extensions to certain customers. Of note—a deliquency rate (over 30-day) greater than 10 percent would violate minimum loan delinquency covenants with lenders.

Estimated notes deemed uncollectible as a percentage of Vacation Interval sales increased to 22 percent, up from 16 percent during the same period of 2007.

In addition, certain states have laws that limit the company’s ability to recover personal judgments against customers who have defaulted on their loans. Accordingly, Silverleaf rarely pursues this remedy.

Deferred Taxes

Is the company counting its proverbial chickens before they hatch? Liability for deferred taxes (owed on previously reported installment income sales) was $100.7 million at December 31, 2007. Should foreclosed properties trigger tax payments—and the company not be able to fully recover the value of said properties—cash flow may not be adequate to cover accelerated tax payments.

Corporate Governance

In addition to a salary of $750,000, Silverleaf rewarded its Chairman and Chief Executive, Robert E. Meade (who beneficially owns 24.6% of the outstanding stock), with a cash bonus of $2.9 million, according to a pre-tax incentive bonus structure outlined in its
Proxy Statement filed on July 3 with the SEC. Were it not for interest income of $53 million, Meade would have earned nil for a cash bonus for his 2007 performance!

The share price of Silverleaf lost about 6.9% in market value last year, closing at $4.16 a share on December 31—what was that argument about aligning the chief executive’s compensation with the interests of shareholders?


The Company forecasts 2008 net income and EPS guidance of approximately $28 million and $0.70, respectively.

To borrow from Shakespeare:

"The quality of earnings is thus strained;
It droppeth as gentle interest income from unsuspecting buyers
Upon the income statement;
It is twice blest;
It blesseth Silverleaf that gives and CEO Meade who takes."

Editor David J. Phillips does not hold a financial interest in any stocks mentioned in this article. The 10Q Detective has a Full Disclosure Policy.

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