UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

 

 

 

 

Form 10-Q

 

 

Commission File No. 001-32876

 

 

 

 

Wyndham Worldwide Corporation

(Exact name of registrant as specified in its charter)

 

 

(973) 753-6000

(Registrant’s telephone number, including area code)

 

 

 

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.  Yes þ     No o

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act.

 

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).  Yes o     No þ

 

The number of shares outstanding of the issuer’s common stock was 182,303,755 shares as of April 30, 2007.

 

 

Table of Contents

 

 

 

To the Wyndham Worldwide Corporation Board of Directors and Shareholders
Parsippany, New Jersey

 

We have reviewed the accompanying condensed consolidated balance sheet of Wyndham Worldwide Corporation and subsidiaries (the “Company”) as of March 31, 2007, the related condensed consolidated and combined statements of income and cash flows for the three-month periods ended March 31, 2007 and 2006, and the related condensed consolidated statement of stockholders’ equity for the three-month period ended March 31, 2007. These interim financial statements are the responsibility of the Company’s management.

 

We conducted our reviews in accordance with the standards of the Public Company Accounting Oversight Board (United States). A review of interim financial information consists principally of applying analytical procedures and making inquiries of persons responsible for financial and accounting matters. It is substantially less in scope than an audit conducted in accordance with the standards of the Public Company Accounting Oversight Board (United States), the objective of which is the expression of an opinion regarding the financial statements taken as a whole. Accordingly, we do not express such an opinion.

 

Based on our reviews, we are not aware of any material modifications that should be made to such condensed consolidated and combined interim financial statements for them to be in conformity with accounting principles generally accepted in the United States of America.

 

As discussed in Note 1 to the condensed consolidated and combined financial statements, prior to its separation from Cendant Corporation (“Cendant”; known as Avis Budget Group since August 29, 2006), the Company was comprised of the assets and liabilities used in managing and operating the lodging, vacation exchange and rental and vacation ownership businesses of Cendant. Included in Notes 12 and 13 of the condensed consolidated and combined financial statements is a summary of transactions with related parties. As discussed in Note 12 to the condensed consolidated and combined financial statements, in connection with its separation from Cendant, the Company entered into certain guarantee commitments with Cendant and has recorded the fair value of these guarantees. As discussed in Note 1 to the condensed consolidated and combined financial statements, as of January 1, 2006, the Company adopted the provisions for accounting for real estate time-sharing transactions. Also as discussed in Notes 1 and 7 of the condensed consolidated and combined financial statements, the Company adopted the provisions for accounting for uncertainty in income taxes, as of January 1, 2007.

 

We have previously audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheet of Wyndham Worldwide Corporation and subsidiaries as of December 31, 2006, and the related consolidated statements of income, stockholders’ equity, and cash flows for the year then ended (not presented herein); and in our report dated March 7, 2007, we expressed an unqualified opinion (which included an explanatory paragraph relating to the fact that, prior to its separation from Cendant Corporation (“Cendant”; known as Avis Budget Group since August 29, 2006), the Company was comprised of the assets and liabilities used in managing and operating the lodging, vacation exchange and rental and vacation ownership businesses of Cendant; included in Notes 20 and 21 of the consolidated and combined financial statements is a summary of transactions with related parties; discussed in Note 20 to the consolidated and combined financial statements, in connection with its separation from Cendant, the Company entered into certain guarantee commitments with Cendant and has recorded the fair value of these guarantees as of July 31, 2006; and the Company adopted the provisions for accounting for real estate time-sharing transactions) on those consolidated financial statements. In our opinion, the information set forth in the accompanying condensed consolidated balance sheet as of December 31, 2006 is fairly stated, in all material respects, in relation to the consolidated balance sheet from which it has been derived.

 

Parsippany, New Jersey
May 10, 2007

WYNDHAM WORLDWIDE CORPORATION

CONDENSED CONSOLIDATED AND COMBINED STATEMENTS OF INCOME
(In millions, except per share amounts)
(Unaudited)

 

 

See Notes to Condensed Consolidated and Combined Financial Statements.

WYNDHAM WORLDWIDE CORPORATION
CONDENSED CONSOLIDATED BALANCE SHEETS
(In millions, except share and per share amounts)
(Unaudited)

 

 

See Notes to Condensed Consolidated and Combined Financial Statements.

WYNDHAM WORLDWIDE CORPORATION
CONDENSED CONSOLIDATED AND COMBINED STATEMENTS OF CASH FLOWS
(In millions)
(Unaudited)

 

 

See Notes to Condensed Consolidated and Combined Financial Statements.

WYNDHAM WORLDWIDE CORPORATION
CONDENSED CONSOLIDATED STATEMENT OF STOCKHOLDERS’ EQUITY
(In millions)
(Unaudited)

 

 

See Notes to Condensed Consolidated and Combined Financial Statements.

 

 

Prior to July 31, 2006, Cendant Corporation (“Cendant” or “former Parent”; known as Avis Budget Group since August 29, 2006) transferred to Wyndham Worldwide Corporation (“Wyndham” or “the Company”), a Delaware corporation, all of the assets and liabilities primarily related to the hospitality services (including timeshare resorts) businesses of Cendant. On July 31, 2006, Cendant distributed all of the shares of Wyndham common stock to the holders of Cendant common stock issued and outstanding on July 21, 2006, the record date for the distribution. The separation of Wyndham from Cendant (“Separation”) was effective on July 31, 2006. On August 1, 2006, the Company commenced “regular way” trading on the New York Stock Exchange under the symbol “WYN.”

 

The accompanying Condensed Consolidated and Combined Financial Statements include the accounts and transactions of Wyndham, the entities in which Wyndham directly or indirectly has a controlling financial interest. The accompanying Condensed Consolidated and Combined Financial Statements have been prepared in accordance with accounting principles generally accepted in the United States of America. All intercompany balances and transactions have been eliminated in the Condensed Consolidated and Combined Financial Statements.

 

The Company’s condensed consolidated and combined results of operations, financial position and cash flows may not be indicative of its future performance and do not necessarily reflect what its consolidated results of operations, financial position and cash flows would have been had the Company operated as a separate, stand-alone entity during the periods presented prior to August 1, 2006, including changes in its operations and capitalization as a result of the Separation and distribution from Cendant.

 

Certain corporate and general and administrative expenses, including those related to executive management, tax, accounting, payroll, legal and treasury services, certain employee benefits and real estate usage for common space were allocated by Cendant to the Company through July 31, 2006 based on forecasted revenues or usage. Management believes such allocations were reasonable. However, the associated expenses recorded by the Company in the Condensed Consolidated and Combined Statements of Income may not be indicative of the actual expenses that would have been incurred had the Company been operating as a separate, stand-alone public company for the periods presented prior to August 1, 2006. Following the Separation and distribution from Cendant, the Company began performing these functions using internal resources or purchased services, certain of which are provided by Cendant or one of the separated companies during a transitional period pursuant to the Transition Services Agreement. Refer to Note 13—Related Party Transactions for a detailed description of the Company’s transactions with Cendant and its former subsidiaries.

 

In presenting the Condensed Consolidated and Combined Financial Statements, management makes estimates and assumptions that affect the amounts reported and related disclosures. Estimates, by their nature, are based on judgment and available information. Accordingly, actual results could differ from those estimates. In management’s opinion, the Condensed Consolidated and Combined Financial Statements contain all normal recurring adjustments necessary for a fair presentation of interim results reported. The results of operations reported for interim periods are not necessarily indicative of the results of operations for the entire year or any subsequent interim period. Certain reclassifications have been made to prior period amounts to conform to the current period presentation. These financial statements should be read in conjunction with the Company’s 2006 Consolidated and Combined Financial Statements included in its Annual Report filed on Form 10-K with the Securities and Exchange Commission on March 7, 2007.

 

 

The Company operates in the following business segments:

 

 

 

Vacation Ownership Transactions.  In December 2004, the Financial Accounting Standards Board (“FASB”) issued Statement of Financial Accounting Standards (“SFAS”) No. 152, “Accounting for Real Estate Time-Sharing Transactions,” (“SFAS No. 152”) in connection with the issuance of the American Institute of Certified Public Accountants’ Statement of Position No. 04-2, “Accounting for Real Estate Time-Sharing Transactions.” SFAS No. 152 provides guidance on revenue recognition for vacation ownership transactions, accounting and presentation for the uncollectibility of vacation ownership contract receivables, accounting for costs of sales of vacation ownership interests and related costs, accounting for operations during holding periods and other transactions associated with vacation ownership operations.

 

The Company’s revenue recognition policy for vacation ownership transactions has historically required a 10% minimum down payment (initial investment) as a prerequisite to recognizing revenue on the sale of a vacation ownership interest. SFAS No. 152 requires that the Company consider the fair value of certain incentives provided to the buyer when assessing whether such threshold has been achieved. If the buyer’s investment has not met the minimum investment criteria of SFAS No. 152, the revenue associated with the sale of the vacation ownership interest and the related cost of sales and direct costs are deferred until the buyer’s commitment satisfies the requirements of SFAS No. 152. In addition, certain costs previously included in the Company’s percentage-of-completion calculation prior to the adoption of SFAS No. 152 are now expensed as incurred rather than deferred until the corresponding revenue is recognized.

 

SFAS No. 152 requires the Company to record the estimate of uncollectible vacation ownership contract receivables, without consideration of estimated inventory recoveries, at the time a vacation ownership transaction is consummated as a reduction of net revenues. Prior to the adoption of SFAS No. 152, the Company recorded such provisions within operating expense on the Condensed Consolidated and Combined Statements of Income. SFAS No. 152 also requires a change in accounting for inventory and cost of sales such that cost of sales is allocated based on a relative sales value method, under which cost of sales is calculated as an estimated percentage of net sales.

 

SFAS No. 152 also requires that revenue in excess of costs associated with the rental of unsold units be accounted for as a reduction to the carrying value of vacation ownership inventory (which reduces the cost of such inventory when it is sold) and that costs in excess of revenues associated with the rental of unsold units be charged to expense as incurred. Prior to the adoption of SFAS No. 152, rental revenues and expenses were separately recorded in the Condensed Consolidated and Combined Statements of Income.

 

The Company adopted the provisions of SFAS No. 152 effective January 1, 2006, as required, and recorded an after tax charge of $65 million during the first quarter of 2006 as a cumulative effect of an accounting change, which consisted of (i) a pre-tax charge of $105 million representing the deferral of revenue, costs associated with sales of vacation ownership interests that were recognized prior to January 1, 2006 and the recognition of certain expenses that were previously deferred and (ii) an associated tax benefit of $40 million. There was no impact to cash flows from the adoption of SFAS No. 152.

 

 

Accounting for Servicing of Financial Assets.  In March 2006, the FASB issued SFAS No. 156, “Accounting for Servicing of Financial Assets—an amendment of FASB Statement No. 140” (“SFAS No. 156”). SFAS No. 156 requires an entity to recognize a servicing asset or servicing liability each time it undertakes an obligation to service a financial asset by entering into a servicing contract and requires all separately recognized servicing assets and servicing liabilities to be initially measured at fair value, if practicable. The Company adopted SFAS No. 156 on January 1, 2007, as required. There was no impact to the Company’s consolidated financial statements from the adoption of SFAS No. 156.

 

Accounting for Uncertainty in Income Taxes.  In June 2006, the FASB issued FASB Interpretation No. 48, “Accounting for Uncertainty in Income Taxes—an Interpretation of FASB Statement No. 109” (“FIN 48”), which is an interpretation of SFAS No. 109, “Accounting for Income Taxes.” FIN 48 prescribes a recognition threshold and a measurement attribute for the financial statement recognition and measurement of tax positions taken or expected to be taken in a tax return. For those benefits to be recognized, a tax position must be more-likely-than-not to be sustained upon examination by taxing authorities. The amount recognized is measured as the largest amount of benefit that is greater than 50 percent likely of being realized upon ultimate settlement. The Company adopted the provisions of FIN 48 on January 1, 2007, as required. See Note 7—Income Taxes for a detailed explanation of the impact of the adoption.

 

 

Fair Value Measurements.  In September 2006, the FASB issued SFAS No. 157, “Fair Value Measurements” (“SFAS No. 157”). SFAS No. 157 defines fair value, establishes a framework for measuring fair value in accordance with generally accepted accounting principles, and expands disclosures about fair value measurements. SFAS No. 157 explains the definition of fair value as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. SFAS No. 157 clarifies the principle that fair value should be based on the assumptions market participants would use when pricing the asset or liability and establishes a fair value hierarchy that prioritizes the information used to develop those assumptions. The Company plans to adopt SFAS No. 157 on January 1, 2008, as required, and is currently assessing the impact of such adoption on its consolidated financial statements.

 

The Fair Value Option for Financial Assets and Financial Liabilities.  In February 2007, the FASB issued SFAS No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities, including an amendment of FASB Statement No. 115” (“SFAS No. 159”). SFAS No. 159 permits entities to choose to measure many financial instruments at fair value that are not currently required to be measured at fair value. It also establishes presentation and disclosure requirements designed to facilitate comparisons between entities that choose different measurement attributes for similar types of assets and liabilities. The Company will adopt SFAS No. 159 on January 1, 2008, as required, and is currently assessing if it will choose to measure any financial assets and liabilities at fair value.

 

 

The computation of basic and diluted earnings per share (“EPS”) is based on the Company’s net income divided by the basic weighted average number of common shares and diluted weighted average number of common shares, respectively. On July 31, 2006, the Separation from Cendant was completed in a tax-free distribution to the Company’s stockholders of one share of Wyndham common stock for every five shares of Cendant common stock held on July 21, 2006. As a result, on July 31, 2006, the Company had 200,362,113 shares of common stock outstanding. This share amount is being utilized for the calculation of basic and diluted earnings per share for all periods presented prior to the date of Separation.

 

The following table sets forth the computation of basic and diluted EPS:

 

		Three Months Ended
		March 31,
		2007				2006
Income before cumulative effect of accounting change		$	86			$	93
Cumulative effect of accounting change, net of tax			—				(65	)
Net income		$	86			$	28
Basic weighted average shares outstanding			188				200
Stock options, warrants and restricted stock units			2				—
Diluted weighted average shares outstanding			190				200
Basic earnings per share:
Income before cumulative effect of accounting change		$	0.46			$	0.46
Cumulative effect of accounting change, net of tax			—				(0.32	)
Net income		$	0.46			$	0.14
Diluted earnings per share:
Income before cumulative effect of accounting change		$	0.45			$	0.46
Cumulative effect of accounting change, net of tax			—				(0.32	)
Net income		$	0.45			$	0.14

 

The computations of diluted net income per common share available to common stockholders for the three months ended March 31, 2007 do not include approximately 15 million stock options, as the effect of their inclusion would have been anti-dilutive to earnings per share.

 

 

Intangible assets consisted of:

 

		As of March 31, 2007												As of December 31, 2006
		Gross								Net				Gross								Net
		Carrying				Accumulated				Carrying				Carrying				Accumulated				Carrying
		Amount				Amortization				Amount				Amount				Amortization				Amount
Unamortized Intangible Assets
Goodwill		$	2,702											$	2,699
Trademarks		$	620											$	619
Amortized Intangible Assets
Franchise agreements		$	597			$	243			$	354			$	596			$	238			$	358
Trademarks			2				1				1				2				—				2
Other(*)			86				22				64				80				21				59
		$	685			$	266			$	419			$	678			$	259			$	419

 

The changes in the carrying amount of goodwill are as follows:

 

										Adjustments
						Goodwill				to Goodwill				Foreign
		Balance at				Acquired				Acquired				Exchange				Balance at
		January 1,				during				during				and				March 31,
		2007				2007				2006				Other				2007
Lodging		$	245			$	—			$	—			$	—			$	245
Vacation Exchange and Rentals			1,116				—				—				3	(*)			1,119
Vacation Ownership			1,338				—				—				—				1,338
Total Company		$	2,699			$	—			$	—			$	3			$	2,702

 

      _ _

 

Amortization expense relating to amortizable intangible assets was as follows:

 

		Three Months Ended
		March 31,
		2007				2006
Franchise agreements		$	5			$	4
Other			1				4
Total(*)		$	6			$	8

 

      _ _

 

Based on the Company’s amortizable intangible assets as of March 31, 2007, the Company expects related amortization expense as follows:

 

		Amount
Remainder of 2007		$	19
2008			23
2009			23
2010			22
2011			21
2012			20

 

The Company generates vacation ownership contract receivables by extending financing to the purchasers of VOIs. Current and long-term vacation ownership contract receivables, net consisted of:

 

		March 31,				December 31,
		2007				2006
Current vacation ownership contract receivables:
Securitized		$	226			$	201
Other			71				86
			297				287
Less: Allowance for loan losses			(30	)			(30	)
Current vacation ownership contract receivables, net		$	267			$	257
Long-term vacation ownership contract receivables:
Securitized		$	1,848			$	1,545
Other			626				826
			2,474				2,371
Less: Allowance for loan losses			(251	)			(248	)
Long-term vacation ownership contract receivables, net		$	2,223			$	2,123

 

The activity in the allowance for loan losses on vacation ownership contract receivables was as follows:

 

		Amount
Allowance for loan losses as of January 1, 2007		$	(278	)
Provision for loan losses			(61	)
Contract receivables written-off			58
Allowance for loan losses as of March 31, 2007		$	(281	)

 

In accordance with SFAS No. 152, the Company recorded a provision for loan losses of $61 million and $61 million as a reduction of net revenues during the three months ended March 31, 2007 and 2006, respectively.

 

Principal payments that are contractually due on the Company’s vacation ownership contract receivables during the next twelve months are classified as current on the Company’s Condensed Consolidated Balance Sheets. During the three months ended March 31, 2007 and 2006, the Company originated vacation ownership receivables of $341 million and $256 million, respectively, and received principal collections of $178 million and $159 million, respectively. The weighted average interest rate on outstanding vacation ownership contract receivables was 12.6% and 12.7% as of March 31, 2007 and December 31, 2006, respectively.

 

 

Inventory consisted of:

 

		March 31,				December 31,
		2007				2006
Land held for VOI development		$	175			$	101
VOI construction in process			493				495
Completed inventory and vacation credits(*)			402				358
Total inventory			1,070				954
Less: Current portion			543				520
Non-current inventory		$	527			$	434

      _ _

 

Inventory that the Company expects to sell within the next twelve months is classified as current on the Company’s Condensed Consolidated Balance Sheets.

 

Capitalized interest on the Company’s inventory was $6 million and $2 million for the three months ended March 31, 2007 and 2006, respectively.

 

 

		March 31,				December 31,
		2007				2006
Securitized vacation ownership debt:
Term notes		$	887			$	838
Bank conduit facility(a)			826				625
Total securitized vacation ownership debt			1,713				1,463
Less: Current portion of securitized vacation ownership debt			231				178
Long-term securitized vacation ownership debt		$	1,482			$	1,285
Long-term debt:
6.00% senior unsecured notes (due December 2016)(b)		$	796			$	796
Term loan (due July 2011)			300				300
Revolving credit facility (due July 2011)(c)			48				—
Bank borrowings:
Vacation ownership			112				103
Vacation rentals(d)			—				73
Vacation rentals capital leases			147				148
Other			16				17
Total long-term debt			1,419				1,437
Less: Current portion of long-term debt			123				115
Long-term debt		$	1,296			$	1,322

      _ _

 

On February 12, 2007, the Company closed a securitization facility, Premium Yield Facility 2007-A, in the amount of $155 million, which bears interest at LIBOR plus 43 basis points and an additional bond insurance fee and matures in February 2020. As of March 31, 2007, the Company had $155 million of outstanding borrowings under this facility. The Company’s outstanding debt as of March 31, 2007 matures as follows:

 

		Securitized
		Vacation
		Ownership
		Debt				Debt				Total
Within 1 year		$	231			$	123			$	354
Between 1 and 2 years			304				10				314
Between 2 and 3 years			666				10				676
Between 3 and 4 years			93				20				113
Between 4 and 5 years			86				357				443
Thereafter			333				899				1,232
		$	1,713			$	1,419			$	3,132

 

As debt maturities of the securitized vacation ownership debt are based on the contractual payment terms of the underlying vacation ownership contract receivables, actual maturities may differ as a result of prepayments by the vacation ownership contract receivable obligors.

 

The revolving credit facility and unsecured term loan include covenants, including the maintenance of specific financial ratios. These financial covenants consist of a minimum interest coverage ratio of at least 3.0 times as of the measurement date and a maximum leverage ratio not to exceed 3.5 times on the measurement date. The interest coverage ratio is calculated by dividing EBITDA (as defined in the credit agreement and Note 11 to the Condensed Consolidated and Combined Financial Statements) by Interest Expense (as defined in the credit agreement), excluding interest expense on any Securitization Indebtedness and on Non-Recourse Indebtedness (as the two terms are defined in the credit agreement), both as measured on a trailing 12 month basis preceding the measurement date. The leverage ratio is calculated by dividing Consolidated Total Indebtedness (as defined in the credit agreement) excluding any Securitization Indebtedness and any Non-Recourse Secured debt as of the measurement date by EBITDA as measured on a trailing 12 month basis preceding the measurement date. Covenants in these credit facilities also include

limitations on indebtedness of material subsidiaries; liens; mergers, consolidations, liquidations, dissolutions and sales of all or substantially all assets; and sale and leasebacks. Events of default in these credit facilities include nonpayment of principal when due; nonpayment of interest, fees or other amounts; violation of covenants; cross payment default and cross acceleration (in each case, to indebtedness (excluding securitization indebtedness) in excess of $50 million); and a change of control (the definition of which permitted our separation from Cendant).

 

The 6.00% senior unsecured notes contain various covenants including limitations on liens, limitations on sale and leasebacks, and change of control restrictions. In addition, there are limitations on mergers, consolidations and sales of all or substantially all assets. Events of default in the notes include nonpayment of interest, nonpayment of principal, breach of a covenant or warranty, cross acceleration of debt in excess of $50 million, and bankruptcy related matters.

 

As of March 31, 2007, the Company was in compliance with all of the covenants described above including the required financial ratios.

 

As of March 31, 2007, available capacity under the Company’s borrowing arrangements was as follows:

 

		Total				Outstanding				Available
		Capacity				Borrowings				Capacity
Securitized vacation ownership debt:
Term notes		$	887			$	887			$	–
Bank conduit facility			1,000				826				174
Total securitized vacation ownership debt(a)		$	1,887			$	1,713			$	174
Long-term debt:
6.00% senior unsecured notes (due December 2016)		$	796			$	796			$	–
Term loan (due July 2011)			300				300				–
Revolving credit facility (due July 2011)(b)			900				48				852
Bank borrowings:
Vacation ownership(c)			182				112				70
Vacation rentals capital leases(d)			147				147				–
Other			17				16				1
Total long-term debt		$	2,342			$	1,419				923
Less: Issuance of letters of credit(b)											(38	)
										$	885

 

             _ _

 

Interest expense incurred in connection with the Company’s securitized vacation ownership debt amounted to $23 million and $14 million during the three months ended March 31, 2007 and 2006, respectively, and is recorded within operating expenses on the Condensed Consolidated and Combined Statements of Income. Cash paid related to such interest expense was $20 million and $12 million during the three months ended March 31, 2007 and 2006, respectively.

 

Interest expense incurred in connection with the Company’s other debt amounted to $24 million and $12 million during the three months ended March 31, 2007 and 2006, respectively, and is recorded within the interest expense line item on the Condensed Consolidated and Combined Statements of Income. Cash paid related to such interest expense was $9 million and $11 million during the three months ended March 31, 2007 and 2006, respectively.

 

Interest expense is partially offset on the Condensed Consolidated and Combined Statements of Income by capitalized interest of $6 million and $2 million as of March 31, 2007 and 2006, respectively.

 

 

The Company or one of its subsidiaries files income tax returns in the U.S. federal jurisdiction and various states and foreign jurisdictions. With few exceptions, the Company is no longer subject to U.S. federal, state and local, or non-U.S. income tax examinations by tax authorities for years before 2003. During the first quarter of 2007, the Internal Revenue Service (“IRS”) opened an examination for Cendant’s taxable years 2003 through 2006 during which the Company was included in Cendant’s tax returns.

 

The Company adopted the provisions of FIN 48 on January 1, 2007. As a result of the implementation of FIN 48, the Company recognized an increase of $20 million in the liability for unrecognized tax benefits, which was accounted for as a reduction of retained earnings on the Condensed Consolidated Balance Sheet at January 1, 2007. The total gross amount of unrecognized tax benefits was $20 million as of January 1, 2007. The amount of the unrecognized tax benefits at January 1, 2007 that, if recognized, would affect the Company’s effective tax rate is $20 million.

 

The Company’s liability for unrecognized tax benefits increased by a gross amount of $1 million during the three months ended March 31, 2007. The increase relates to tax positions taken during prior periods. The statue of limitations is scheduled to expire within 12 months of the reporting date in certain taxing jurisdictions and the Company believes that it is reasonably possible that the total amounts of its unrecognized tax benefits will decrease by $0 to $4 million.

 

The Company recorded both accrued interest and penalties related to unrecognized tax benefits as a component of income tax expense on the Condensed Consolidated Statement of Income. Prior to January 1, 2007, accrued interest and penalties were recorded as a component of operating expenses and interest expense on the Condensed Consolidated and Combined Statements of Income. During the three months ended March 31, 2007, the Company recognized less than $1 million in interest and penalties. Included within the unrecognized tax benefits recorded on January 1, 2007 was accrued interest and penalties of $2 million and $2 million, respectively.

 

The Company made cash income tax payments, net of refunds, of $8 million and $6 million during the three months ended March 31, 2007 and 2006, respectively. Such payments exclude income tax related payments made to former Parent.

 

 

The Company is involved in claims, legal proceedings and governmental inquiries related to contract disputes, business practices, intellectual property and other matters relating to the Company’s business, including, without limitation, commercial, employment, tax and environmental matters. Such matters include, but are not limited to, allegations that (i) the Company’s vacation ownership business alleged failure to perform its duties arising under its management agreements, as well as for construction defects and inadequate maintenance, which claims are made by property owners’ associations from time to time; and (ii) for our vacation exchange and rentals business, breach of contract claims by both affiliates and members in connection with their respective agreements and bad faith and consumer protection claims asserted by members. See Note 12—Separation Adjustments and Transactions with Former Parent and Subsidiaries regarding contingent litigation liabilities resulting from the Separation.

 

The Company believes that it has adequately accrued for such matters with a reserve of approximately $26 million, or, for matters not requiring accrual, believes that such matters will not have a material adverse effect on its results of operations, financial position or cash flows based on information currently available. However, litigation is inherently unpredictable and, although the Company believes that its accruals are adequate and/or that it has valid defenses in these matters, unfavorable resolutions could occur. As such, an adverse outcome from such unresolved proceedings for which claims are awarded in excess of the amounts accrued, if any, could be material to the Company with respect to earnings or cash flows in any given reporting period. However, the Company does not believe that the impact of such unresolved litigation should result in a material liability to the Company in relation to its consolidated financial position or liquidity.

 

 

The after-tax components of accumulated other comprehensive income are as follows:

 

						Unrealized				Accumulated
		Currency				Losses on				Other
		Translation				Cash Flow				Comprehensive
		Adjustments				Hedges, Net				Income
Balance, January 1, 2007, net of tax of $43		$	191			$	(7	)		$	184
Current period change			4				(3	)			1
Balance, March 31, 2007, net of tax of $42		$	195			$	(10	)		$	185

 

Foreign currency translation adjustments exclude income taxes related to investments in foreign subsidiaries where the Company intends to reinvest the undistributed earnings indefinitely in those foreign operations.

 

 

The Company has a stock-based compensation plan available to grant non-qualified stock options, incentive stock options, stock settled stock appreciation rights (“SSARs”), restricted stock, restricted stock units (“RSUs”) and other stock or cash-based awards to key employees, non-employee directors, advisors and consultants. Under the Wyndham Worldwide Corporation 2006 Equity and Incentive Plan, which was approved by Cendant, the sole shareholder, and became effective on July 12, 2006, a maximum of 43.5 million shares of common stock may be awarded. As of March 31, 2007, approximately 17.7 million shares of availability remained.

 

Incentive Equity Awards Conversion

 

Prior to August 1, 2006, all employee stock awards (stock options and RSUs) were granted by Cendant. At the time of Separation, a portion of Cendant’s outstanding equity awards were converted into equity awards of the Company at a ratio of one share of Company’s common stock for every five shares of Cendant’s common stock. As a result, the Company issued approximately 2 million RSUs and approximately 24 million stock options upon completion of the conversion of existing Cendant equity awards into Wyndham equity awards. As of March 31, 2007, there were zero converted RSUs outstanding.

 

The activity related to the converted stock options through March 31, 2007 consisted of the following:

 

						Weighted
		Number				Average
		of Options(c)				Grant Price
Balance at January 1, 2007			22.0			$	39.87
Exercised(a)			0.8				21.91
Canceled			0.5				42.17
Balance at March 31, 2007(b)			20.7			$	40.50

 

             _ _

 

The following table summarizes information regarding the Company’s outstanding and exercisable stock options as of March 31, 2007:

						Weighted
		Number				Average
Range of Exercise Prices		of Options				Strike Price
$10.00–$19.99			2.7			$	19.72
$20.00–$29.99			2.5				24.44
$30.00–$39.99			3.8				37.43
$40.00–$49.99			8.0				42.86
$50.00 & above			3.7				64.76
Total Options			20.7			$	40.50

      Incentive Equity Awards Granted by the Company

 

The activity related to the Company’s incentive equity awards through March 31, 2007 consisted of the following:

 

		RSUs(a)								SSARs(a)
						Weighted								Weighted
		Number				Average				Number				Average
		of RSUs				Grant Price				of SSARs				Grant Price
Balance at January 1, 2007			2.2			$	31.81				0.5			$	31.85
Granted			—				—				—				—
Vested/exercised			—				—				—				—
Canceled			0.1				31.85				—				—
Balance at March 31, 2007(b)			2.1	(c)		$	31.81				0.5	(d)		$	31.85

      _ _

 

      Stock-Based Compensation

 

During the three months ended March 31, 2007, the Company recorded stock-based compensation expense of $5 million ($3 million, after tax) related to the incentive equity awards granted by the Company.

 

During the three months ended March 31, 2006, Cendant allocated pre-tax stock-based compensation expense of $6 million ($4 million, after tax) to the Company. Such compensation expense relates only to the options and RSUs that were granted to Cendant’s employees subsequent to January 1, 2003. The allocation was based on the estimated number of options and RSUs Cendant believed it would ultimately provide and the underlying vesting period of the awards. As Cendant measured its stock-based compensation expense using intrinsic value method during the periods prior to January 1, 2003, Cendant did not recognize compensation expense upon the issuance of equity awards to its employees.

 

 

The reportable segments presented below represent the Company’s operating segments for which separate financial information is available and which is utilized on a regular basis by its chief operating decision maker to assess performance and to allocate resources. In identifying its reportable segments, the Company also considers the nature of services provided by its operating segments. Management evaluates the operating results of each of its reportable segments based upon net revenues and “EBITDA,” which is defined as net income before depreciation and amortization, interest expense (excluding interest on securitized vacation ownership debt), income taxes and cumulative effect of accounting change, net of tax, each of which is presented on the Company’s Condensed Consolidated and Combined Statements of Income. The Company’s presentation of EBITDA may not be comparable to similarly-titled measures used by other companies.

		Three Months Ended March 31,
		2007								2006
		Net								Net
		Revenues				EBITDA(c)				Revenues				EBITDA(c)
Lodging		$	152			$	45			$	144			$	41
Vacation Exchange and Rentals			314				85				282				77
Vacation Ownership			549				63				445				64
Total Reportable Segments			1,015				193				871				182
Corporate and Other(a)(b)			(3	)			(1	)			(1	)			—
Total Company		$	1,012			$	192			$	870			$	182

 

      _ _

 

The reconciliation of EBITDA to income before income taxes is noted below:

 

		Three Months Ended
		March 31,
		2007				2006
EBITDA		$	192			$	182
Depreciation and amortization			38				34
Interest expense (excluding interest on securitized vacation ownership debt)			18				10
Interest income			(3	)			(12	)
Income before income taxes		$	139			$	150

 

 

Transfer of Cendant Corporate Liabilities and Issuance of Guarantees to Cendant and Affiliates

 

Pursuant to the Separation and Distribution Agreement, upon the distribution of the Company’s common stock to Cendant shareholders, the Company entered into certain guarantee commitments with Cendant (pursuant to the assumption of certain liabilities and the obligation to indemnify Cendant and Cendant’s former real estate services (“Realogy”) and travel distribution services (“Travelport”) for such liabilities) and guarantee commitments related to deferred compensation arrangements with each of Cendant and Realogy. These guarantee arrangements primarily relate to certain contingent litigation liabilities, contingent tax liabilities, and Cendant contingent and other corporate liabilities, of which the Company assumed and is responsible for 37.5% of these Cendant liabilities. The amount of liabilities which were assumed by the Company in connection with the Separation approximated $404 million and $434 million at March 31, 2007 and December 31, 2006, respectively. These amounts were comprised of certain Cendant corporate liabilities which were recorded on the books of Cendant as well as additional liabilities which were established for guarantees issued at the date of Separation related to certain unresolved contingent matters and certain others that could arise during the guarantee period. Regarding the guarantees, if any of the companies responsible for all or a portion of such liabilities were to default in its payment of costs or expenses related to any such liability, the Company would be responsible for a portion of the defaulting party or parties’ obligation. The Company also provided a default guarantee related to certain deferred compensation arrangements related to certain current and former senior officers and directors of Cendant, Realogy and Travelport. These arrangements, which are discussed in more detail below, have been valued upon the Company’s separation from Cendant with the assistance of third-party experts in accordance with Financial Interpretation No. 45 (“FIN 45”) “Guarantor’s Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others” and recorded as liabilities on the balance sheet. To the extent such recorded liabilities are not adequate to cover the ultimate payment amounts, such excess will be reflected as an expense to the results of operations in future periods.

 

The $404 million is comprised of $36 million for litigation matters, $234 million for tax liabilities, $111 million for other contingent and corporate liabilities including liabilities of previously sold businesses of Cendant and $23 million of liabilities where the calculated FIN 45 guarantee amount exceeded the SFAS No. 5 “Accounting for Contingencies” liability assumed at the date of Separation (of which $21 million of the $23 million pertain to litigation liabilities). $130 million of these liabilities are recorded in current Due to former Parent and subsidiaries and $239 million are recorded in long-term Due to former Parent and subsidiaries at March 31, 2007 on the Condensed Consolidated Balance Sheet. The Company is indemnifying Cendant for these contingent liabilities and therefore any payments would be made to the third party through the former Parent. The $23 million relating to the FIN 45 guarantees is recorded in other current liabilities at March 31, 2007 on the Condensed Consolidated Balance Sheet. In addition, the Company has a $35 million receivable due from former Parent relating to a refund of excess funding paid to the Company’s former Parent resulting from the Separation and income tax refunds, which is recorded in current due from former Parent and subsidiaries on the Condensed Consolidated Balance Sheet. At December 31, 2006, the Company had recorded a $37 million receivable in non-current due from former Parent and subsidiaries on the Condensed Consolidated Balance Sheet, which represented the Company’s right, pursuant to the Separation agreement, to receive 37.5% of any proceeds from the ultimate sale of Cendant’s preferred stock investment in and warrants of Affinion Group Holdings, Inc. (“Affinion”). On January 31, 2007, Affinion redeemed a portion of the preferred stock investment owned by Avis Budget Group, of which the Company owned a 37.5% interest pursuant to the Separation agreement. Upon the Company’s receipt of its share of the proceeds resulting from Affinion’s redemption, such receivable was reduced to $10 million. As of March 31, 2007, the $10 million receivable was reclassified to other non-current assets on the Condensed Consolidated Balance Sheets as the investment has been legally transferred to the Company from Avis Budget Group. Accordingly, the Company owns a preferred stock investment and warrants in Affinion and accounts for them in accordance with SFAS No. 115, “Accounting for Certain Investments in Debt and Equity Securities.”

 

Following is a discussion of the liabilities on which the Company issued guarantees:

 

 

Transactions with Avis Budget Group, Realogy and Travelport

 

Prior to the Company’s Separation from Cendant, it entered into a Transition Services Agreement (“TSA”) with Avis Budget Group, Realogy and Travelport to provide for an orderly transition to becoming an independent company. Under the TSA, Cendant agrees to provide the Company with various services, including services relating to human resources and employee benefits, payroll, financial systems management, treasury and cash management, accounts payable services, telecommunications services and information technology services. In certain cases, services provided by Cendant under the TSA may be provided by one of the separated companies following the date of such company’s separation from Cendant. For the three months ended March 31, 2007, the Company recorded $6 million of expenses in the Condensed Consolidated Statements of Income related to these agreements.

 

Separation and Related Costs

 

During the three months ended March 31, 2007, the Company incurred costs of $6 million in connection with executing the Separation, consisting primarily of consulting and legal services and expenses related to the rebranding initiative at our Vacation Ownership business. During the three months ended March 31, 2006, the Company incurred costs of $3 million in connection with executing the Separation, consisting primarily of consulting and legal services.

 

 

Net Intercompany Funding to Former Parent

 

The following table summarizes related party transactions occurring between the Company and Cendant:

 

		Three Months Ended
		March 31, 2006
Net intercompany funding to former Parent, beginning balance		$	1,125
Corporate-related functions			(23	)
Income taxes, net			(52	)
Net interest earned on net intercompany funding to former Parent			10
Advances to former Parent, net			99
Net intercompany funding to former Parent, ending balance		$	1,159

 

Corporate-Related Functions

 

Prior to the date of Separation, the Company was allocated general corporate overhead expenses from Cendant for corporate-related functions based on a percentage of the Company’s forecasted revenues. General corporate overhead expense allocations included executive management, tax, accounting, payroll, financial systems management, legal, treasury and cash management, certain employee benefits and real estate usage for common space. The Company was allocated $9 million during the three months ended March 31, 2006, of general corporate expenses from Cendant, which are included within general and administrative expenses on the Condensed Combined Statement of Income. There were no allocations during the three months ended March 31, 2007 since the Company was operating as a stand-alone company.

 

Prior to the date of Separation, Cendant also incurred certain expenses on behalf of the Company. These expenses, which directly benefited the Company, were allocated to the Company based upon the Company’s actual utilization of the services. Direct allocations included costs associated with insurance, information technology, telecommunications and real estate usage for Company-specific space. The Company was allocated $14 million during the three months ended March 31, 2006, of expenses directly benefiting the Company, which are included within general and administrative and operating expenses on the Condensed Combined Statement of Income. There were no allocations during the three months ended March 31, 2007 since the Company was operating as a stand-alone company.

 

The Company believes the assumptions and methodologies underlying the allocations of general corporate overhead and direct expenses from Cendant were reasonable. However, such expenses were not indicative of, nor is it practical or meaningful for the Company to estimate for all historical periods presented, the actual level of expenses that would have been incurred had the Company been operating as a separate, stand-alone public company.

 

Income Taxes, net

 

Prior to the Separation, the Company was included in the consolidated federal and state income tax returns of Cendant. Balances due to Cendant for this short period return and related tax attributes were estimated as of December 31, 2006 and will be adjusted in connection with the eventual filing of the short period tax return and the settlement of the related tax audits of these periods.

 

Net Interest Earned on Net Intercompany Funding to Former Parent

 

Prior to the Separation, Cendant swept cash from the Company’s bank accounts while the Company maintained certain balances due to or from Cendant. Inclusive of unpaid corporate allocations, the Company had net amounts due from Cendant, exclusive of income taxes, of $1,914 million as of March 31, 2006. Prior to the Separation, certain of the advances between the Company and Cendant were interest-bearing. In connection with the interest-bearing balances, the Company recorded net interest income of $10 million during the three months ended March 31, 2006.

 

Related Party Agreements

 

Prior to the Separation, the Company conducted the following business activities, among others, with Cendant’s other business units or newly separated companies, as applicable: (i) provision of access to hotel accommodation and vacation exchange and rental inventory to be distributed through Travelport; (ii) utilization of employee relocation services, including relocation policy management, household goods moving services and departure and destination real estate related services; (iii) utilization of commercial real estate brokerage services, such as transaction management, acquisition and disposition services, broker price opinions, renewal due diligence and portfolio review; (iv) utilization of corporate travel management services of Travelport; and (v) designation of Cendant’s car rental brands, Avis and Budget, as the exclusive primary and secondary suppliers, respectively, of car rental services for the Company’s employees. The majority of the related party agreement transactions were settled in cash. The majority of these commercial relationships have continued since the Separation under agreements formalized in connection with the Separation.

 

 

Acquisition of Realogy by Apollo Management VI, L.P.

 

On April 10, 2007, Realogy was acquired by an affiliate of Apollo Management VI, L.P. and no longer trades as an independent public company. The acquisition does not negate Realogy’s obligation to satisfy 62.5% of the contingent and other corporate liabilities of Cendant or its subsidiaries pursuant to the terms of the separation agreement. As a result of the acquisition, Realogy has greater debt obligations and its ability to satisfy its portion of the liabilities may be adversely impacted. In accordance with the terms of the separation agreement, Realogy posted a letter of credit to cover its share of certain liabilities relating to the Cendant Corporation plan of separation.

 

Dividend Plan

 

On May 1, 2007, the Company’s Board of Directors approved a dividend plan and anticipates an initial quarterly cash dividend of $0.04 per share, or $0.16 annually, beginning in the third quarter of 2007. The actual declaration of dividends and the establishment of record and payment dates are subject to final determination by the Company’s Board of Directors.

 

Incentive Equity Awards Granted by the Company

 

On May 2, 2007, the Company approved the grant of incentive awards of approximately $53 million to key employees and senior officers in the form of RSUs and SSARs. The awards will vest ratably over a period of four years.

 

This report includes “forward-looking” statements, as that term is defined by the Securities and Exchange Commission in its rules, regulations and releases. Forward-looking statements are any statements other than statements of historical fact, including statements regarding our expectations, beliefs, hopes, intentions or strategies regarding the future. In some cases, forward-looking statements can be identified by the use of words such as “may,” “will,” “expects,” “should,” “believes,” “plans,” “anticipates,” “estimates,” “predicts,” “potential,” “continue,” or other words of similar meaning. Forward-looking statements are subject to risks and uncertainties that could cause actual results to differ materially from those discussed in, or implied by, the forward-looking statements. Factors that might cause such a difference include, but are not limited to, general economic conditions, our financial and business prospects, our capital requirements, our financing prospects, our relationships with associates, and those disclosed as risks under “Risk Factors” in Part I, Item 1A, in our Annual Report filed with the SEC on March 7, 2007 on Form 10-K. We caution readers that any such statements are based on currently available operational, financial and competitive information, and they should not place undue reliance on these forward-looking statements, which reflect management’s opinion only as of the date on which they were made. Except as required by law, we disclaim any obligation to review or update these forward-looking statements to reflect events or circumstances as they occur.

 

BUSINESS AND OVERVIEW

 

We are a global provider of hospitality products and services and operate our business in the following three segments:

 

 

Separation from Cendant

 

On July 31, 2006, Cendant Corporation (or “former Parent”) distributed all of the shares of Wyndham common stock to the holders of Cendant common stock issued and outstanding on July 21, 2006, the record date for the distribution. On August 1, 2006, we commenced “regular way” trading on the New York Stock Exchange under the symbol “WYN.”

 

Before our separation from Cendant, we entered into separation, transition services and several other agreements with Cendant, Realogy and Travelport to effect the separation and distribution, govern the relationships among the parties after the separation and allocate among the parties Cendant’s assets, liabilities and obligations attributable to periods prior to the separation. Under the separation agreement, we assumed 37.5% of certain contingent and other corporate liabilities of Cendant or its subsidiaries which were not primarily related to our business or the businesses of Realogy, Travelport or Avis Budget, and Realogy assumed 62.5% of these contingent and other corporate liabilities. These include liabilities relating to Cendant’s terminated or divested businesses, the sale of Travelport on August 22, 2006, taxes of Travelport for taxable periods through the date of the Travelport sale, certain litigation matters, generally any actions relating to the separation plan and payments under certain contracts that were not allocated to any specific party in connection with the separation.

 

Prior to the separation and in the ordinary course of business, we were allocated certain expenses from Cendant for corporate functions including executive management, finance, human resources, information technology, legal and facility related expenses. Cendant allocated corporate expenses to subsidiaries based on a percentage of the subsidiaries’ forecasted revenues. Such expenses amounted to $9 million in the three months ended March 31, 2006.

 

Because we now conduct our business as an independent, publicly traded company, our historical financial information does not reflect what our results of operations, financial position or cash flows would have been had we been an independent, publicly traded company during the periods presented. Therefore, the historical financial information for such periods may not necessarily be indicative of what our results of operations, financial position or cash flows will be in the future and may not be comparable to periods ending after July 31, 2006.

 

RESULTS OF OPERATIONS

 

Discussed below are our key operating statistics, consolidated results of operations and the results of operations for each of our reportable segments. The reportable segments presented below represent our operating segments for which separate financial information is available and which is utilized on a regular basis by our chief operating decision maker to assess performance and to allocate resources. In identifying our reportable segments, we also consider the nature of services provided by our operating segments. Management evaluates the operating results of each of our reportable segments based upon net revenues and EBITDA. Our presentation of EBITDA may not be comparable to similarly-titled measures used by other companies.

 

OPERATING STATISTICS

 

The following table presents our operating statistics for the three months ended March 31, 2007 and 2006. See Results of Operations section for a discussion as to how these operating statistics affected our business for the periods presented.