| SILVERLEAF RESORTS INC ITEM 1A RISK FACTORS If our assumptions and estimates in our business model are wrong, our future results could be negatively impacted |
| The financial covenants in our credit facilities are based upon a business model prepared by our management |
| We used a number of assumptions and estimates in preparing the business model, including: o We estimated that we will sell our existing and planned inventory of Vacation Intervals within 15 years; o We assumed that our level of sales and operating profits and costs can be maintained and will grow in future periods; o We assumed the availability of credit facilities necessary to sustain our operations and anticipated growth; and o We assumed that we can raise the prices on our products and services as market conditions allow |
| These assumptions and estimates are subject to significant business, economic and competitive risks and uncertainties |
| If our assumptions and estimates are wrong, our future financial condition and results of operations may vary significantly from those projected in the business model |
| Neither our past nor present independent auditors have reviewed or expressed an opinion about our business model or our ability to achieve it |
| Changes in the timeshare industry could affect our operations |
| We operate solely within the timeshare industry |
| Our results of operations and financial position could be negatively affected by any of the following events: o An oversupply of timeshare units, o A reduction in demand for timeshare units, o Changes in travel and vacation patterns, o A decrease in popularity of our resorts with our consumers, o Governmental regulations or taxation of the timeshare industry, and o Negative publicity about the timeshare industry |
| We may be impacted by general economic conditions |
| Our customers may be more vulnerable to deteriorating economic conditions than consumers in the luxury or upscale timeshare markets |
| An economic slowdown in the United States could depress consumer spending for Vacation Intervals |
| Additionally, significant increases in the cost of transportation may limit the number of potential customers who travel to our resorts for a sales presentation |
| During an economic slowdown we could experience increased delinquencies in the payment of Vacation Interval promissory notes and monthly Club dues |
| 22 _________________________________________________________________ We are at risk for defaults by our customers |
| We offer financing to the buyers of Vacation Intervals at our resorts |
| Notes receivable from timeshare buyers constitute one of our principal assets |
| These buyers make down payments of at least 10prca of the purchase price and deliver promissory notes to us for the balances |
| The promissory notes generally bear interest at a fixed rate, are payable over a seven-year to ten-year period, and are secured by a first mortgage on the Vacation Interval |
| We bear the risk of defaults on these promissory notes |
| Although we prescreen prospects by credit scoring them in the early stages of the marketing and sales process, we generally do not perform a detailed credit history review of our customers, as is the case with most other timeshare developers |
| We recorded 16dtta2prca of the purchase price of Vacation Intervals as a provision for uncollectible notes for the year ended December 31, 2005 |
| Our sales were decreased by dlra2dtta6 million for customer returns in 2005 |
| When a buyer of a Vacation Interval defaults, we foreclose on the Vacation Interval and attempt to resell it |
| The associated marketing, selling, and administrative costs from the original sale are not recovered; and we will incur such costs again when we resell the Vacation Interval |
| Although we may have recourse against a Vacation Interval buyer for the unpaid price, certain states have laws that limit our ability to recover personal judgments against customers who have defaulted on their loans |
| For example, if we were to file a lawsuit to collect the balance owed to us by a customer in Texas (where approximately 52prca of Vacation Interval sales took place in 2005), the customer could file a court proceeding to determine the fair market value of the property foreclosed upon |
| In such event, we may not recover a personal judgment against the customer for the full amount of the deficiency |
| We would only recover an amount that the indebtedness owed to us exceeds the fair market value of the property |
| Accordingly, we have generally not pursued this remedy |
| At December 31, 2005, we had Vacation Interval customer notes receivable in the approximate principal amount of dlra230dtta5 million, and had an allowance for uncollectible notes of approximately dlra52dtta5 million |
| We must borrow funds to finance our operations |
| Our business is dependent on our ability to finance customer notes receivable through our banks |
| At December 31, 2005, we owed approximately dlra174dtta9 million of principal to our senior lenders |
| Borrowing Base |
| We have receivable-based loan agreements with senior lenders to borrow up to approximately dlra243dtta1 million |
| We pledged our customer promissory notes and mortgages as security under these agreements |
| Our senior lenders typically lend us 75prca of the principal amount of our customers &apos notes, and payments from Silverleaf Owners on such notes are credited directly to the senior lender and applied against our loan balance |
| At December 31, 2005, we had a portfolio of approximately 30cmam293 Vacation Interval customer notes receivable in the approximate principal amount of dlra230dtta5 million |
| Approximately dlra337cmam000 in principal amount of our customers &apos notes were 61 days or more past due and, therefore, ineligible as collateral |
| The amount of customer notes receivable eligible as collateral in the future may not be sufficient to support the borrowings we may require for our liquidity and continued growth |
| Negative Cash Flow |
| We ordinarily receive only 10prca to 15prca of the purchase price as a down payment on the sale of a Vacation Interval, but we must pay in full the costs of development, marketing, and sale of the interval |
| Maximum borrowings available under our credit facilities may not be sufficient to cover these costs, thereby straining our capital resources, liquidity, and capacity to grow |
| Interest Rate Mismatch |
| At December 31, 2005, our portfolio of customer loans had a weighted average fixed interest rate of 15dtta3prca |
| At such date, our borrowings (which bear interest predominantly at variable rates) against the portfolio had a weighted average cost of funds of 8dtta1prca |
| We have historically derived net interest income from our financing activities because the interest rates we charge our customers who finance the purchase of their Vacation Intervals exceed the interest rates we pay to our senior lenders |
| Because our existing indebtedness currently bears interest at variable rates and our customer notes receivable bear interest at fixed rates, increases in interest rates charged by our senior lenders would erode the spread in interest rates that we have historically enjoyed and could cause the interest expense on our borrowings to exceed our interest income on our portfolio of customer notes receivable |
| Therefore, any increase in interest rates, particularly if sustained, could have a material adverse effect on our results of operations, liquidity, and financial position |
| To the extent interest rates decrease on loans available to our customers, we face an increased risk that customers will pre-pay their loans, which would reduce our income from financing activities |
| To partially offset an increase in interest rates, we have engaged in one interest rate hedging transaction related to our conduit loan through SF-II, with a balance of dlra58dtta1 million on December 31, 2005 |
| In addition, the Series 2005-A Notes related to our off-balance sheet special purpose finance subsidiary, SF-III, had a balance of dlra89dtta1 million at December 31, 2005 and bear interest at fixed rates ranging from 4dtta857prca to 6dtta756prca |
| 23 _________________________________________________________________ Maturity Mismatch |
| We typically provide financing to our customers over a seven-year to ten-year period |
| Our customer notes had an average maturity of 5dtta5 years at December 31, 2005 |
| Our senior credit facilities have scheduled maturity dates between March 2007 and March 2014 |
| Additionally, should our revolving credit facilities be declared in default, the amount outstanding could be declared to be immediately due and payable |
| Accordingly, there could be a mismatch between our anticipated cash receipts and cash disbursements in 2006 and subsequent periods |
| Although we have historically been able to secure financing sufficient to fund our operations, we do not presently have agreements with our senior lenders to extend the term of our existing funding commitments beyond their scheduled maturity dates or to replace such commitments upon their expiration |
| If we are unable to refinance our existing loans, we could be required to sell our portfolio of customer notes receivable, probably at a substantial discount, or to seek other alternatives to enable us to continue in business |
| Limitations on the availability of financing would inhibit sales of Vacation Intervals due to (i) the lack of funds to finance the initial negative cash flow that results from sales that we finance and (ii) reduced demand if we are unable to provide financing to purchasers of Vacation Intervals |
| We may not be able to obtain additional financing |
| Several unpredictable factors may cause our adjusted earnings before interest, income taxes, depreciation and amortization to be insufficient to meet debt service requirements or satisfy financial covenants |
| We incurred net losses in one of the past three years and in two of the past five years |
| Should we record net losses in future periods, our cash flow and our ability to obtain additional financing could be materially and adversely impacted |
| Many of the factors that will determine whether or not we generate sufficient earnings before interest, income taxes, depreciation and amortization to meet current or future debt service requirements and satisfy financial covenants are inherently difficult to predict |
| These factors include: o the number of sales of Vacation Intervals; o the average purchase price per interval; o the number of customer defaults; o our cost of borrowing; o our sales and marketing costs and other operating expenses; and o the continued sale of notes receivable |
| Our current and planned expenses and debt repayment levels are and will be to a large extent fixed in the short term, and are based in part on past expectations as to future revenues and cash flows |
| We may be unable to reduce spending in a timely manner to compensate for any past or future revenue or cash flow shortfall |
| It is possible that our revenue, cash flow or operating results may not meet the expectations of our business model, and may even result in our being unable to meet the debt repayment schedules or financial covenants contained in the various agreements which evidence our indebtedness |
| Our leverage is significant and may impair our ability to obtain additional financing, reduce the amount of cash available for operations, and make us more vulnerable to financial downturns |
| Our agreements with our various lenders may: o require a substantial portion of our cash flow to be used to pay interest expense and principal; o impair our ability to obtain on acceptable terms, if at all, additional financing that might be necessary for working capital, capital expenditures or other purposes; and o limit our ability to further refinance or amend the terms of our existing debt obligations, if necessary or advisable |
| We may not be able to manage our financial leverage as we intend, and we may not be able to achieve an appropriate balance between the rate of growth which we consider acceptable and future reductions in financial leverage |
| If we are not able to achieve growth in adjusted earnings before interest, income taxes, depreciation and amortization, we may not be able to refinance our existing debt obligations and we may be precluded from incurring additional indebtedness due to cash flow coverage requirements under existing or future debt instruments |
| 24 _________________________________________________________________ Our business is highly regulated |
| We are subject to substantial governmental regulation in the conduct of our business |