Hilton Grand Vacations Inc (HGV) 2017 Q2 法說會逐字稿

Good morning, and welcome to the Hilton Grand Vacations' Second Quarter 2017 Earnings Conference Call. Today's call is being recorded and will be available for replay beginning at 2:30 p.m. Eastern Daylight Time today. The dial-in number is (888) 203-1112 or 1 (719) 457-0820 and enter pin number 5231524. (Operator Instructions)

I would now like to turn the conference over to Robert LaFleur, Vice President of Investor Relations. Please go ahead, sir.

Thank you, Mariah. Welcome to the Hilton Grand Vacations' Second Quarter 2017 Earnings Call. Before we get started, we would like to remind you that our discussion this morning will include forward-looking statements. Actual results could differ materially from those indicated by these forward-looking statements, and the forward-looking statements made today are effective only as of today. We undertake no obligation to publicly update or revise these statements. For a discussion of some of the factors that could cause actual results to differ, please see the risk factors section of our previously filed 10-K or our 10-Q which we expect to file later today.

In addition, we will refer to certain non-GAAP financial measures in our call this morning. You can find definitions and components of such non-GAAP numbers as well as reconciliations of non-GAAP and GAAP financial measures discussed today in our earnings press release and on our website, investors.hgv.com. This morning, Mark Wang, our President and Chief Executive Officer, will provide highlights for the second quarter 2017 in addition to an overview of current operations and company strategy. Jim Mikolaichik, our Executive Vice President and Chief Financial Officer, will then provide more details on our second quarter and expectations for the balance of 2017. Following their remarks, we will open the line for questions.

With that, let me turn the call over to Mark.

Well, thank you, Bob, and good morning, everyone. This quarter's results demonstrate the strength and versatility of HGV's direct-to-consumer business model and the power of our highly-aligned relationship with Hilton. Operationally, HGV's business is performing well across the board. Our real estate business had a great second quarter as our marketing teams delivered high single-digit tour growth and our sales teams delivered double-digit contract sales growth.

Both the Mainland and Asia Pacific region performed well with Las Vegas, Myrtle Beach, Hawaii and Japan, all seeing double-digit sales growth. Overall, the second quarter contract sales were up 11%, driven by 9.5% higher tours and 1.6% increase in VPG. Considering the tough second quarter '16 comps last year, we are very pleased with these results.

As you can see, contract sales growth this quarter was more reliant on tour flow than VPG. Last quarter was more VPG driven, which highlights the dynamic nature of our business and the multiple levers we have to drive growth. While the comps remain tough for the balance of the year, our strong first half results and building sales momentum gives us confidence to raise our full contract sales guidance to 6.5% to 8.5% from 5% to 7%. This quarter's real estate results and 2017 outlook demonstrate the distinct competitive edge we have enjoyed from combining our powerful sales and marketing platform with Hilton brand and its marketing reach. And we only see this advantage growing over time.

Last week, Hilton recorded 5.5 million new members have joined Hilton HHonors this year, up 20% over last year. Today, Hilton HHonors has 64 million members and plans to have 100 million by 2019. We are Hilton's second largest fee payer and our interests are highly aligned through our variable license agreement. As Hilton grows, we grow and we couldn't be more excited to have them as our partner.

Second quarter trends were also favorable in our resort and club business with net owner growth, or NOG, coming in at 7.2%. As many of you heard me say multiple times, NOG is a foundation of future growth in our business. It drives recurring club and management fees, which increased 3% in the quarter, but more importantly it embeds significant value into our business from future real estate purchases. Over 20 years of internal data shows us that most secondary purchases happen within 7 to 8 years of the owner's initial purchase. Therefore as long as we sustain healthy NOG each year, we should always have a large pool of owners that are still within that 7- to 8-year window.

The ability to leverage our relationship with Hilton in our powerful marketing and sales [vision] drives new owner growth. But the key to retaining owners, the net side of net owner growth, is building owner loyalty through engagement. This takes time and effort and we're always looking for better ways to engage our owners. It all begins with communication and our owners today want to move seamlessly between the world of digital and personal contact. For example, while over 90% of our owners have created online accounts or signed up for our mobile app, over 80% of our owners have contacted an HGV club counselor for a personalized assistance with their membership in the past year. While half of all club transactions now happen online, owners still tell us that the counselor program is the most important resource for helping them understand how to get the most out of their ownership.

It really is all about communicating with our owners on their terms and our members are very engaged. Today, every club member that uses our mobile app gets a how is your stay request notification when they're on property and a follow-up shortly after they arrive home. They are asked to rate us with a green thumbs up or a red thumbs down button. We're very proud to report that we're achieving a thumbs up in 95% of mid-stay reviews and 94% of postdeparture reviews.

We also know that vacation options and destination choices are critical satisfiers for owners. As we start to deploy our own capital, our goal is to announce 2 to 3 new projects a year that will expand our footprint and allow us to accelerate growth. Depending on the scale and deal structure, it can take between 12 and 36 months before a new project produces reportable results. By layering in 2 to 3 project announcements a year, in a few years we’ll have multiple projects coming online to support future growth.

Looking at some of the areas of future growth, last quarter, we spoke about introducing product directly into the Japanese market to leverage our 56,000 Japanese owners. We're making progress there, working with local development partners and we still expect to announce a new project details later this year. Our brand resonates with the Japanese consumers, and we are expanding our sales infrastructure with the opening this week of our ninth Japanese sales center in Sapporo. Outside of Japan, we continue to look at both urban and resort projects in highly demanded destinations in the U.S. as well as Mexico and the Caribbean.

Executing on our strategic objective to pursue opportunistic ventures, we invested $40 million in a joint venture with Blackstone to purchase the Elara property in Las Vegas, a property we've been operating under a fee-for-service contract since 2011. Getting this deal across the finish line was an important milestone for us. And I'd like to publicly thank the team members in our development, asset management, legal, resort operations and other groups for their hard work on this very complex transaction. Jim will provide some more details on this in a minute.

While Elara didn't give us new distribution, the deal terms were very attractive and allows us to participate in the project's development and consumer financing economics. Beyond Elara, we're still looking at bulk purchases of remaining inventory at some of our other seasoned fee-for-service projects. For a final project update, our third property in Myrtle Beach is now under construction. This is our fourth fee-for-service deal in the Carolinas with Goldman Sachs and Strand Group. The 330 unit high rise is planned to open in the spring of 2019. So we'll be able to start selling the sequel project early next year.

When we entered the Myrtle Beach market in 2012, it was our first entry into a drive to market with a mostly regional draw. It introduced HGV to a new base of customers and in a short period of time, this market became a meaningful growth driver.

In closing, we had a very strong first half of the year. The operational momentum we built gives us confidence to increase our 2017 guidance in contract sales and other areas, which Jim will take you through shortly. Behind the scenes, we're managing through the expected challenges of standing up a public company as we continue to bring in-house many of the functions Hilton previously provided. This includes the full build out of our own technology infrastructure in functional areas like finance and human resources. While most of the heavy lifting should be done by year-end, some projects may spill into next year.

With that said, we could not be more excited about the future. Our owners are highly satisfied and engaged and our owner base continues to grow, which embed significant future value in our business. With the Elara deal, we’ve begun executing on our strategy to invest in growth and our development options are bigger today than at any time in our company's history.

We've got a compelling organic growth story and we're working to deploy our capital on new markets and customer channels that will allow us to generate strong earnings growth and returns. I couldn't be more proud of the dedication, hard work and execution of our team this year. I continue to believe that HGV is uniquely positioned in the timeshare industry to create meaningful value for our owners, our team members and our shareholders.

With that I'd like to turn the call over to Jim for some more details on the quarter and the balance of the year. Jim?

Thank you, Mark, and good morning everyone. As Mark indicated, we had another quarter of high-quality performance. While 2016 set a high standard for growth comps, we remain focused on the balance of the year, and in fact, are increasing the guidance for many of our key measures. I'll review the updates to our guidance after discussing our operating results.

Looking at our 2017 second quarter results, our key financial and performance metrics demonstrated strength across business lines. With the real estate line leading the way, second quarter revenues were $439 million, an increase of $48 million or approximately 12% in comparison to the second quarter of 2016. Real estate revenues increased by $30 million led by a 25% increase in sales of VOI net, and a $10 million onetime benefit related to a change in accounting estimate related to marketing packages. Net income in the quarter was $51 million. This represented a $4 million increase over second quarter of 2016 as some of the operating gains were offset by the year-over-year increases in general and administrative expenses. We also benefited from a lower income tax provision, which resulted from the lower expected interest due on our tax deferred revenue that we discussed last quarter. As a result, our effective tax rate decreased to 39% in the quarter from 41% in the second quarter last year. And at this point, our full year tax rate is likely to normalize at approximately 39% for 2017, which is lower than expected and reflected in our updated guidance.

Turning to our operating segments. Total segment adjusted EBITDA increased by 12% in the second quarter to $151 million. Second quarter results in the real estate business line experienced an increase in contract sales of 11% with owned sales up 31% and fee-for-service sales down 3%. We saw strong results from newly developed projects such as Washington D.C., which began sales in the fourth quarter of last year and total real estate revenues increased by 14% as commissions and other fees were relatively flat in the quarter.

Real estate margin was up $18 million compared to the second quarter of 2016, while the real estate margin percentage rose 380 basis points to 32.8%. Product cost coupled with sales and marketing cost net were both higher in the quarter with higher owned sales driving product cost and higher contract sales driving selling cost. While sales and marketing costs increased on an absolute basis due to sales growth, they decreased as a percentage of contract sales by 240 basis points. While we continue to witness higher costs from ramping our new market distribution channels and building our tour pipeline, this was more than offset by the onetime benefit from the change in accounting estimate from marketing packages.

In our financing business, revenues increased 6% on higher receivable balances and financing margin decreased 4% while financing margin percentage declined to 69.4% as higher nonrecourse debt balance is related to the spin led to increased interest expense.

At the end of the quarter, our consumer finance portfolio stood at approximately $1.2 billion and carried an average interest rate of 12.1%. Delinquencies remain low on an absolute basis at 2.1%, 10 basis points lower than they were at the end of the first quarter. And our default rate was essentially unchanged from year-end at just under 3.7%. And our long-term allowance for loan loss stood at approximately 11.2%, a 30 basis point increase from last quarter. Combining these 2 business lines into our real estate and financing segment, second quarter segment revenues increased 17% and segment adjusted EBITDA increased 17.9%. Real estate sales and financing segment adjusted EBITDA margins increased 30 basis points to 30.7%.

Turning to our resort and club management business line. Second quarter revenue increased 3%. The increase was a result of net owner growth, price increases and incremental management fees from recently opened properties. However, the increase was partially offset by onetime fees earned last year on a prepaid contract, and resort and club margin decreased 4% on higher costs related to a larger member base and newly opened properties, coupled with the onetime fee earned last year.

In our rental and ancillary business line, second quarter revenues decreased $2 million as rental revenues were down 5%. Second quarter 2016 results include a onetime $2 million payment on an insurance claim that affected comparability. Ancillary revenues were flat and rental and ancillary expense increased 3% due to higher subsidy expenses from newly opened properties, and higher Hilton HHonors expenses related to the increase in club members. Rental and ancillary margin decreased 16% in the quarter, and margin percentage contracted 480 basis points. Combining these 2 business lines into our resort operations and club management segment, second quarter segment revenues increased 3% and segment adjusted EBITDA increased 2%. Resort operations and club segment adjusted EBITDA margin percentage decreased 80 basis points to 56.5%. Bridging the gap between segment adjusted EBITDA and adjusted EBITDA, second quarter license fees increased 15% and general and administrative cost increased $10 million, reflecting the additional public company expenses. And this resulted in second quarter adjusted EBITDA of $106 million, a 3% increase year-over-year.

Turning to inventory management. We remain capital efficient with 3/4 of a contract sales in the quarter, coming from either fee-for-service or just-in-time inventory sources. And our fee-for-service sales mix was 51% for the second quarter. Year-to-date, we are within our 2017 guidance range of 52% to 57% and still expect to finish the year in that range.

And at the end of the quarter, our pipeline of inventory represented 5.1 years of sales at our current pace, including 2.6 years of owned inventory and 2.5 years of fee-for-service inventory. Just under 90% of our pipeline is capital efficient, reflecting either fee-for-service or just-in-time sources, and we continue to focus on new development opportunities and believe we have sufficient inventory to support our sales strategy.

Our capital structure remains flexible and supportive of new development projects and growth. We ended the quarter with $486 million of corporate debt and $645 million of nonrecourse debt. Our corporate leverage is approximately 1.2x on a trailing 12-month basis or 0.8x using net debt. From a capacity standpoint, our $200 million bank revolver is fully available and we have over $320 million of capacity on our timeshare facility. We also have approximately $253 million in cash comprised of $191 million in unrestricted cash and $62 million in restricted cash.

In the second quarter, we generated $31 million of free cash flow compared to $46 million in the second quarter last year. Year-to-date, we've generated $156 million of free cash flow compared to $74 million for the first 6 months of 2016. And as we discussed last quarter, some of year-to-date strength in free cash flow is spend related payment timing and timing of inventory spend at our Ocean Tower property in Waikoloa where we have shifted construction by 3 months.

Given these items, we believe free cash flow for the year is likely to come in above the high end of our original full year 2017 guidance range of $140 million to $160 million. As such, we are updating our full year free cash flow guidance to $180 million to $200 million. That being the case, we would like to point out that the timing issues this year are onetime in nature, and as a result, our guidance longer term remains at a normalized run rate of $140 million to $160 million. It is also worth noting that we consider the $40 million invested in Elara joint venture could be outside of our definition of free cash flow.

I'll wrap up by walking you through our updated guidance and some data points for modeling the Elara joint venture. We now expect full year contract sales growth of 6.5% to 8.5%, delivering net income of $180 million to $198 million. We are increasing our adjusted EBITDA guidance range to $380 million to $410 million. This increase reflects our expected adjusted EBITDA contribution from the Elara joint venture for the last 2 quarters of the year and continued strength in contract sales.

Given the strong operating trends, our segment EBITDA expectations have continued to increase. However, incremental public company related G&A costs are affecting adjusted EBITDA growth in 2017, which should level off as we close out the year. We indicated that the income statement G&A would increase 18% to 20% this year and at that time we did not indicate the breakdown between recurring and onetime G&A expectations.

With half the year behind us, we are maintaining the overall guidance with an 18% to 20% increase in income statement G&A. We now expect 80% will be recorded above the adjusted EBITDA line with the balance split evenly between stock-based compensation and nonrecurring items. The EBITDA impact is slightly higher than we originally anticipated which does impact the flow-through of segment EBITDA to adjusted EBITDA.

Finally, for modeling the Elara deal, we paid approximately $40 million for our 25% interest in the joint venture. It will be treated as an investment in unconsolidated affiliate and our share of the earnings will be shown on our income statement as equity in earnings from unconsolidated affiliate. The JV carried approximately $211 million of debt when the deal closed and the joint venture is expected to contribute approximately $5 million to our adjusted EBITDA over the next 2 quarters.

This completes the prepared remarks and we'll now turn the call back to the operator and look forward to your questions.

(Operator Instructions) We'll take our first question from Harry Curtis with Nomura Instinet.

Quick follow-up question on Elara. If you could discuss the environment for the possibility of additional Elara like transactions and are you likely to continue taking minority positions or is there appetite for majority positions?

Harry, it’s Mark. Yes, the Elara deal -- just a little background on that. We've been involved with Elara since 2011. We looked at it as a very low risk deal for us. And in our opinion, it's the finest timeshare in Vegas, incredible location on the strip, 1,200 units. It's really -- it's the single biggest timeshare ever built in one building. So when the process was -- when Centerbridge went through the process, we were a logical buyer. I think we ended up with a 25% stake which we thought made the most sense and it aligned our interest on the project. I think as we -- and it's also driving -- generating very strong returns on our investment. I think as we look at future deals, we have a number of other deals that are maturing and so I think there are some other opportunities, but nothing at this point that we can talk about in detail.

And I think, Harry, we're open to minority or majority. I think minority made sense to us on this deal because it was less strategic and more economic for us. It wasn't a new distribution area. And as a result, we thought putting some money to work to improve the economics made a lot of sense for good returns, but we didn't put too many of our eggs in one basket because we do have quite a rich development pipeline beyond that.

Yes, and I’d also add, I think it really shows our ability to bring in new deals with varying structures which gives us flexibility on how we can best allocate our capital going forward.

Okay. And then my follow-up question, Jim, you mentioned -- you threw out in rapid succession some of your expectations for G&A and I'm just wondering if you can specifically address the extent to which your expenses this year are impacted by onetime items, you mentioned maybe 80% to 90% number, but I'm not sure if that was apples to apples.

So I think we're looking at about $92 million of P&L expense in 2016. From a G&A standpoint, we guided 18% to 20%, which is approximately $109 million to $110 million, I think. 80% of that we're expecting to be above the line recurring and the other 20% split evenly between stock-based comp and onetime. And of the onetime expenses, we do think some of those don't really fit the name because they're going to creep into next year, largely I think it's system driven on financial and benefit systems. So we are expecting a couple million dollars to creep out of it roughly $10 million into next year.

And as you look into next year, you had mentioned some new -- developing new [tour trend] channels, new marketing and distribution. Is there likely incremental expense next year that we should factor in?

Nothing. We are looking at a couple of new distribution opportunities, nothing that we’ve discussed or have concrete plans on at this point. So I think what we're looking at right now is more business as usual and really incremental. So I'd expect margins to remain relatively consistent. We do think that we've got really healthy margins to begin with so we don't see a ton of upside. If we did have something that was a brand new opportunity from a distribution or tour generation, we probably come back out and give you some additional guidance on that. But right now, it's incremental and more business as usual.

(Operator Instructions) We'll take our next question from Brandt Montour, JPMorgan.

You revised contract sales guidance, it implies modest deceleration in the second half obviously due to tougher comps that you had coming up. Is it fair to say that the main driver in the second half of that contract sales growth will be tour growth? And can you may be shed some light on maybe forward tours booked and how comfortable you are with that and maybe the ongoing ramp of your 2 new sales centers as well?

So Brandt, the -- I think the back half of the year, we continue to see some of the trends we saw in quarter 2 where we're getting a higher percentage of new buyer tours. It's outpacing our owner tour which is great for embedding future value in our business and it did achieve our goal of strong NOG. But with that, it's really a mix shift. And so I think what you're going to see is you're going to see a slight reduction in year-over-year VPG on the back half. And again and as we talked about, the last 2 quarters in ‘16 represented very high comparables. Also, we're lapping the start of sales in D.C. and Hilton Head, so -- which started contributing back in Q3 of last year. So I’d say that the back half of the year is, you're going to see a bit of a slowdown in VPG, but our tour flow visibility is looking very good. In fact, we've got a good ramp up. We -- our pipeline grew considerably in Q2 and that's some of the pressure we had on our costs as we started investing in future customers.

Great, that helpful. And just as a follow-up, regarding Japan and kind of the early strategy there, I just wanted to ask you about potentially the ramp there versus other markets and basically given the fact that you have that solid base of owners already living there, would you consider that relatively low risk market for you versus other new markets that you are thinking about?

We do because of this base of owners. I don't think anybody out there in our space has been able to develop a market to scale like this in any other country than the U.S. And we've got 56,000 members there today. Our net owner growth continues to be slightly better in that market than they are -- than what we're seeing in the U.S. And so we've got incredible team, incredible distribution network, as I said in my prepared remarks, we just opened our ninth sales center there in Sapporo. And importantly, I think from a development risk standpoint, we're not looking to be the lead developer on the project. More than likely, these will be just in time deals. And we will have -- we will be working with very seasoned and experienced developers there that know how to get development done there in an efficient manner and in a timely manner.

We'll take our next question from Bradford Dalinka with SunTrust.

Just a quick housekeeping question on Elara first, if I can. On the capital structure, as I recall the securitization last year, is that $211 million of debt inclusive of that? Is there consumer paper sitting in there? I saw something about possibility for a sequel project in the agreement. Should we just look at kind of your share of that $211 million in the EBITDA or is there more to do with that?

Yes, there’s -- I think you should -- we're treating it purely as an investment. So we're getting a stream of earnings from it. The debt and the securitizations, everything lives within that entity and ultimately it lives in an entity below the JV that was purchased by the entity that we bought into. So I think you really need to look at it as the earnings that come off of it, and we look at it more distinctly as the cash flow that are coming off of the -- the cash flow stream that's coming off of the deal which we think returns after-tax something in the high teens to low 20s, if it meets our modeling expectations. The $211 million is the piece of corporate debt and beyond that there are some securitizations but that all lives within the enterprise, and I think it's probably easiest just to think about it as an earnings stream.

Yes. And then Brad, on the question on the additional land, there is potential for an opportunity to add some more units there, but we valued and Blackstone value that opportunity as 0. So we didn't price that in, in our purchase price. We think it's more unlikely that any future development will happen at that site other than the conversion of the top 4 floors where we have the opportunity to convert what was designated for penthouse units into additional HGV timeshare units.

Understood, and one more if I could sneak it in there. When you guys took up the contract sales guy, was there any geography or channel that outperformed the expectations? Or was it just general to everything clicking on all cylinders?

Yes. I’d have to say, we -- pretty much across the board, we had great performance. But if you look at just contract sales, Vegas and the Carolinas, were both up 12% and 13% respectively. We had strong performance in Japan, up 12%, and in Waikoloa -- our teams in Waikoloa continue to outperform, we’re up 19%. So it's pretty much across the board. And then of course we benefited from our new distribution in D.C. and Hilton Head which really contributed about close to 40% of our growth in tour flow.

(Operator Instructions) We'll take our next question from Chris Agnew with MKM Partners.

With respect to the free cash flow guidance that you increased and talked about timing issues, so just to be clear, as we're thinking about 2018, I'm not asking to give guidance, but just to make sure that if $140 million, $160 million is kind of your long-term goal. We would be thinking more along the lines of $100 million to $120 million in ‘18 because that timing issue comes out next year.

It depends. It probably depends on where we are with working through the construction in some of our development projects. But I mean I don't know if it will be quite that low. I think it might be an even share between the next 2 and I think it also had something to do with the shift of some of the payment timing. We expected to pay license fees at the beginning of the year, which we actually ended up sweeping late last year in '16 so that shifted and there was a tax payment that went in our favor as well. So I do think it will be down a little bit to kind of level that out to $140 million to $160 million, but I don't think it will be as low as what you're thinking.

Okay. And then as you think about urban versus resort, the new projects, are either one of those more or less suited to fee-for-service or sort of just in time. And does that influence your thinking about the timing on executing on either one of those or do these deals fall when they fall?

Interesting question. I think for us, we're fairly nimble in how we look at this and it's a dynamic marketplace. And so we're going to be opportunistic on the model. I think part of it really has to do with the potential partner and how they’re looking to structure the deal. I would say we're heavily focused on just-in-time deals right now, as we've got a good pipeline of fee deals and we just -- as I announced earlier, we just added a new deal in Myrtle Beach. So I would say though, anything that's coming out of the ground that's vertical, we tend to be more focused on doing those fee deals because there’s a tremendous amount of capital that has to be put in the ground to go vertical. Anything that's horizontal, where units can be built in phases, we prefer to do it just in time where we can take those on ourselves.

Ladies and gentlemen, at this time, we will conclude the question-and-answer session. I would now like to turn the call back to Mr. Mark Wang for any additional comments and closing remarks.

All right. Well, I want to thank everyone who joined us on the call today. Some great questions. We covered a lot and look forward to talking you after Q3. Thank you.

And this concludes today's call. Thank you for your participation. You may now disconnect.