Hilton Grand Vacations Inc. Q3 FY2020 Earnings Call

Good morning, and welcome to Hilton Grand Vacations Third Quarter 2020 Earnings Conference Call. A telephone replay will be available for seven days following the call. The dial-in number is (844) 512-2921 and enter pin number 13697043. At this time, all participants have been placed in a listen-only mode. The floor will be open for your questions following the presentation. I would now like to turn the call over to Mark Melnyk, Vice President of Investor Relations. Please go ahead, sir.

Thank you, operator, and welcome to the Hilton Grand Vacations third quarter 2020 earnings call. Before we get started, please note that we have prepared slides that are available to download from a link on our webcast and also on the main page of our website at investors.hgv.com. We may refer to these slides during the course of our call for a question-and-answer session. As a reminder, our discussions this morning will include forward-looking statements. Actual results could differ materially from those indicated by these forward-looking statements, and these statements 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 10-K as well as similar sections in our 10-Q, which we expect to file after the conclusion of this call and in any other applicable SEC filings. We'll also be referring to certain non-GAAP financial measures. 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 at investors.hgv.com. As a reminder, our reported results for both periods in 2020 and 2019 reflect accounting rules under ASC 606, which we adopted in 2018. Under ASC 606, we're required to defer certain revenues and expenses related to sales made in the period when a project is under construction and then hold off on recognizing these revenues and expenses until the period when construction is completed. To help you make more meaningful period-to-period comparisons, you can find details of our current and historical deferrals and recognitions in Table T-1 of our earnings release. For ease of comparability and to simplify our discussion today, our comments on adjusted EBITDA and our real estate results will refer to results excluding the net impact of construction-related deferrals and recognitions for all reporting periods. Finally, unless otherwise noted, results discussed today refer to third quarter 2020 and all comparisons are accordingly against the third quarter of 2019. In a moment, Mark Wang, our President and Chief Executive Officer, will provide highlights from the quarter in addition to an update of our current operations and company strategy. After Mark's comments, our Chief Financial Officer, Dan Mathewes, will go through the financial details for the quarter. Mark and Dan will then make themselves available for your questions. With that, let me turn the call over to our President and CEO, Mark Wang.

Morning, everyone. The results we released today improved substantially as we returned to a full quarter of operations at the majority of our resorts. As we sit here today, we're optimistic about the future while being realistic about the present. Our optimism stems from the fact that we continue to see improvements in demand for our owners' reservations and prepaid vacation packages, which is an indication of pent-up desire to travel. Additionally, in markets that are unconstrained, this consumer demand is driving a strong resurgence in occupancy and contract sales. I'm also encouraged that Hawaii, a key market for us, has just restarted to reopen and we continue to see resilience from our owners who remain committed to HGV and are predisposed to travel. However, this must be balanced within near-term realities. The path of improvement will be pinned on local markets where we operate, and many of our markets today remain closed or constrained. For example, Las Vegas and Orlando, our largest markets that represent nearly 40% of our contract sales last year, still have capacity restrictions at their important tourist attractions coupled with reduced air travel. And compared to our owners, new buyers will likely take longer to recover as consumers continue to evaluate their level of comfort with travel. Most importantly, though, we've adjusted as a company and have the financial flexibility to manage through the near-term environment and ultimately capitalize on the long-term opportunities that will return over time. Now let me take a few minutes to talk to you about what we're seeing in our different markets and consumer segments. Since we restarted our operations in late May, we've seen monthly sequential improvements in our key operating metrics. In the markets where we're open, our contract sales have recovered to nearly half of the levels that we produced at these properties last year. VPGs in open markets improved substantially, up over 80% versus prior year to about $4,200. And our consolidated six months forward bookings are tracking at over 60% of prior year levels. While this data is somewhat volatile as our booking and cancellation windows remain shorter than normal, it indicates to us that there's a desire to travel. Cancellation rates, which peaked in the mid-30% range this summer, have now fallen to under 10%. Diving deeper into the trends that our open properties show that these improvements have varied from market to market. Our regional resorts, particularly outdoor-oriented locations like South Carolina, California, and Utah have seen a rapid recovery. South Carolina, for example, is trending at 95% of the contract sales pace they had in the prior year, owing to strong close rate gains and occupancy rates in the 90%. As a whole, our regional markets have seen similar improvements, surpassing last year's contract sales levels in the month of September with strong occupancy rates. On the other hand, our largest resorts in destination markets associated with local attractions that have capacity restrictions, such as Orlando and Las Vegas, have seen more measured progress. Occupancy levels have improved to roughly 50% in Orlando versus 30% to 40% at reopening. Las Vegas has moved to the range of 40% from 30%. But while they've improved at a slower pace, the appeal of these markets is time-tested and we're confident that they will ultimately come back as the local attractions return and air travel normalizes. One market we're excited to bring back is Hawaii, and we think we'll see great demand there. It's an important market for us. In 2019, it represented 22% of our total contract sales. We've got nine high-quality resorts in prime locations on Oahu and the Big Island. And our 10th resort in Maui is currently under construction and in presales. On October 15, the state of Hawaii officially moved forward with its reopening plan. It was met with a release of pent-up demand from over 10,000 travelers returning on the first day. We're about a third of the normal daily pace in inbound traffic. We also continue to see notable enthusiasm for Hawaii product from our members. In fact, despite having no operating sales centers, the Hawaii inventory made up 34% of our inventory mix this quarter versus 37% last year. A big driver of that stability was our Japanese business, which again proved to be a key advantage to us this quarter. Our network of regional off-site sales centers in Japan remained operational through the pandemic and has recovered to over 60% of last year's contract sales levels, the majority of which was Hawaii product. We'll be reopening our resorts and sales centers as we progress through the quarter. As a result, they're unlikely to contribute to our consolidated results this year. However, we hope to be back to full operating capacity in Hawaii in the first quarter and expect our properties to ramp through the first half of next year and be meaningful contributors again in 2021. Finally, our urban sales centers remain closed in New York, Chicago, and Washington, D.C. These markets accounted for just over 11% of our contract sales last year, and we expect they will be the last to recover. Turning to our customer segments, we had another quarter of strong execution. Our VPGs benefited from two factors: buyer-owner mix and improvements in both our owner and new buyer close rates. We expect the segment close rates will trend towards historical levels and drive a moderation in our VPG growth. But we'll continue to see a benefit from a higher mix of owner sales in the quarters ahead. Owner sales were 67% this quarter versus 50% historically, and that outperformance will likely continue as new buyer traffic takes longer to recover. Our financing in Club and Resort segments continued to provide an important source of stability to the company by generating solid results in cash flow. Although we did see a slight decline in our Club and Resort business due to lower activation fees and member usage fees, importantly, NOG was 1.9% as we continue to see growth in new buyers that will add to the embedded value of our business for years to come. As we mentioned before, we revisited our strategic priorities at the onset of the pandemic, and we've kept making progress here. We now have a full quarter with the implementation of the HGV Enhanced Care initiative and have received great feedback from our guests on the program. Importantly, we haven't noticed any adverse effect from the initiatives on either our sales process or our resort operations as masks and social distancing have become commonplace across the globe. Maintaining our financial health has remained a critical focus throughout the pandemic, and we've continued our efforts to fortify our balance sheet and optimize our cash flow. We found cost savings across all levels of our organization, some of those have unfortunately required us to make tough decisions around our staffing levels, as you likely saw in our recent filing. As a result, we believe we found sustainable cost savings and reset our cost structures to allow us to get back to our pre-COVID levels of EBITDA at a lower level of contract sales. We've also re-examined our inventory and project spending in light of the new environment, but we're well-positioned through the pandemic and beyond due to the inventory investments we've made over the past few years in the projects like Ocean Tower and Maui. Due to these efforts, we now believe our adjusted free cash flow will be comfortably positive for the year, which has extended our liquidity to 31 months, assuming no further improvement from September trends. Throughout the pandemic, we kept sight of what's most important: our commitment to our owners and our team members. Our teams have done a great job restarting our operations smoothly, both at a resort level and at our member service centers. I want to take a moment to recognize them for their efforts. We've provided our members with additional flexibility to roll their unused points in 2021 to preserve the value of their membership with HGV. Our marketing teams have been successful in engaging potential new buyers, driving sequential package growth trending at nearly 75% of last year's levels versus only 10% of the prior year back in April. It's clear to us that people have the desire to travel, but it's also clear to us that you can't force people to travel until they're comfortable doing so. However, the demand for prepaid vacation experiences gives us confidence that those travelers will ultimately choose to vacation and tour with us. Looking ahead, our outlook reflects an acceptance that we're going to have to continue to contend with the impact of the virus as consumers define their individual level of comfort with travel. While we're seeing moderate week-over-week and month-over-month improvements, we expect the pace of recovery to vary across different markets. I'm confident in the long-term strength of our business model and our plan, and I remain optimistic about our future. With that, I'll turn it over to Dan to walk you through the financial results.

Thank you, Mark and good morning, everyone. As Melnyk mentioned in his introduction to our call, our results for the quarter included $13 million in sales deferrals impacting reported revenue and net deferrals of $8 million impacting both adjusted EBITDA and net income. All references to consolidated net income, adjusted EBITDA, and real estate segment results on this call for the current and prior periods will exclude the impact of deferrals and recognitions. A complete accounting of our historical deferral and recognition activity can be found in Excel format on the financial reporting section of our Investor Relations website. Let's review the results for the quarter. Total third quarter revenue was $221 million, reflecting declines across our business segments due to the ongoing impact of global travel from the COVID-19 pandemic, along with the absence of resorts in several major markets where we haven't yet resumed sale operations. Q3 adjusted EBITDA was $27 million as our financing resort and club segment generated positive EBITDA, with flat EBITDA at our rental segment and a slight decline in real estate. Our EBITDA was also impacted by $3.8 million of one-time charges, primarily due to restructuring and COVID-related expenses during the period. In addition, as we laid out in our press release, there were another $6 million of COVID-related items that were not adjusted from our EBITDA, including a $7 million benefit from employee-related credits offset by a $1 million loss of club transaction fees that were refunded during the quarter for reservation charges associated with property closures. Net income was $1 million and diluted earnings per share was $0.02 compared to net income of $58 million in diluted earnings per share of $0.67 in the third quarter of 2019. Within real estate, Q3 contract sales were $117 million or one-third of the prior year, reflecting operations resuming at roughly three quarters of our resorts. For the quarter tours were down 75% and VPG has grown by 25%. Our mix of owner contract sales remained elevated this quarter at over two-thirds of the total. Our recovery was steady over the course of the quarter, with absolute numbers and the year-over-year growth rate of our tour flow improving sequentially each month. Close rates were once again up in each of the months for the quarter for both owners and new buyers, reflecting solid execution in driving our strong VPG. As we progressed through the quarter, we saw an expected normalization of close rates from the elevated levels seen in Q2. We expect that trend to continue, although we anticipate VPG will settle at a higher level than pre-COVID in the short-term owing to shifts for higher VPG owner sales. Our fee-for-service mix for the quarter was 57%. On the consumer lending side, our provision for bad debt was $12 million, and our overall allowance on the balance sheet was $217 million, or 17.7% of gross financing receivables. SMG&A was $67 million, reflecting both fixed expenses as well as a full quarter of variable expenses as we resumed sales operations. Real estate margin was a loss of $1 million. Our financing business's third-quarter margin was $27 million with a margin percentage of 67.5% versus a margin of $29 million and a margin percentage of 67.4% last year. Margin was lower based on the declining receivables balance versus last year, limiting portfolio income along with higher interest expense associated with the securitization completed in Q2. Our gross receivable balance decreased by $1.2 billion. Our average down payment year-to-date is 11.8%, and our portfolio average interest rate increased to 12.6% from 12.4% last year. Over the past three months, we've seen an improvement in our delinquency rate to 3.35% of our receivables portfolio versus 3.5% at the end of the second quarter. But it is up from 2.5% at the end of 2019. Our annualized default rate has increased to 5.96% versus 5.48% at the end of the second quarter and 5.14% for the end of 2019. The increase remains consistent with our expectations of seeing upward pressure on both our delinquencies and defaults over the near term as we continue to cycle through the pandemic. But we still believe we are adequately reserved at this time, and we will continue to monitor our portfolio trends closely. The performance of our loans on a payment deferral has been strong. Of the owners who utilized a deferment across our entire platform, which accounts for $27 million in loan balance or 2% of our portfolio, just under 80% were current today. Turning to our resort and club business, NOG for the 12 trailing months was 1.9%, and we grew our member base to over 327,000. Revenue of $39 million was down 13.3% from the prior year, driven by lower transaction fees from reduced member activity, as well as additional one-time fee waivers and refunds related to COVID-19. Margin for Q3 was $30 million with a margin percentage of 76.9% versus a margin of $34 million and margin of 75.6% last year. Rental revenues were $20 million for the quarter, reflecting a resumption of operations and the realities of a global travel market that is still feeling the impact of the COVID pandemic. Expenses in the quarter were $24 million and were driven by expenses associated with Hilton honor point conversion activity and development and maintenance fees. Bridging the gap between segment adjusted EBITDA and total adjusted EBITDA, third-quarter corporate G&A was $15 million, down $5 million or 25% versus the prior year, reflecting the benefits of our cost-saving program and license fees for $11 million. Regarding our cost savings, in the first quarter, we moved quickly to examine the cost structure and adapt to a rapidly changing business environment, including process improvements, spending cuts, temporary furloughs, and unfortunately permanent headcount reduction. The net result is that we believe we've identified $20 million to $25 million of savings across the organization that are recurring in nature. As Mark mentioned earlier, Hawaii recently reached a major milestone in the reopening process by removing the quarantine requirement for COVID-negative travelers, but we are excited to be reopening one of our largest and most important markets. In light of the staggered progression of the openings and the associated ramp-up period, it is important to note that we do not anticipate Hawaii distribution centers to be meaningful contributors to our contract sales in Q4. Thus, our fourth quarter is expected to show continued modest sequential growth in our operating metrics. Our adjusted free cash flow in the quarter was a net use of $99 million, which included inventory spend of $39 million and cash used from non-recourse debt paydown of $90 million, owing to the shift in timing of our securitization into Q2 from our typical third-quarter timing. For the year-to-date, our adjusted free cash flow was $156 million after inventory spend of $108 million. As a reminder, our inventory budget for this year was approximately $400 million, and we now expect to spend slightly less than $200 million. Given this level of inventory spend and the expectations that Q4 will show a modest sequential growth in operations, we now anticipate that we will have positive adjusted free cash flow for the full year of $40 million to $50 million, compared to our prior expectations of achieving roughly breakeven for the year. We continue to maintain a strong balance sheet with low leverage and ample liquidity. Assuming that we saw no further improvement in real estate or rental business from September levels, we estimate that we would have 31 months of available liquidity. As of September 30, our liquidity position consisted of $625 million in unrestricted cash, $39 million of availability under our revolving credit facility and $450 million of capacity in the warehouse. We currently have $100 million of timeshare receivables available for collateralization. On the debt front, we had roughly $1.3 billion in corporate debt and a non-recourse debt balance of $837 million. Turning to our credit metrics, at the end of Q3, our net leverage – first lien net leverage for covenant compliance purposes stood at 2.14 times, and 1.11 times respectively. Our interest coverage ratio for covenant compliance purposes at the end of the quarter was 7.17 times. We will now turn the call over to the operator and look forward to your questions.

Thank you. Our first question is from Jared Shojaian with Wolfe Research. Please proceed.

Hi everybody. Thanks for taking my question. On Hawaii, Dan, I appreciate your commentary that you're not expecting a meaningful contribution in the fourth quarter from Hawaii sales centers. But can you just talk about what you've seen since the quarantine was removed? What have you seen with arrivals? What do you have on the books today versus this time last year? And then I know you've still been selling Hawaii at other locations and you've had some success with that. Can you give us a sense for what Hawaii contract sales are currently running at right now on a year-over-year basis with obviously not being able to go to Hawaii in the third quarter?

Yes, Jared. This is Mark. I'll take part of that and I'll let Dan take part of that question. You had a few questions in that question, so we'll try to connect on everything. First of all, we're excited that the quarantine enforcement is finally lifted and that the state reopened on the 15th for domestic travel. We're still waiting to hear about Japan, and recent indications suggest that the State will probably open up for Japanese visitors sometime in November. We're happy about that. We also think Hawaii is going to be our next catalyst for recovery as we enter 2021. We have amazing assets in prime locations there and historically Hawaii has been one of our highest demand markets for both our U.S. and Japanese numbers. So as far as what we have going on there right now, we have a few very small properties that are open, but really no sales happening in Hawaii right now. The plan is to open up our sales centers on the Big Island by mid-November, and that we're going to open all of our properties and sales centers in mid-December and in Oahu. I think you also mentioned Japan and Hawaii inventory; we're having great success and had a great success in Japan during this crisis. They never really closed down, although the business dropped back considerably early on when the pandemic first started. But we mentioned, I think in our prepared remarks, that 34% of our sales for the quarter were Hawaii and compared to 37% last year, and that really has a lot to do with the work that our Japanese teams are doing. This month in October, we’re tracking at about 75% of prior year's levels. So that's looking really good. As far as forward-looking bookings for next year, we’re showing about 70% on the books at the same time last year, and I know we've had about a 15% pickup over the last four weeks as people have gotten a better line of sight on when we think we're going to be opening. I don't know if there's anything else you want to add, Dan?

Yes. I think just to quantify part of your question on Hawaii, Jared, if you look back to Q2, we did total contract sales of $35 million, just over $10 million of that was associated with Hawaii. If you look at Q3, that number has jumped to just south of $40 million, and we would anticipate that to be probably a bit better, because we do believe operations will be open to some extent in Q4. So we believe there'll be slightly better than that in Q4. But compared to run rate historically, prior year, you're looking at Q2 and Q3 being close to $130 million. So it's still substantially down, but obviously we're making tracks and heading in the right direction.

Yes. And then I’d just add one more thing. I think when you think about Hawaii, obviously, airlift is really important, and from what we're seeing, the airlines are starting to get their airlift back in place. There's a lot of choreographing that goes on when you open up Hawaii versus other markets for us because of this flying component. The other thing to think about is a number of our biggest resorts and properties co-exist on campuses that also have major hotel assets that park resorts own. So we have to work in conjunction and align with them around staffing and such. Generally, we think Hawaii is going to reopen. We’re happy it’s finally going to reopen; we thought it would reopen late in Q3, so it would benefit us in Q4. It got pushed back, but at the end of the day, we're just pleased that it's going to reopen and hopefully the process implemented will endure and create a very safe environment for visitors in Hawaii. We’re very optimistic that our business is going to bounce back stronger.

Okay. Thank you. That's very helpful. I think you got all that from my convoluted question. Just to switch gears here, could you talk about how you're thinking about inventory spend for next year? And I know a lot depends on the demand environment, but is it fair to think that next year is not going to be a free cash flow year and that by 2022, you're starting to just meaningfully ramp up on free cash flow? Is that the right way to think about it? Anything you can share there.

Hey, Jared, it's Dan. It's a great question. I think we've talked about this all year. To take a step back, as you've heard us say on two calls now, the original amount that we expected to spend in 2020 was north of $400 million; we've contracted that below $200 million. I want to emphasize that this contraction is not just moving it from 2020 to 2021. It means really putting things to the side and allowing us to analyze and make the best choices on inventory spend. The most notable example of that is cooperative rights. We've had a contraction in Hawaii particularly on sales, and now the question is when do you need cooperative inventory to come online? We'll continue to analyze that. Fast forward to 2021, the flexibility we had in 2020 is not the same as in 2021. In 2020, our contractual obligations, i.e., the just-in-time projects we had, were roughly $25 million. In 2021, those contractual obligations are closer to $200 million. The good thing to emphasize is they are just-in-time projects, which from a capital efficiency perspective have proved to be very good for us. We’ve got developers spending money on projects, most notably in New York and Suzuka, Japan, that would otherwise be on our balance sheet. But what you will see in 2021 is those obligations will kick in. So the flexibility of contracting inventory spend does come down and like I said, it's roughly $200 million in contractual obligations in 2021. When it comes to free cash flow, look, it's all about recovery. How does 2021 recover versus where we are in 2020? We see some nice trends now that some of our larger markets are on a steady march, albeit slower than we would like, but on a steady march to recovery. Hawaii is just about to open up. It will be dictated around the recovery itself on what 2021 shows. I think I'm trying to give you a lot of color; we're not trying to give specific guidance on 2021, but hopefully that context is helpful.

Yes. No, that’s helpful. I appreciate that. Maybe just quickly follow up on that. I mean, if we assume this recovery that we're seeing continues and you kind of extrapolate that out through all of 2021, so that 2021 is kind of a transition year, you're still far below peak levels, but we're moving in the right direction, we're improving. Under that scenario, should we be assuming that next year is not a free cash flow year? I guess I'm really just trying to help set that expectation on how you're thinking about it. And then by 2022, assuming this recovery is just continuing, should we start to see that meaningfully build again? Is that, under that context, kind of how we should be thinking about it?

Yes. We'll say it in a different way: if you were to look at what a lot of the analysts are saying about the recovery in 2021 and build in the contractual obligations, you’re looking at cash and adjusted free cash flow neutral to down here with the path really building in 2022.

Our next question is from Stephen Grambling with Goldman Sachs. Please proceed.

Hey, thanks for taking the questions. Two quick ones. First, I know you referenced that with the cost cuts that you've announced, you feel like you can get back to prior levels of EBITDA without getting to prior levels of contract sales. Is there any more that you can provide in terms of quantifying that? And perhaps I missed it earlier? And then the second question, which is unrelated, is just, if you can give any more details on what you're seeing in terms of the demographic of new owners arriving? Is that similar or different to what you saw pre-COVID? Are you seeing a different type of customer base, younger maybe coming in?

Great questions. I'll take the first one, and then I'll turn it over to Mark on some of the demographic information. We did say in our prepared remarks that we've done a lot. We have taken out various layers. As we sit here today, and you saw last week where we found 8-K disclosing that we did do a reduction in force. Over the course of 2020, we have taken out significant cost. Initially temporary furloughs, now we've gone to a reduction in force. We still have excess of 2,000 individuals furloughed today. Based on what we've seen today and the course of the recovery we see now out of all the actions we've taken, we believe that there are between $20 million and $25 million in recurring cost savings associated with that reduction in force and other ancillary expense items.

Yes, Stephen. I'm Mark. On the demographic side, if you look at Q3, millennials made up 26% of our new buyers, and Gen X 38%. So it's approximately 65% of our new domestic buyers in Q3 fit in that Gen X millennial age group.

And did that move materially year-over-year? And also, I guess, with the constraints on the sales centers, are you seeing any changes or making any changes in terms of thinking through digital sales?

Yes, good question. We've mentioned in the past that we are experimenting with some shorter-term product. As you can imagine, we're focused on getting the business back in order and getting that trajectory back in order so the focus has really been around our core business. We believe there’s a great opportunity to enhance our offerings and introduce term products. Some of that is being tested right now as we speak, but it's too early to provide any guidance, especially in this reduced volume environment. But we'll make sure to keep you posted as we move forward.

We have reached the end of our question-and-answer session. Before we end, I’d like to turn the call back over to Mark Wang for closing remarks.

Well, thanks everyone for joining us this morning. I mentioned it in my prepared remarks, but I want to give another special thanks to all of our team members for their hard work and dedication to providing our guests with a safe and memorable experience when traveling with us. We look forward to speaking with you over the coming weeks and updating you on our next call. Have a great day. Thanks.

Thank you. This does conclude today's conference. You may disconnect your lines at this time.