MARRIOTT VACATIONS WORLDWIDE Corp Q2 FY2023 Earnings Call

Greetings, and welcome to the Marriott Vacations Worldwide Second Quarter 2023 Earnings Call. At this time, all participants are in a listen-only mode. A question-and-answer session will follow the formal presentation. As a reminder, this conference is being recorded. I would now like to turn the conference over to your host, Mr. Neal Goldner, Vice President, Investor Relations for Marriott Vacations Worldwide. Please go ahead.

Thank you, Melissa, and welcome to the Marriott Vacations Worldwide Second Quarter 2023 Earnings Conference Call. I am joined today by John Geller, President and Chief Executive Officer; Tony Terry, our Executive Vice President and Chief Financial Officer; and Jason Marino, who will be assuming the role of CFO effective September 30 when Tony retires. I need to remind everyone that many of our comments today are not historical facts and are considered forward-looking statements under the federal securities laws. These statements are subject to numerous risks and uncertainties as described in our SEC filings, which could cause future results to differ materially from those expressed in or implied by our comments. Forward-looking statements in the press release that we issued last night, as well as our comments on this call are effective only when made and will not be updated as actual events unfold. Throughout the call, we will make references to non-GAAP financial information. You can find a reconciliation of non-GAAP financial measures referred to in our remarks in the schedules attached to our press release as well as the Investor Relations page of our website at ir.mvwc.com. With that, it's now my pleasure to turn the call over to John Geller.

Thanks, Neal, and good morning, everyone, and thank you for joining our second quarter earnings call. While we were pleased to run nearly a 90% occupancy in the quarter with the high VPGs we had last year in a mixed macroeconomic environment, this year we knew coming into the quarter that comparisons were going to be tough. As a result, we expected VPGs to be lower on a year-over-year basis, though we expected this to be offset by higher tours. However, VPGs declined more than we expected in the second quarter, and while tours did grow 4%, that was a few points below our expectations. We believe most of the VPG difference this quarter compared to what we expected was a result of the changes we've discussed in the past specifically the transition to selling Abound by Marriott Vacations at most of our legacy-Vistana sales centers and the changes we've made at the legacy-Welk locations. For example, despite the difficult comparison, contract sales at locations that didn't transition from selling a legacy-Vistana product were only down 5% in the quarter, while sales at legacy-Vistana locations that made the change were down double digits. And on the Legacy-Welk side, we are aligning the business models and the sales processes, which we expect will improve our business for the long term, but resulted in double-digit sales decline in the quarter. Despite the near-term transition impact, I remain confident that the changes we've made are the right strategic decisions that will benefit us in the future. We are also seeing changes in travel patterns with more Americans vacationing overseas this year, which has not been fully replaced by inbound international travelers. This shift negatively impacted sales and rentals in our higher-end U.S. travel destinations like Hawaii. However, we benefited from the increase in international travel as our European and Asian contract sales grew 56%. We also continue to focus on driving new owner growth with first-time buyers representing one-third of our contract sales this quarter, up 200 basis points from the prior year, which is good for the long-term health of the system. In our Hyatt Vacation Ownership business, we expect to rebrand the Legacy-Welk Resorts later this month to align them under one unified brand, Hyatt Vacation Club. In addition, we will be adding more vacation options for our Hyatt owners, including cruises and tours as we launch the Beyond program in a few weeks. Moving to our Exchange & Third-Party Management segment, active members at Interval International were unchanged compared to the first quarter. Inventory utilization was very strong in the quarter and average revenue per member increased 1% compared to the prior year. However, member deposits remain below pre-pandemic levels. In our Aqua-Aston business, revenue was lower compared to the prior year due to lower ADRs in Hawaii. As a result, excluding cost reimbursements and VRI Americas, which we sold last April, revenue in our Exchange and Third-Party Management segment declined 4% compared to the prior year. Despite the difficult quarter, it was heartening to see our vacation ownership resorts at nearly 90% occupancy, reflecting the continued demand for leisure travel. And I want to thank our associates who have been working tirelessly to deliver exceptional vacation experiences for our owners, members and guests. Looking forward, while I'm not satisfied with our results this quarter, we have some of the best brands in the hospitality industry in sought-after markets and an experienced management team that has successfully integrated new businesses and launched new products in the past, and I'm confident that the strategic changes we've made will provide long-term benefits. In fact, VPG improved sequentially in June and July, even with an increase in first-time buyer mix. And while we are seeing some variability in the macroeconomic environment, we still expect to grow contract sales for the full year. We also expect to grow adjusted earnings per share this year, excluding the impact of last year's alignment, reflecting the benefit of our share repurchases, and to generate between $540 million and $600 million of adjusted free cash flow, illustrating the strength of our leisure-focused business model. With that, I'll turn it over to Tony.

Thanks, John. Today, I'm going to review our second quarter results, the strength of our balance sheet and liquidity and our 2023 outlook. Starting with our Vacation Ownership segment, we grew tours 4% in the second quarter to 96% of pre-pandemic levels. We also grew our package pipeline by 10% from a year ago, ending the second quarter with more than 230,000 packages. However, while we expected VPG to decline due to last year's difficult comp, they did come in lower than expected. As a result, contract sales declined 10% compared to the prior year, though they remain 17% above 2019. Adjusted development profit decreased 20% year-over-year to $118 million. Despite lower sales, adjusted development profit margin remained strong at over 30%. While we expected rental profit to be down in the quarter, it declined more than anticipated due to lower fees rented and lower-than-expected ADR and with the moderation of revenue per available key, we now expect rental profit could decline by $15 million to $25 million this year. In the stickier parts of our Vacation Ownership business, financing profit increased $3 million, excluding the $3 million sales reserve pickup on our acquired notes that we recorded this quarter. This was primarily driven by a higher average notes receivable balance and a 30 basis point increase in the weighted average coupon rate partially offset by an increased borrowing rate. Resort management revenue increased 5% in the quarter, while profit declined $2 million due to higher labor and other costs but profit is still expected to be up roughly 5% for the full year. As a result, adjusted EBITDA in our Vacation Ownership segment decreased 11% in the second quarter to $245 million, while the margin was strong at 32%. Moving to our Exchange & Third-Party Management business, adjusted EBITDA declined $3 million compared to the prior year, primarily due to lower ADRs at Aqua-Aston, while operating margin was 52% for the quarter. Finally, corporate G&A expense was largely unchanged compared to the prior year. As a result, total company adjusted EBITDA declined 13% to $222 million in the quarter and adjusted EBITDA margin was 27%. Moving to the balance sheet, we ended the quarter with approximately $1 billion in liquidity, including $242 million of cash, $59 million of gross notes receivable eligible for securitization and $684 million of revolver capacity. With $3 billion of corporate debt outstanding at the end of the quarter, our net debt to adjusted EBITDA ratio stood at 3.1 times, roughly in line with our targeted 2.5 to 3 times leverage range. We ended the quarter at an average interest rate of 3.6% with no corporate debt maturities until 2025. We have a combined $550 million of interest rate hedges that mature by next April. However, after those hedges mature, our corporate debt will still be 70% fixed with a pro forma interest rate of only 4.1%. We ended the quarter with $2 billion of non-recourse debt related to our securitized notes receivable. In June, we renewed our warehouse facility, extending its maturity and increasing its capacity to $500 million to support future growth. Finally, the sales reserve increased $8 million year-over-year on our $2.5 billion gross originated notes portfolio. Defaults were up 50 basis points compared to the prior year and delinquencies were up approximately 70 basis points. While delinquencies were higher than the previous year, we have seen them trend downward in the first half of 2023. Our new guidance also assumes 100 to 150 basis points higher sales reserves compared to last year. We continue to return excess cash to shareholders during the quarter, repurchasing $82 million of common stock and paying $26 million in dividends. Our Board of Directors increased our share repurchase authorization to $600 million during the quarter with $561 million remaining at the end of the quarter. Moving to our 2023 guidance. As you saw in last night's earnings release, we now expect contract sales to be between $1.84 billion and $1.9 billion this year. This is roughly 5% lower than our previous guidance, with the difference being driven by a mix of lower tours and lower VPG. We expect VPG to improve sequentially in the third quarter but to be down year-over-year, while tours are expected to be up a few points compared to last year's third quarter. However, we still expect 2023 contract sales to increase year-over-year, reflecting the continued demand for our leisure-based products. Despite the lower contract sales guidance, we still expect 2023 full-year development margin to be around 30%, even after a slightly higher sales reserve. As I mentioned earlier, we now expect rental profit to decline this year versus being up 10% in our previous guidance and for resort management profit to be up. We also expect financing profit to increase slightly, excluding last year's alignment benefit. We expect Exchange and Third-Party Management profit to decline $15 million to $20 million for the full year versus our previous guidance of roughly flat due primarily to lower transactions by Interval International as well as lower ADRs at Aqua-Aston. As a result, we now expect our 2023 adjusted EBITDA to be between $880 million and $910 million, 8% lower than our prior guidance. As a reminder, we also reported a $44 million alignment benefit in last year's third quarter that we do not expect to recur this year. Moving to cash flow, we have a strong balance sheet and ended the quarter with roughly $470 million of excess inventory enough to support approximately $2.4 billion of future sales. We sold three noncore assets during the quarter, generating $14 million in total proceeds which we exclude in the calculation of adjusted free cash flow. We also paid down $135 million of our outstanding revolver during the quarter. With the lower expected adjusted EBITDA this year, we now expect our adjusted free cash flow to be between $540 million and $600 million. Our capital allocation strategy remains consistent in that we continue to use our free cash flow to grow the business and in the absence of compelling acquisitions, we believe our best use of excess free cash flow remains returning it to shareholders. As always, we appreciate your interest in Marriott Vacations Worldwide. With that, we'll be happy to answer your questions.

Our first question comes from Chris Woronka with Deutsche Bank. Please proceed with your question.

Hey, good morning, guys. Thanks for taking the question. I guess maybe we could drill down a little bit as you guys go back and unpack the quarter on the Abound. I mean, was this where you implemented it? Was this just an issue of salespeople not having a lot of experience kind of selling yet? Or is it more pushback from consumers? Just trying to get a sense for what you think was kind of a little bit off.

Yes, the sales team has received comprehensive training on the product. However, transitioning from one product to another can take some time for them to refine their sales pitch. Additionally, there is a need for consumer education. This situation is somewhat reminiscent of when we switched from our weeks product to points back in 2010. Customers who purchased weeks were specifically sold that product, and now we are introducing a new product that arguably offers better options in terms of flexibility and usage for consumers. It requires some time for adaptation. Ideally, the existing owners of the Westin Flex or Sheraton Flex products will participate in the Abound program, utilize their ownership, and enjoy stays at various resorts while taking advantage of different exchanges. It's important to note that the Abound program includes more cruise options and trips than the previous Marriott program. There is an educational component to encourage consumers to use the product, and since we launched it earlier this year, many customers already had their vacation plans made under their previous products. Consequently, it will take some time for education and for the Westin and Sheraton Flex owners to begin using the new product.

And Chris, one add-on to that is that educating the owners means that there's something out there to talk to them about, and they are interested in the new products. So that is a good source for us for tours. You get something to come in the door to talk to us about.

Sure. I understand. My follow-up question relates to the mention at the end of the prepared remarks regarding the increase in some of the reserves. Could you provide a bit more detail on that? Is it associated with a specific segment or type of customer? Is there a way to analyze this and determine if it indicates that a larger issue is unlikely in the future? Could you elaborate on this? Thank you.

Yes. Let me start, and then if John has anything to say you can jump in. In total, when you start looking at our reserves, we have a $2.5 billion originated notes receivable balance out there. So a pretty big portfolio. When we took a look at the quarter, we had about $11 million of true-ups in defaults. And those defaults came from a lot of different places, but we tend to take a look at those and treat them as permanent. And that's one way that we do our calculation. So we don't assume that it's an acceleration of anything on our default curve. We do assume that they are permanent and they're going to continue into the future. So we feel that we have an adequate reserve for those right now. We feel that we have increased the default rate or the sales reserve rate that we put against contract sales for the remainder of the year, and that will get us to the right place based on what we know today.

So, regarding delinquencies, which could indicate future defaults, we've seen an increase compared to last year. However, when we look historically post-COVID, our delinquency rates were actually below average. While they have risen, they are now aligning more closely with historical trends. Importantly, the trend this year shows that delinquencies are decreasing, which is a positive sign for the future. Additionally, in our outlook, despite the charge we took in the second quarter, we acknowledge there is a range of potential higher defaults. Nevertheless, we feel confident about our current position.

Okay, very helpful. Thanks guys.

Thank you. Our next question comes from the line of Brandt Montour with Barclays. Please proceed with your question.

Hey everybody. Thanks for taking my question. I would like to discuss Abound a bit more. Can we start by reviewing how much of the system was sold under Abound in the second quarter? Also, what is the plan for the rollout moving forward?

The majority of our sales centers are focused on selling Abound. The core of the Abound program is the Marriott Vacation Club, which allows Westin and Sheraton Flex owners to participate in the broader Marriott exchange program. Approximately 20% to 25% of the sales centers in the quarter transitioned from selling the legacy Vistana brand, like Westin Flex, to selling the Marriott Vacation Club. This transition involves educating owners about the new product so they can see its benefits through usage. We're also working to attract first-time buyers and assisting current owners. While some Sheraton Flex centers still have inventory and have not yet transitioned, they are performing as anticipated. Overall, the transition is impactful, especially in the legacy sales centers, similar to what we've seen with Hyatt.

Okay. John, you compared it to the transition from weeks to points, which I remember was a long and quite disruptive process for you. This transition had significant positive financial impacts on balance sheet management and inventory management. Can you remind us of the meaningful benefits that will come from Abound? When do you anticipate that the benefits will start to outweigh the disruptions caused by these specific legacy brands?

Yes, I believe the improvement will occur gradually over time. If we reflect on previous weeks, the changes we've seen now are more significant than what's currently happening. While I understand the desire for things to return to normal within six to nine months, I expect ongoing enhancements as we progress through the year. Despite our outlook not indicating a rapid recovery, we did observe sequential improvements in VPGs during June and July. Currently, our VPGs are approximately 5% higher than those in the second quarter. Although the recovery won't follow a straightforward path, there are encouraging signs of improvement in the VPG overall. We hope to navigate these challenges and see better results moving into next year. Already, we are witnessing some early signs of progress. While it's challenging to predict a timeline for a complete recovery, I can reference our experience with Vistana, where VPGs initially dropped 25% compared to Marriott, and we recovered more quickly than anticipated. We have strong leadership in place that is focused on addressing these issues swiftly, and I am confident in our ability to achieve our goals.

And Brandt, I'd add on to that, that we've probably already seen a little bit of benefit here from a balance sheet perspective of Abound. Remember, we were selling three different trusts. And we were running low on inventory in the Western Trust specifically. And had we not done the Abound program, we would have probably had to build inventory in that trust over the last couple of years. So that's one of the reasons why we have lower inventory spend. It's because we have Abound. We knew it was coming, and now we're selling one major trust to our customers instead of three separate.

A helpful color. Thanks all.

Thank you. Our next question comes from the line of David Katz with Jefferies. Please proceed with your question.

Hi, good morning everyone. So a couple of things. One, I have your Analyst Meeting deck open, which obviously has a little bit of datedness to it, but it has some 2025 targets. And I suppose the assumption should be that those get pushed out by some amount, and we'd love to get some sense about how far that could be and coupled with that, and just listening to your comments on the last couple of questioners. Have we seen the worst of the pressure that is from Abound? Do we feel like we have the rollout of World of Hyatt under good control right at this point? And I suppose what I'm asking is, what's your degree of confidence that the guidance we have today is relatively firm versus where we might be 90 days from now, the next time we address it.

Sure. So taking the second part, yes, as I said a little bit earlier, yes, we are seeing sequential improvement. So that said, as we look at our guidance for the full year, we haven't assumed that we get a hockey stick up on sales at the Legacy transition Vistana sites and the Welk sites that are transitioning. We're assuming some gradual improvement, but the outlook we give you, that's where we are in terms of confident that we should achieve that for the full year based on the current outlook. Going back to the Investor Day, look, we got a couple of years. I think a lot of what happens in 2025 is how quickly, as you guys have asked, we recover and get the Abound going because it is the right longer-term strategic decision. And some of these things, we knew was you're going to have some bumps to it, right, as you transition. We talked about that anytime you make a transition or change to a product. The harder part is trying to predict when and how quickly it will come back and get you going again. And that's where, like I said, we got a couple of years here. So we are not giving up in terms at this point of where we're at in 2025. We'll get better clarity. And as we've also talked about, this isn't the only thing we have in the hopper. I mean we're making significant investments on the technology side. We're going to be rolling out from a marketing and sales perspective sales force out at our sites, our digital marketing, how we target, so you got a lot of initiatives going at the same time as you're transitioning this product. So we'll come back at some point here and look longer term in terms of 2025, but the team is focused, and we're not giving up on 2025 at this point.

Understood. If I could just ask for an additional perspective, you have certainly been active throughout the quarter, and I’m wondering if there was an increase in some of these pressures as we approached the end of the quarter and into June. What I’m really asking is whether these challenges caught us off guard in some way, or if this was anticipated, and perhaps I didn’t fully catch the details.

When we started the quarter, things worsened a bit in May, but we began to see improvements in June. Looking at our expectations, we didn't provide guidance for the second quarter, but consensus was about $250 million in EBITDA while we anticipated around $241 million to $242 million. We missed our own forecast by around $20 million, with about half of that due to development profit, primarily because we faced higher sales reserves that we hadn't expected. Despite lower contract sales, we maintained a development margin above 30%, but the sales reserve contributed to our shortfall for the quarter. The other part of our miss was in rentals. In the first quarter, we performed well in rentals regarding occupancy and rate. However, as we moved into the second quarter and assessed our outlook for the year, we noted changes in travel patterns, with more domestic travelers going international, impacting our results. We have many properties in high-end markets like Hawaii and Florida Beach, where we previously achieved higher average daily rates. Now, those markets are experiencing three to four points of lower occupancy and decreased rates. We estimate that approximately $10 million of our miss in the second quarter came from the rental segment. Looking ahead, we've adjusted our outlook accordingly, estimating an additional $10 million and about $20 million more for the rest of the year. Although the current market remains strong relative to past performance, the trends mirror those observed in the second quarter. As Tony mentioned, we still anticipate an increase in contract sales despite the challenges posed by Abound and HVO, while we aim to maintain a development margin above 30%. Unfortunately, shifts in travel patterns, including on the exchange side where deposits have not yet returned to pre-pandemic levels, have not followed our expectations for year-over-year improvement. This reflects broader changes in travel behavior following COVID-19, with people utilizing their weeks differently. Although we expect these patterns to begin normalizing next year, particularly as U.S. travelers might shift back from Europe, we are monitoring the situation closely. This was somewhat surprising in terms of rentals compared to our earlier observations.

And David, I would add one other thing in there on the rental side. When you're getting into the year and especially when you get to that second quarter, a lot of your rental costs are already fixed for the year. So if you think about the inventory costs, we pay unsold maintenance fees at the beginning of the year. You look at the programs that our owners have that they use to do other excursions. We get that inventory back and we have to rent. So we're not going to stop owners from participating in the Explorer program or the Bonvoy program. So a lot of that cost of rentals is kind of fixed. So when you miss a little bit on the ADR side or on the revenue side, a lot of that flows through to the bottom line, and that's part of what we're seeing here on why rentals saw a little bit of weakness on the bottom line.

Got it. Thank you very much. Appreciate the answers.

Thank you. Our next question comes from the line of Patrick Scholes with Truist Securities. Please proceed with your question.

Hi, good morning. Can we break down a little bit further the components of the $80 million at the midpoint guidance cut, you just said roughly $20 million from rentals. It looks like there's three other items. It's tougher comp, Abound and the Hyatt's alignment. For those tougher comp, Abound, and Hyatt alignment, how much EBITDA taking down would you ascribe to each one of those roughly?

Sure, Patrick. We had a $10 million shortfall in rentals in the second quarter, plus another $20 million, which totals about $30 million of the $80 million. In terms of exchange, we are not seeing inventory deposits and trends there, which accounts for another $20 million. So that brings us to about $50 million of the $80 million. The remaining balance is development, roughly $30 million, due to a combination of lower sales and some higher sales reserves I previously mentioned. Depending on how the year unfolds, we've already factored in about $9 million or $10 million of that $30 million, but provided a range on the sales reserves. Part of it comes from sales reserves, while the rest is related to the impact on contract sales.

Okay. And I believe you talked about 25% of the legacy-Vistana sales centers have transitioned to Abound, what's the timing on the other 75%?

So yes, it's about 20% to 25%. The remaining ones will be the Sheraton Flex, which is likely to be later next year and is primarily focused on sales centers in Orlando and Myrtle Beach. There are some locations that offer different products and are not selling the Sheraton or Westin Flex. For instance, in Mexico, we sell a different trust called Adventuras, so that won't transition and will continue to sell the Mexican Trust. Our Westin St. John is an example of a stand-alone product. Therefore, not all of them will transition because they do not necessarily sell the Westin or Sheraton Flex. It's the Sheraton and Westin sales that will continue to transition. I might not have the exact number, but it's probably another 30% to 40%, and the rest will keep selling their current products.

Yes. If you think about it, it's going to be inventory driven. We do have more inventory left in the Sheraton Flex that we have to sell through. So we have some of our locations still selling that old product so that we can get through that and deplete that trust. There's always going to be some inventory trickling back. So we'll always have to keep selling in some of our sales centers but through the end of this year and probably early into next year, you should probably see more of the Sheraton sales centers shifting over.

So the nice thing about that delay, notwithstanding the sales process and all that is those owners are enrolled in the Abound program on the Sheraton Flex side, for example, Patrick. So they can start using it now and getting educated and all that. So that's the good thing, right? That's the piece that I mentioned before, which is not only educating but getting your owners to use it and see the benefit of it. So I would expect time will tell here a little bit. When we go to transition, you're going to have a much more educated owner base about the new product.

Okay. So is it safe to I guess, assume that all the challenges you had out of the box with the first slug of 25% likely at least to the degree that you saw with that first 25% won't continue for that remaining 75%?

I think it should go smoother. That's my point. The owner education aspect and allowing Sheraton Flex owners to utilize the Abound program now will demonstrate its advantages, such as staying at various resorts or exchanging for cruises or tours. This approach parallels what we observed with the weeks space product. Once people enrolled their weeks in the points program and experienced its benefits, they expressed interest in acquiring more points. Admittedly, transitioning takes some time. My main observation is that postponing the Sheraton Flex launch to sell through the existing inventory should make the transition easier compared to starting from scratch.

Okay. And can you remind us before you started to transition into Abound, the legacy-Vistana owners what percentage of VOI sales did that represent. Roughly any acquisition, but roughly.

30% to 40%, I would say. I'm looking at Tony here.

I think between 30% to 40%, I'd have to go confirm that number for you, Patrick, but it should be in that ballpark.

I hope we go back and look at it, but I think that's ballpark-ish.

Okay, I am all set. Thank you.

Ladies and gentlemen, that concludes our question-and-answer session. I'll turn the floor back to Mr. Geller for final comments.

Great. Thank you, Melissa, and thanks for everyone joining our call today. Despite the uncertain macro environment, our resorts again experienced high occupancy this quarter, illustrating the power of vacations. And while I'm not satisfied with our results this quarter, that doesn't diminish my enthusiasm for the long our long-term trajectory. We have some of the best brands in the hospitality business with a portfolio of resorts that would be impossible to replicate and the improvements that we've made to our core Marriott branded vacation ownership product, in addition to the alignments we're making on the Hyatt side are the right strategic decisions that will propel our growth over the long term. On behalf of all of our associates, owners, members, and customers around the world, I want to thank you for your continued interest in our company and hope to see you on vacation soon. Thank you.

Thank you. This concludes today's conference call. You may disconnect your lines at this time. Thank you for your participation.