Earnings Call Transcript - VAC Q4 2020

Operator, Operator

Greetings, and welcome to Marriott Vacations Worldwide Fourth Quarter 2020 Earnings Conference Call. I would now like to turn the conference over to your host, Neal Goldner. Thank you. You may begin.

Neal Goldner, Host

Thank you, Rob, and welcome to the Marriott Vacations Worldwide Fourth Quarter 2020 Earnings Call. I’m joined today by Steve Weisz, Chief Executive Officer, and John Geller, President and Chief Financial Officer. 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.

Steve Weisz, CEO

Thanks, Neal. Good morning, everyone, and thank you for joining our fourth quarter call. Before we get started, I'd appreciate it if you would indulge me for a moment to reflect on the passing of Arne Sorenson last week. As many of you have noted, Arnie was an outstanding businessperson with a keen understanding of not only where to take Marriott International, but also what the future looked like for the hospitality industry. I think it goes without saying that leaders with the combination of outstanding intellect, coupled with a passion for the business, and a true ability to relate to associates at all levels of the company are not easy to come by. Bill Marriott once again showed our industry his wisdom in selecting Arne to be the only person to be CEO who did not have Marriott as the last name, and he chose wisely. But I'd like to take just a moment to reflect on Arnie, the person. I had the good pleasure to be able to work as both a colleague of Arnie's as well as having him as a boss for a short period of time before our spin-off in 2011. Not only was Arne a good friend of mine, but he was a good friend of our business. His unique understanding of the timeshare business and the connectedness that it had with the core lodging business helped to frame his recommendation to create two separate public companies as a way to unlock considerable value for the Marriott shareholders. Now almost 10 years later, I believe that history has shown that it was an outstanding decision for the shareholders of both of our companies. I ask you to join me and all the members of our team here at Marriott Vacations Worldwide when I say, thank you, Arne. Godspeed. You will be missed but surely not forgotten. Thank you for allowing me the opportunity to express my thoughts. Now I'll proceed to our call. What a difference a year makes. It was just one year ago when we reported double-digit fourth quarter year-over-year contract sales growth, and we were talking about the resiliency of our business model. One month later, we closed all of our sales centers and recommended that owners not come to our resorts due to the pandemic, even going so far as to cancel transient rental bookings. But once government restrictions started to lift, occupancies quickly returned, beginning first in our drive-through markets, but expanding as the year went on, illustrating timeshare owners' desire to get back on vacation.

John Geller, CFO

Thanks, Steve, and good morning, everyone. Today, I'm going to review our fourth quarter results, the recovery we've continued to experience across our business, the status of our synergy initiatives, and the overall strength of our balance sheet and liquidity position. Our fourth quarter results reflect a strong sequential improvement from the third quarter, illustrating the resiliency of our business with resort occupancies, contract sales, and exchange transactions all improving. As a result, we reported $72 million of adjusted EBITDA for the fourth quarter, more than doubling our third quarter results, once again, demonstrating the strength of our leisure-focused business model.

Operator, Operator

Thank you. At this time, we will conduct a question-and-answer session. Our first question comes from David Katz with Jefferies. Please proceed with your question.

Steve Weisz, CEO

Hi, David.

David Katz, Analyst

Good morning, gentlemen. Appreciate all of the detail. I wanted to go back on two things, if I may. There's so much discussion about pent-up demand, and if we could maybe break that down just a little bit further, right? We would expect that there is pent-up tours, right, pent-up marketing packages, pent-up visitation, right? But can you maybe give us just a bit more detail as to how we would break down the notion of pent-up demand, which seems obvious and intuitive, but some more detail would help.

Steve Weisz, CEO

Sure. In my remarks, I mentioned that the second half of the year is looking about 8% higher than the same period in 2019. However, the first half of the year is down 16% compared to 2019, with most of the decline occurring in the first quarter and a slight dip in the second quarter. Overall, when averaging for the full year, it’s down roughly 8%. This makes sense given that people are eager to travel and are starting to book trips, especially with the vaccine rollout. Many expect that by summer, a significant portion of the U.S. population will be vaccinated. Additionally, a large number of people did not take vacations in 2020, which further adds to their desire to travel now. Currently, 80% of our resort sales come from local residents, with 50% being in-house guests and 30% being vacationers or package purchasers. As our resorts continue to fill, we anticipate our sales will grow accordingly.

David Katz, Analyst

Understood. I have a quick follow-up regarding the Welk opportunity, which seems to highlight some potential value for Hyatt. Could you provide more details on what you might reasonably expect the Hyatt brand to contribute in terms of tour flow sales, visitation, or any qualitative insights? While we often associate you with Marriott, there's additional potential here as well.

Steve Weisz, CEO

Sure. I think probably the easiest way to think about it is that when we acquired ILG, I would tell you that the Hyatt Vacation Residence business was basically relatively dormant in terms of what people were doing actively to try to grow the business. I think I've reported in previous calls that when ILG acquired Hyatt, they had 16 resorts. And when we acquired ILG, they had 16 resorts; that was four years later. So we do believe that there is quite a bit of opportunity there. In the Welk business, the way they typically source customers is because they didn't have one of the major hospitality brands affiliated with it. They did a lot through sports marketing and OPC venues where they generated customers. Typically speaking, those are low yield, high cost kind of channels to source customers out of. We believe that we will start to strip out some of those costs as we replace them with things where we'll continue to look to penetrate the World of Hyatt program just as we have done in the Marriott Bonvoy program. We will continue to change practices about how sales are done at the site level. For instance, putting in the equivalent of our Encore program, which has proved to be very successful for us and has a very high VPG number. We'll put that in. And the only caveat I would throw into this is it's going to take us a little while to rebadge the Welk Resorts as Hyatt. Call that the end of this year, first quarter next year. But then there's another impediment to be able to integrate all the inventory, and that is the fact that Welk today is an RCI affiliate, not an Interval International affiliate. So that makes putting the exchange program in place, much as we have done on the Marriott side, a little more problematic. That affiliation ends in 2022. And obviously, we'd look to then reaffiliate Welk back with Interval International from which they used to be, by the way. So, I think I reported that we said that we think by 2024, and hopefully sooner, it's going to mean somewhere in the neighborhood of $60 million to $70 million of adjusted EBITDA. I think we should look to take their development margin, which is today, low single digits, up into that 20% to 30% range. And contract sales, obviously, we want to try to grow substantially. We think contract sales by 2024 could be $160 million to $180 million in that range, roughly.

David Katz, Analyst

Perfect.

John Geller, CFO

Just for reference, David, I'd add there. I mean that $60 million, $70 million Steve mentioned versus, call it, Hyatt, on a pre-COVID basis of EBITDA, I mean it is a fraction of that $60 million to $70 million incremental. Just to put it in relative size, all the improvements you're talking about are really are going to drive not only the top line but on a percentage basis, huge EBITDA growth over the next two to three years within the combined Hyatt and Welk business.

David Katz, Analyst

Thank you very much.

Steve Weisz, CEO

Thank you.

Operator, Operator

Our next question comes from Patrick Scholes with Truist Securities. Please proceed with your question.

Steve Weisz, CEO

Good morning, Patrick.

Patrick Scholes, Analyst

Hi, good morning. What is the timing for reopening the Hawaii sales centers? Also, could you provide some insights on the preliminary reservations and bookings for Hawaii moving forward? Thank you.

Steve Weisz, CEO

Yes. As I previously mentioned, Hawaii, excluding Kauai, is currently operating at about 50% occupancy. There are still requirements in place, such as needing a negative COVID test prior to arriving at the islands. Kauai remains the exception, with a 14-day quarantine rule. However, at the Kauai Beach Club, for example, guests can move around the resort as long as they stay on campus, though it is still somewhat restrictive. I wish I had clearer insight into the mayor of Kauai's plans. As it stands, they indicate a possible easing of restrictions by the end of March, but we informally hear that it might be extended further. They want to ensure that most of their population has been vaccinated. Meanwhile, our sales centers and the other islands are open, and as occupancy rates rise, we anticipate continued positive trends. For instance, last week, Maui had an occupancy rate of 75%, while Oahu reached 85%, in contrast to Kauai's 20%. We are fairly optimistic about Hawaii's recovery; it's a key market for us regarding both our combinations and our sales representatives. We believe we are beginning to see a rebound, and Hawaii continues to be a highly desired destination for most of our owners.

Patrick Scholes, Analyst

Yes, absolutely. And I aspire to be there in July of this coming summer...

Steve Weisz, CEO

There you go.

Patrick Scholes, Analyst

Thank you. John, could you share your expectations and thoughts regarding potential securitizations for this year? Thank you.

John Geller, CFO

Yes, sure. We're targeting one here in the second quarter. Just from kind of where rates are today, we see potentially some significant improvement even over the cost of funds we did last year of, call it, 2.5%. So we still got a few months here, obviously, before we execute that deal. But the demand's there. We've seen spreads continue to tighten since the deal we did last year. So the setup looks pretty good right now. And no different than we've done in the past. As recovery comes back, we'll target in that, call it, $350 million, $400 million type securitization. And once again, similar to last year and what we've done historically, we expect probably in the 98% advance rate.

Patrick Scholes, Analyst

Okay. Good to hear. Thank you very much.

John Geller, CFO

Yes.

Steve Weisz, CEO

Thanks.

Neal Goldner, Host

Rob? Jared? Are you there?

Jared Shojaian, Analyst

Hello. Can you hear me?

Steve Weisz, CEO

Yes. Little technical snafu there. Good morning.

Jared Shojaian, Analyst

Good morning, everyone. Thanks for taking my question. So you talked about reservations being up 8% in the back half of the year versus 2019. Hypothetically, assuming that largely materializes and reservations end up coming in pretty similar to 2019, and we assume the world is largely back to normal. Can you help us think about what that translates into for contract sales and revenue relative to 2019? Because, obviously, I know there's a little bit of a lag. You're not going to have the same level of new owner sales. I think the financing portfolio is obviously smaller today than it was then. So I think we're kind of struggling to understand what that revenue ramp is going to look like, assuming the forward bookings end up materializing. So anything you can kind of share to help us think about those puts and takes would be helpful.

John Geller, CFO

Sure, it's John. I'll walk through different aspects of our business. As we have always mentioned, the majority of our sales occur on-site. Therefore, as occupancies improve, along with a mix of owners, packages, tours, and rentals, this is advantageous since we generate over 80 percent of our sales from guests staying at the resort. If occupancies return to previous levels, that should be beneficial. I anticipate a larger proportion of owner usage in the latter half of the year compared to package tours, and we're navigating that situation. There are both benefits and drawbacks. Owner sales tend to have higher VPGs and are more efficient, though they usually result in a lower first-time purchase average. We are also focused on rebuilding our market pipeline, which involves reopening connections at many of our resorts. However, we are going to limit the revival of certain off-premise contacts, particularly in Orlando and Myrtle Beach related to Sheraton. While this isn't a large percent of tours, we're not aiming to bring back less efficient tours. This change will likely reduce costs in the future and enhance our VPGs. If you look at a run rate in the fourth quarter, you should see contract sales approaching the levels of 2019, with great potential for improvement as we enter 2022. Other segments of the business will also bounce back with increased occupancies. Currently, we're somewhat lacking in on-site ancillary businesses, so as those occupancies rise in the third and fourth quarters, we should be able to boost that ancillary profit and see year-over-year growth. On the financing side, despite the decline in notes receivable balance, we anticipate financing profit in the first quarter to remain stable compared to the fourth quarter. As sales rebound and we grow the notes receivable balance later this year, we expect financing profits to also start increasing as we progress towards the end of the year and into the next. Another significant consideration is rentals, where we expect continued pressure in the second half of the year due to owners wanting to stay. We are experiencing lower occupancy in the first quarter and fewer nights booked currently. This owner compression will affect our capacity to pursue open market rentals. However, the positive aspect is an increase in owners staying at the resort will aid contract sales. It might not be a detrimental trade-off, but rentals will take longer to recover through 2021. As we move into 2022, assuming occupancies normalize, much of this compression will begin to resolve. Meanwhile, we are observing sequential growth in the exchange and third-party management sectors, which we hope will continue to progress upward. This segment was less affected revenue-wise compared to the VO business, showing resilience. Additionally, our G&A and other synergies will support our recovery moving forward.

Steve Weisz, CEO

Hey Jared, let me add one more point, which I don't think will surprise you. In 2019, I don't have the exact figure in front of me, but I believe our linkage sales—those from guests staying in hotels in areas where we have sales centers—were nearly a couple of hundred million dollars. As hotel occupancy continues to lag behind our recovery, we may have fewer people to target and recruit for tours. This presents an additional challenge we need to address. However, I believe everything that John explained aligns with my perspective. As I mentioned in my remarks, I'm very optimistic about how this year is developing and what it will bring for us towards the end of the year.

Jared Shojaian, Analyst

Okay. Thank you very much for that. And then, John, just going back to the first quarter, you gave a lot of really helpful commentary on a bunch of different line items, which I'm going to have to go back and aggregate. But at a high level, to summarize, you did $72 million of adjusted EBITDA in the fourth quarter. Do you think first quarter is higher or lower than that number based on all of the puts and takes you gave us?

John Geller, CFO

Yes, it will be lower mainly due to revenue reportability. As the business recovers each quarter, keep in mind that in a typical year, the first quarter often shows negative revenue reportability because the end of February and March usually have higher contract sales compared to November and December. However, even though contract sales may be higher, the benefits are not realized until the second quarter when those sales close. In a recovery scenario, this effect is magnified. You not only have the usual seasonal patterns from November and December, but you also see an acceleration in sales from quarter to quarter, making the differences more pronounced. If the recovery continues, this pattern will likely be evident every quarter. For the full year, given the situation in 2020, we expect to see heightened negative reportability. This is primarily just a matter of timing regarding when sales occur and when they are reflected in the profit and loss statements. That's why we report contract sales, as it's a better leading indicator of business activity, even though reporting lags behind. Aside from that, there are synergies that help mitigate cost increases, and we are starting to reinstate bonuses that were previously eliminated in 2020. Depending on future actions by the Biden administration regarding COVID relief, we anticipate receiving fewer tax credits from retention incentives compared to past packages. Additionally, we are still in the process of fully returning our workforce, aligning with top line growth. So yes, from a cost perspective, there are various elements that will continue to evolve as recovery progresses.

Jared Shojaian, Analyst

Okay. Thank you very much for all that color. I'll jump back on the queue.

John Geller, CFO

Yup.

Operator, Operator

Our next question comes from Ben Chaiken with Credit Suisse. Please proceed with your question.

Ben Chaiken, Analyst

Hey. Thanks for taking my question. How's it going? Just to clarify, Jared's question. So maybe looking just at the VOI business. Should contract sales follow bookings, which I think you said in the back half of the year was plus 8% for the back half of the year, or higher or lower, sorry, just maybe had a little bit of trouble following that? Sorry.

Steve Weisz, CEO

I want to clarify that our bookings for the second half of the year are 8% higher than they were at this time in 2019, which indicates the relative demand during that period. Since 80% of our sales come from in-house clients, it can be inferred that the pace of sales growth will continue to increase as we move into the following quarters leading up to the first quarter.

Ben Chaiken, Analyst

Got it.

John Geller, CFO

Yes. Think just to, Ben, on the occupancy, right? Just take fourth quarter North America occupancy, which I think was in 60%...

Steve Weisz, CEO

North America was 7%.

John Geller, CFO

If occupancy reaches over 90%, as it typically does, the current bookings indicate that we're heading in that direction. We still need to observe how the recovery unfolds. Occupancy is increasing approximately 40%, and this will be a key factor in driving contract sales relative to our past performance. The eight-point difference highlights our position today compared to the same time in 2019, but the more significant aspect is the recovery of occupancy from our current levels to that 90% range, which is what we achieved in 2019.

Ben Chaiken, Analyst

I understand. That makes sense and is helpful. I have a quick question regarding the $200 million in synergies. Can you provide a high-level overview? I'm curious about how much of that $200 million would be additional to what you achieved in 2019, considering you've been working on this for a couple of years now. I'm just trying to clarify.

John Geller, CFO

Yes, I mean, in 2019, I'm looking at Neal here; I want to say we add $40 million to $50 million of in-year savings of that $200 million. We can get to the actual number, Ben. So it would be that to the $200 million, right, apples-to-apples, when you get a full year run rate of the $200 million, it would be something in that $150 million, plus or minus, I think, of incremental as you think about 2019 actuals.

Ben Chaiken, Analyst

Great. Appreciate that. Thanks. That's all for me.

Operator, Operator

Our next question comes from Brandt Montour with JPMorgan. Please proceed with your question.

Steve Weisz, CEO

Hi, Brandt.

Brandt Montour, Analyst

Hey. Good morning, everyone. How are you? Thanks for taking my question. So just thinking about the sequential lift in the 1Q or the sequential progression in the 1Q versus the 4Q. I just wanted to understand if that is coming from one or two markets, one or two large markets that are improving or if it's more broad-based? What did you sort of assume in that guidance?

Steve Weisz, CEO

No, it's clearly more broad-based. As you will recall, we sell a portfolio product, so each one of our sales centers is selling the same product that we are elsewhere. We're seeing demand increase across the board, not focused on any one particular area. However, it will be interesting to see how quickly Europe and Asia Pacific respond. In Europe, there are still cross-border restrictions, and we'll see how long it takes to resolve that. In Asia Pacific, most activity is within individual countries, limiting international travel. That said, the vast majority of our sales depend on what happens here in North America, and we see that growing nicely.

Brandt Montour, Analyst

Okay. That's great. Thanks for that. And then on the consumer loan book, and John, I think you sort of wrapped this up by giving us the recent delinquency rates. But just wanted to maybe close the loop; it sounds like there's no sort of incremental reserves that would need to be taken unless something really bad happens. So I guess the question is, what would you have to see this year so far for a situation for you to take more excess reserves?

John Geller, CFO

Yes. I mean, clearly, I think you'd have to see something more broadly from an economic impact. Remember, we took that reserve back in May, end of April, right, with our first quarter with very limited visibility. We told you at the time that the other reserve actually was based on not only what we saw but what the Vistana business saw, which we didn't own at the time, right? So we didn't know all their marketing practices and what they were doing. But coming out of the financial crisis, obviously, not the best comparison, but it was the best we had, right? And we looked at what defaults did back then. And obviously, the portfolio is different. Our portfolio is different coming into COVID than what was coming out of the financial crisis. So there were variables in there. And we took our best estimate as we've looked at it, Brent. I mean, we think this is what we need. Delinquencies, as we mentioned, we're basically at the end of the year back to pre-COVID delinquency levels. And even over the last, call it, 30 to 45 days, we've seen delinquencies by brand come down another 30, 40 basis points. So in a lot of cases, below right, back where we were pre-COVID last year. And the other final point I'd make on that is which is on a declining notes receivable balance, meaning that's a headwind, right? As you originate new notes and you're growing the balance, your delinquencies, apples-to-apples because you have more newer notes, would generally trend down, right? We're on a declining, and we continue to trend down. So I think it all frames up. It's what we think we need here going forward. But yes, I mean, we feel like we got a little bit better sense as to how the notes have performed over the last eight or nine months, obviously, with the impact of COVID.

Brandt Montour, Analyst

Makes sense. Thanks a lot, guys.

Steve Weisz, CEO

Thank you.

Operator, Operator

Our next question comes from Jared Shojaian with Wolfe Research. Please proceed with your question.

Steve Weisz, CEO

Welcome back.

Jared Shojaian, Analyst

Thank you for taking my follow-up. You mentioned the excess inventory you have, totaling $580 million, and that you anticipate considerable free cash flow over the next few years. Could you help us understand how to approach this in terms of historical conversion rates compared to what you expect moving forward? Alternatively, is there a specific figure for free cash flow that should exceed what is typically expected? How should we view the relationship between that excess inventory and the potential for additional free cash flow?

John Geller, CFO

Sure. Historically, if we look at our adjusted EBITDA with more normalized cash flow, we've been converting around 55%, give or take. By normalized free cash flow, I mean that from an inventory standpoint, you're replacing what you're selling from the inventory spend, resulting in a net neutral rate regarding free cash flow. Regarding conversion, interest expense is somewhat fixed, so EBITDA needs to return to the levels seen in 2019 to achieve a similar conversion rate for interest expense. Taxes are linked to EBITDA and are more variable, which allows some flexibility in considering cash taxes as a percentage of EBITDA. Additionally, we've typically allocated around $80 million to $100 million for corporate CapEx. As the business recovers, we'll aim to manage that lower, returning to more normalized levels as growth continues. The levers to consider here are that as EBITDA returns to around 2019 levels, a conversion rate of 55% plus or minus will be supported by that additional $580 million. This will enhance the conversion over time. We will also continue buying back inventory favorably on the secondary market. This is expected to be a multiyear recovery, but the potential represented by the $580 million will contribute positively to your conversion ratio.

Jared Shojaian, Analyst

Got it. Okay. Thank you for that.

John Geller, CFO

Yup.

Jared Shojaian, Analyst

And then I wanted to ask about the comment you made about one of the Interval customers chose not to renew. I know that's largely immaterial bottom line impact, what you were saying. But can you help us understand and think about the risk of other customers choosing not to renew, and I guess what gives you confidence that this was kind of an isolated event rather than a potential new trend?

Steve Weisz, CEO

Yes. First, we're not aware of any other significant affiliate of Interval choosing not to renew or considering alternative options. Typically, in the exchange business, it's mainly Interval and RCI competing for market share. If an affiliate leaves RCI for Interval or the other way around, it's usually just a shift. In this case, this affiliate has opted out of working with any external exchange company, believing that their individual portfolio is robust enough to meet the vacation needs of their owners. Time will tell if this approach is effective. Moreover, back in 2010 when we transitioned to points, we established our own internal exchange system, allowing guests to move between Marriott-branded resorts without going through Interval. This decision by the other developer might be similar. We will see what happens. We maintain our connection with Interval because there are destinations where we don't have products or vacation options that people want, which gives us an advantage with both exchange companies. Personally, I believe Interval is the superior exchange company. Nevertheless, this is their decision, and we are not aware of anyone else considering a similar move.

Jared Shojaian, Analyst

Great. Thank you so much for taking the time.

Steve Weisz, CEO

Thank you.

John Geller, CFO

Thanks, Jared.

Operator, Operator

We have reached the end of the question-and-answer session. At this time, I'd like to turn the call back over to Steve Weisz for closing comments.

Steve Weisz, CEO

Thank you, everyone, for joining our call today. 2020 was certainly a difficult year for the hospitality industry, but it also proved how strong our business model really is. People like to vacation. And when they own their vacations, they try to find a way to use it. You really don't need to look much further than fourth quarter results and see just how resilient our business really is. Our North America resort occupancy has averaged nearly 70% during the fourth quarter in the midst of a pandemic. Total contract sales increased 27% sequentially. Interval exchange transactions grew 17% on a year-over-year basis. Adjusted EBITDA margin improved nearly 650 basis points sequentially from the third quarter. And our run rate cost savings grew to roughly $135 million in 2020, nearly double where we were at the end of 2019 and taking us even closer to our goal of at least $200 million in savings. Looking forward, our tour pipeline is now more than 165,000 packages sold with more than 50,000 of those customers already booked for this year. And reservations on the books for the second half of this year are 8% higher than at the same time in 2019, illustrating the pent-up demand we think will start to manifest itself later this year. As always, thank you for your interest in Marriott Vacations Worldwide, take care of yourselves. And finally, to everyone on the call and your families, stay safe and enjoy your next vacation.

Operator, Operator

Thank you. This concludes today’s conference. You may disconnect your lines at this time, and we thank you for your participation.