Greetings. Welcome to Marriott Vacations Worldwide second quarter 2018 earnings conference call. At this time, all participants are on a listen-only mode. A question-answer session will follow the formal presentation. If anyone should require operator assistance during the conference, please press star zero on your telephone keypad. As a reminder, this conference is being recorded. It is now my pleasure to introduce your host for today's call, Jeff Hansen, Vice President, Investor Relations. Thank you. You may begin.
Thank you, Rob. Welcome everyone to the Marriott Vacations Worldwide second quarter 2018 earnings conference call. I'm joined today by Steve Weisz, President and Chief Executive Officer, and John Geller, Executive Vice President and Chief Financial and Administrative Officer. I do need to remind everyone that many of our comments today are not historical facts and are considered forward-looking statements under 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 this morning, along with our comments on this call, are effective only today, August 2nd, 2018, 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 on our website at ir.mvwc.com. I will now turn the call over to Steve Weisz, President and CEO of Marriott Vacations Worldwide.
Thanks, Jeff. Good morning, everyone. Thank you for joining our second quarter earnings call. It's been an active summer for us as we continue to achieve the many milestones required to close on our acquisition of ILG, which we expect to complete later this month. Before I step through our progress as it relates to the transaction, let me take a few minutes to provide some background on our performance in the quarter, much of which we released last week. I'll hand the call over to John to share additional detail about the quarter, after which we will be happy to take your questions. In the second quarter, company contract sales were $233 million, up more than 8% over the second quarter of last year. Adjusted EBITDA was $76 million, a decrease of almost $8 million over the second quarter of 2017.
This stemmed from expected revenue reportability impacts, which John will speak to in more detail in a moment. In North America, contract sales improved 8%, driven by a 3% improvement in VPG to $3,672 and a 5% increase in tour flow. Tour flow to first-time buyers continues to grow, improving 5% over the second quarter of last year. As we mentioned last quarter, we are substantially past the impacts from last year's hurricanes, opening our new units on Marco Island and a temporary sales center on St. Thomas during the first quarter. With that said, it is important to keep in mind that the lack of hotel linkage tours in St. Thomas and the smaller on-site sales center will continue to impact our ability to generate sales there, and we expect it will deliver less than half the volume generated under normal operations for the full year.
Adjusting for these hurricane-related impacts, we believe second quarter total company contract sales would have improved 10% over the second quarter of last year. Staying with contract sales, our tour package programs improved over last year, driven primarily by growth from our Encore and Call Transfer programs. Looking out through the remainder of the year, our pipeline for these package tours remains very strong, up more than 14% over last year. Even more importantly, activated tours from these programs in the second half of 2018 are up over 19% compared to last year, giving us confidence in our ability to drive the top-line growth. As it relates to our newer sales centers, which have opened since 2016, I'm very pleased with how they are performing.
While they each have their own pace of sales growth, as a whole, they are ahead of initial expectations and well on their way to achieving their longer-term contract sales targets. Additionally, we continue to look for new destinations with strong on-site sales potential and are pleased with the progress at our newest destination in San Francisco, which we plan to open early next year. In our Asia Pacific segment, contract sales were up 19% over the second quarter of last year. I am pleased to report that our sales center in Bali opened in the second quarter, and while very early, is off to a good start. Our location in Surfers Paradise is ramping up well as it begins its third year of sales.
As is expected at this stage of our growth in the region, our bottom-line results are affected by the ramp-up costs from both Surfers Paradise and our new Bali location, as well as the impact of unsold maintenance fees from new locations on the rental results. While the Asia Pacific segment is relatively small, we remain focused on growing our presence in this region through new destinations. This includes our second location in Bali, which is progressing towards an expected completion early in 2020. These new destinations and potential future destinations will drive top-line growth and improve results from increased scale. Let me spend a moment on our contract sales guidance relative to what you've just heard.
With the majority of the negative impacts from last year's hurricanes behind us and our first sales center in Bali now open, we are pleased with our performance in the first half of the year and are poised to drive even more improvement in the second half of 2018. We expect our newer sales centers to continue to provide solid incremental contract sales growth and activations in our tour package pipeline in the third and fourth quarter of this year continue to grow. Additionally, we will face an easier comparison to last year as we lap the hurricane impacts from the fourth quarter, which negatively impacted contract sales by over $20 million. When we put all of this together, it highlights why we expect double-digit contract sales growth for the second half of 2018, and why we remain confident in our full-year guidance range of 7% to 12% growth.
Let me turn to our progress on the acquisition of ILG and our integration planning efforts. The last significant closing conditions are the shareholder votes, which I am pleased to report are scheduled for August 28th for both the ILG and MVW shareholders. Assuming all other remaining conditions are satisfied, we expect to close on Friday, August 31st. This is an exciting time. Our integration team has been working very hard putting together the plans necessary for us to start on day one as a newly combined company designed to drive future growth and shareholder value. As you can probably imagine, shifting the closing up by roughly a month from our initial expectations has caused the same amount of effort to be put into a shorter amount of time.
This has not diminished our focus, however, which is to create a transformational change to our businesses to drive shareholder value by combining two of the premier vacation ownership and hospitality companies in the world. Upon closing, we will have the rights to market and sell vacation ownership under seven upper upscale and luxury vacation brands with 110 locations worldwide and 650,000 owners. In addition to this, we will serve almost two million exchange members around the world through the Premier Exchange network of Interval International. Last, but by no means least, we will manage over 200 properties across the globe through VRI, Trading Places International, and Aqua-Aston Hospitality. As a combined company, on a pro forma basis, we expect to generate more than $4 billion of total revenues and Adjusted EBITDA of over $750 million, including $75 million in synergies, creating a global leader in our industry.
We are hard at work on plans to achieve our synergy goals, including plans to take advantage of top-line growth opportunities, which we believe are the most compelling reasons for bringing our two companies together. We expect the combined company will benefit from additional tour generation from broader linkage opportunities as well as an ability to maximize tour generation from our Call Transfer and Encore programs, driving continued growth in our tour package pipeline. Additionally, as you've heard us say before, we are very excited about the digital marketing opportunities that lie ahead for the combined company, which we expect to be a driver of our long-term growth. To repeat a comment I made after our announcement last quarter, for all of these reasons I just laid out and more, we see our combination with ILG as a clear win for our shareholders, owners, and associates.
Now let me hand the call over to John to walk through further detail on our second quarter results. John?
Thank you, Steve, and good morning, everyone. I am very pleased with our strong second quarter results. Adjusted EBITDA totaled $76 million and reflects year-over-year growth from our resort management, financing, and rental businesses. Contract sales grew by 8% in the second quarter. However, our development margin reflected lower year-over-year results due to nearly $10 million of unfavorable revenue reportability. As I mentioned on our last earnings call, with the adoption of the new revenue recognition accounting standard this year, we now recognize development revenue when contract sales are closed, which ends up deferring revenue from when it was previously recognized by roughly 35 days.
In our 2018 second quarter, while we did benefit from the recognition of revenue deferred from the first quarter, that benefit was more than offset by a higher deferral in the second quarter as contract sales in the last 35 days of the second quarter were stronger than at the end of the first quarter, resulting in $3 million of unfavorable revenue reportability. In contrast, in our second quarter last year, we had $7 million of favorable revenue reportability, as last year benefited from higher unclosed contracts at the end of 2016. In our development business, contract sales were up over 8% to nearly $233 million in the second quarter, driven by an 8% increase in sales in our North America segment and a 19% increase in our Asia Pacific segment. As Steve mentioned, the 2017 hurricanes continued to have a negative impact on our second quarter performance.
Adjusting for that estimated impact, total company and North America contract sales would have each grown nearly 10%. Our development margin in the first quarter was $39 million, down $13 million to the prior year. Adjusting for the impact of revenue reportability in both years, adjusted development margin was $42 million, $3 million less than last year, and adjusted development margin percentage was 20% compared to 23% in the prior year. The margin decline in the quarter was driven primarily by a 230 basis point increase in product costs, resulting from a higher mix of new inventory being sold.
While our development margin for the first half of the year has been below our targeted level of over 20%, our development margin in the second half of the year is projected to benefit from a lower product cost, reflecting a higher mix of reacquired inventory being sold, as well as from higher sales and revenue reportability, which allows us to leverage our fixed marketing and sales costs. As a result, we expect total company development margin to be in excess of 20% for the full year. In our financing business, revenues increased $3 million, or 10%, to $36 million in the second quarter of 2018. Financing revenue, net of expenses and consumer financing interest expense increased $2 million, or 11%. This reflects a $4 million increase in interest income from our growing notes receivable balance, partially offset by additional costs from our financing incentive programs.
Our notes receivable portfolio continues to perform very well. The average FICO score of buyers who financed with us in the quarter was 739, while delinquency rates remain near historic lows and financing propensity remains strong at nearly 63%. During the quarter, we successfully completed a $436 million note securitization at a blended interest rate of 3.52% and a 97% advance rate. The transaction generated $423 million of gross proceeds. As of June 30th, $106 million of the proceeds were included in restricted cash until we deliver the remaining notes receivable in accordance with the terms of the securitization. Last week, we sold an additional $57 million of the notes to the trust and received $55 million. We expect to sell the remaining notes and receive the remaining funds of $51 million by the end of September.
In our rental business, rental revenues increased $5 million, or 8%, to $75 million. Rental revenues net of expenses were $12 million, a 2% increase from the prior year. These results reflect a 2% increase in transient rate and a 1% increase in transient keys rented. This was partially offset by $2 million of higher unsold maintenance fees and a 1% increase in preview room nights, as we continue to dedicate more rental inventory for our tour package arrivals. With our growing tour package pipeline, this activity will continue to grow for the foreseeable future, impacting our rental margins while driving contract sales growth. In our resort management and other services business, revenues increased $6 million, or 8%, and resort management and other services margin improved $4 million, or 12%, to $37 million in the quarter.
These results were driven by higher fees for managing our portfolio of resorts and higher internal exchange company activity. G&A costs were up $3 million in the quarter, reflecting normal inflationary cost increases, as well as higher technology spending and higher litigation-related expenses. Royalty fees were down slightly from the second quarter of 2017, driven by the reduction in the fixed portion of our royalty fee resulting from the amendments to our license agreement with Marriott International in the first quarter of 2018, partially offset by a higher mix of new inventory being sold. Moving to our balance sheet at the end of the quarter, cash and cash equivalents totaled $548 million. We also had approximately $40 million of gross vacation ownership notes receivable eligible for securitization and roughly $248 million in available debt capacity under our $250 million revolving credit facility.
Our total net debt outstanding at the end of the quarter was roughly $1.3 billion, consisting primarily of $1.1 billion associated with our non-recourse securitized notes receivable and $196 million associated with our convertible notes. Turning to our outlook for 2018. As Steve mentioned, given what we've achieved year to date and considering an easier year-over-year comparison in the second half of the year from the 2017 hurricanes, we are reaffirming our full-year 2018 guidance for contract sales growth of 7%-12%.
With respect to Adjusted EBITDA, based on our full-year contract sales growth projections, including double-digit growth expected in the second half of 2018, development margin expansion that we are expecting in the second half of the year from the turnaround of unfavorable revenue reportability, lower-cost inventory being sold, and from the benefit of marketing and sales cost efficiencies, as well as the realization of the benefits from the amended agreements with Marriott International, we continue to expect that we will generate Adjusted EBITDA of between $310 million and $325 million. Given lower projected inventory spending as well as higher-than-expected proceeds from our term securitization, we are increasing our adjusted free cash flow guidance by $15 million to a new range of $200 million-$230 million for the full year 2018.
As we've done in the past, we will continue to identify further ways to maximize cash flow in 2018 by deferring inventory and CapEx spending when possible. Let me take a moment to update you on the status of our insurance claims related to Hurricane Irma and Hurricane Maria that occurred last fall. We are pleased to say that all the properties and sales centers impacted by the hurricanes are up and running at this time, with the exception of The Ritz-Carlton Club Resort in St. Thomas, which is expected to open in the fourth quarter of 2018. We also continue to work with our insurance providers and expect to submit a claim in the third quarter for our business interruption losses, as well as property damage experienced by both us and our owners associations from the hurricanes.
I should note our Adjusted EBITDA and adjusted free cash flow guidance do not reflect the receipt of any insurance proceeds for our business interruption losses. We will continue to update you as these efforts progress. As Steve mentioned, we're making great progress towards meeting the conditions to close on the ILG transaction, with the key remaining condition to close being the approvals by the shareholders of both MVW and ILG. We've been working on debt financing to fund the cash portion of the acquisition price, and we expect to receive corporate ratings at closing of Ba2 and BB, with stable outlooks from Moody's and S&P, respectively. With a targeted closing date of August 31st, 2018, associates from both companies continue to work hard to not only ensure day one readiness for the new organization, but also to complete planning for the longer-term integration of the two businesses.
Lots of work to get done, in a very exciting time. We started the year with a solid first half. Our new sales centers continue to ramp up nicely. Our marketing programs are generating excellent tour flow, VPG remains strong, even with our continued focus on growing first-time buyers. As a result, we continue to feel confident that 2018 will be a great year for us. As always, we appreciate your interest in Marriott Vacations Worldwide. With that, we will open the call up for Q&A. Rob?
Thank you. At this time, we'll be conducting a question and answer session. If you'd like to ask a question, please press star one on your telephone keypad. A confirmation tone will indicate your line is in the question queue. You may press star two if you'd like to remove your question from the queue. For participants using speaker equipment, it may be necessary to pick up your handset before pressing the star keys. One moment, please, while we poll for questions. Our first question is from Cameron McKnight with Credit Suisse. Please proceed with your question.
Hi. Good morning.
Good morning.
Thanks very much. A question maybe for John or perhaps Steve. A few quarters ago, you gave commentary on the contribution to sales growth from the new assets. Are you able to give us an update in terms of what those newer assets are contributing to contract sales growth?
This is Steve. I assume you're referring to our new sales center?
Correct.
On a percentage basis of the eight points, roughly half of that, call it four points, is because of the new sales centers.
Got it. Thanks very much. Just as a follow-up, in terms of the linkage agreements that you've been signing for the past few quarters now, are you able to give any directional indication in terms of how those linkage agreements are contributing?
I think it's still relatively early on some of the new stuff that we've added. As you might imagine, as we've been sorting through the integration efforts with ILG, et cetera, we've kind of throttled back a bit on getting out aggressively signing up new linkage agreements until such time as this gets closed. We're still very encouraged, not only about what the potential holds there for us, but also about what in the various markets where we want to add additional tour flow generation from people that are in market at the time. We're very encouraged by that. We just haven't had much of a chance to do a great deal more. It takes a while from the time that you make the initial contact.
We first have to go through Marriott to get their approval to do it, then we have to work with local hotel ownership to negotiate a presence, get it contracted, et cetera. It just takes a little while to get them put together.
Understood. Thanks very much.
Thank you.
Our next question comes from Patrick Scholes with SunTrust Robinson Humphrey. Please proceed with your question.
Hi.
Good morning, Patrick.
Good morning, gentlemen. That $75 million of Interval synergies, how are you feeling about that now? Is that going to be beatable?
Well, yeah. We've said all along, as you'll recall, that we said it's a minimum of 75. As we've gotten more visibility into it, we feel increasingly positive about not only our ability to make that number, but to exceed that number. As you might imagine, now with kind of 30 days or less of runtime between now and getting the closing in place, we're still trying to get more visibility in a shorter amount of time. We feel very good about it. I would underscore once again, while cost savings are certainly something that you hope to produce as a result of this acquisition, the real upside for us that we see is on the revenue side.
Is it fair to think that perhaps the revenue side of it could eclipse the cost-saving side? I mean, is that-
That would be my expectation. Having said that, we're still kind of working through the various areas in terms of not only what the opportunity is, but how to go after them in sequence to get the biggest bang for the buck.
Okay. On the combined digital marketing, do you have a rough timeline of when that's going to be up and running?
Well, yeah. I think I may have reported even in the last call.
Okay.
A lot of this has to do with Marriott's ability to turn their attention to it. As I think you probably have heard, they have an August 18th date to combine the two loyalty programs, so they're right in the midst of trying to figure out. They're not only figuring out, but they're executing on the system side of things, on the loyalty side. The next thing they have to do is just try to find a way to combine the two reservation platforms. We've been told, and we've known this for some time, that Marriott is very committed to turning to this, but it will have to fall in sequence behind their priority of getting the reservation system.
Our expectation is that they'll start to begin to focus on this more probably in the first quarter of next year, and then we'll see how long it takes to produce it.
Okay. Last question, I might have actually asked this last earnings call, but on the Interval what they laid out in their 2020 projections due to the conversion of those hotels, do those projections continue to be on track?
Yeah. Obviously, we haven't closed on the transaction.
Okay
yet, Patrick, once we do, obviously, we'll be updating you on kind of the outlook of how we're thinking about a lot of the Interval stuff. Today, we're not prepared to comment on that.
Okay. Fair enough. Thank you.
Thank you.
Our next question comes from Edward Engel with Macquarie Group. Please proceed with your question.
Good morning.
Hi, thank you for taking. Good morning. Thanks for taking my question. Just into the digital marketing opportunity, have you put any more thought into potentially quantifying that opportunity? In the long run, do you think it could be potentially as big as maybe the Marriott Rewards SPG loyalty program merger?
Well, let me try to separate the two pieces. Clearly. Let me start with the second one first. As the two loyalty programs have come together as this merger gets closed, we'll have the ability to market to not only the Marriott Rewards members but also to these SPG members. We think that obviously is a very important generator of potential tours for us and ergo sales. We're very encouraged about that. As far as the digital marketing opportunities, let me just remind you what that is. Today, we have a Call Transfer program in place, which means when somebody calls one of Marriott's reservation centers and they want to book a hotel room for a normal stay, whatever, they're given the opportunity to understand a value vacation opportunity with Marriott Vacations, call that a mini vac, and that call gets transferred to us.
If we do our job right, we interest them in booking a tour and hopefully then a sale thereafter. The digital marketing piece of that on the reservation side is taking that same concept and applying it to people that are booking on the digital analog to a Marriott call center, call it marriott.com. marriott.com is a very, very important, viable retail website. The ability to actually get to people there, which we heretofore have not had the ability to do and give them the same kind of opportunity to engage with us about booking a tour is really what this is all about. Given obviously the way the world has worked, more and more people are now booking their hotel reservations online versus booking them over the phone.
We have every expectation that this will be as good or better than the Call Transfer program that we've been successful with the last couple of years.
I guess, what makes this opportunity different than maybe just an umbrella marketing strategy which traditionally hasn't really worked in the timeshare industry?
Well, first of all, you've got loyal Marriott, and now cast that umbrella larger because it's not only the traditional Marriott customers through the various Marriott brands, but also all the former Starwood brands that are now under this umbrella. 30 brands of loyal customers that are engaging in commerce with the hotel company. We know that loyal customers have a tendency to have a stronger affinity to accept one of our offers than people that we go out broad. We've never been active, so to speak, in kind of broad net marketing campaigns trying to ferret out people by doing radio, TV, print advertising, things of that nature. We think this, just as the Call Transfer program has been successful for us, we think this digital version of that will be equally or better in terms of volume.
Great. Thanks. Just a quick housekeeping. When the ILG acquisition closes, are you still expecting three turns of net leverage, or with incremental securitizations, could that be a bit lower?
Well, the 3x, when you say net leverage, that's excluding securitization debt.
I guess the recent cash flows you've gotten, though.
I'm sorry, what about the recent cash flow?
The cash flows that you've gotten from the securitizations. Does that roll into that already?
Yeah. Those are all factored into our outlook, our cash that we knew we'd have generated by closing to use in terms of the additional debt we needed to raise. It's not a meaningful difference. On a net leverage basis, we'll probably be just south of 3 times, but not much at closing. Obviously, as we've talked about, our goal will be to continue to pay that down a little bit with excess cash flow to get to more of a 2 to 2.5 times, which I think gives us more flexibility in the future, too, for other growth opportunities, and giving us more flexibility just longer term with our balance sheet.
Okay, thanks. Just one last one. Have you ever given what % of your tours or your sales come from the Call Transfer?
No, we've not disclosed that.
All right, great. Thank you for the questions.
Thank you.
Great, [guys].
Ladies and gentlemen, we've reached the end of the question and answer session. At this time, I'd like to turn the call back to Steve Weisz for closing comments.
Thank you, Rob. Our performance for the first half of the year provided a foundation for a solid 2018. Contract sales are on pace for a strong second half. We are very close to closing on our acquisition of ILG. We have a lot to do in a short time to ensure a successful close at the end of August, but I have tremendous confidence in the teams on both sides to accomplish what needs to get done. I'll look forward to what the future will bring and to updating you on future calls as a combined company. Finally, to everyone on the call and your families, enjoy your next vacation.
This concludes today's conference. You may disconnect your lines at this time, and we thank you for your participation.