Marriott Vacations Worldwide Corporation: 2018 Second-Quarter Form 10-Q
Business context and reporting period
Unaudited quarterly report for the three and six months ended June 30, 2018, compared with the corresponding 2017 periods. The company develops, markets, sells and manages vacation ownership products and related services under Marriott Vacation Club, Grand Residences by Marriott, Marriott Vacation Club Pulse and Ritz-Carlton brands. It operated more than 65 properties across the United States and nine other countries and territories through North America, Asia Pacific and Europe segments.
The company adopted ASC 606 revenue recognition effective January 1, 2018, using retrospective adoption and restated prior-period results. Cost reimbursements are now presented gross, and vacation ownership sales are generally recognized at closing when control transfers.
Key financial metrics
| Metric | Q2 2018 | Q2 2017 | Six months 2018 | Six months 2017 |
|---|---|---|---|---|
| Total revenue | $594.7 million | $562.4 million | $1,165.5 million | $1,090.7 million |
| Income before taxes | $17.4 million | $71.1 million | $64.1 million | $115.0 million |
| Net income | $10.8 million | $48.2 million | $46.7 million | $76.1 million |
| Diluted EPS | $0.39 | $1.72 | $1.71 | $2.72 |
| Adjusted EBITDA | $76.1 million | $83.6 million | $138.9 million | $137.2 million |
| Operating cash flow | Not separately provided for the quarter | Not separately provided for the quarter | $58.5 million | $14.1 million |
- Q2 revenue increased 5.7%; six-month revenue increased 6.9%. Contract sales increased 8% in Q2 to $232.6 million and 5% in the first half to $436.3 million.
- Net income declined 77.7% in Q2 and 38.6% in the first half. The effective tax rate for the first half was 27.05%, compared with 33.83% in the prior-year period, benefiting from the Tax Cuts and Jobs Act.
- Development margin declined to 19.0% in Q2 from 25.6% and to 16.2% in the first half from 20.3%, primarily because of unfavorable revenue reportability, higher-cost inventory mix and increased marketing and sales costs.
- Resort management and other services margin improved to 47.1% in Q2 from 45.2% and to 46.7% in the first half from 44.8%. Rental margin was $11.8 million in Q2 and $30.1 million in the first half.
- Cash and cash equivalents were $547.7 million at June 30, 2018, compared with $409.1 million at December 31, 2017. Cash, cash equivalents and restricted cash totaled $718.2 million at period-end.
- Debt, net, was $1.332 billion, compared with $1.095 billion at year-end 2017. Gross debt was approximately $1.4 billion, including $1.114 billion of securitization debt, $230.0 million of convertible notes and a $30.9 million non-interest-bearing note payable.
- The $250.0 million revolving corporate credit facility had no cash borrowings outstanding, with $2.2 million of letters of credit outstanding. The company stated that it was in compliance with applicable covenants.
- Vacation ownership notes receivable, net, increased to $1.168 billion from $1.115 billion at year-end. The weighted-average stated interest rate was 12.2%, and the estimated average remaining default rate was 7.05%.
- Cash dividends declared were $0.40 per share in each quarter of the first half, or $0.80 per share year to date.
Material changes versus the prior comparable period
- Reported earnings were materially reduced by $16.3 million of litigation settlement charges, $6.7 million of losses from fraudulently induced electronic payments, and $19.8 million of costs associated with the pending ILG acquisition in Q2.
- Adjusted EBITDA decreased 9.0% in Q2 but increased 1.2% in the first half after excluding certain items. The filing excludes acquisition costs, litigation settlements and fraud-related losses from Adjusted EBITDA.
- North America contract sales increased 8% in Q2 and 5% in the first half. North America segment financial results declined to $106.4 million in Q2 from $122.7 million and to $214.4 million in the first half from $221.1 million.
- Asia Pacific contract sales rose 19% in Q2 and 11% in the first half, but the segment remained unprofitable, with financial losses of $3.1 million in Q2 and $4.2 million in the first half.
- Europe contract sales declined 3% in Q2 and 4% in the first half. Europe segment financial results fell to $2.1 million in Q2 from $4.8 million and to $1.3 million in the first half from $4.4 million.
- The company completed a $423.0 million securitization in June 2018. It issued $423.0 million of vacation ownership loan-backed notes, with a weighted-average interest rate of 3.52%.
- Operating cash flow improved substantially, while financing cash flow was $187.4 million, primarily reflecting securitization proceeds. Capital expenditures were $7.5 million in the first half.
Guidance, outlook, risks and unusual items
- Management expected 2018 financing propensity of approximately 60% to 65% and expected financing interest income to increase as new loan originations outpaced collections on existing notes.
- Management expected the 2018 annual effective tax rate to be approximately 25.69%, subject to finalization of provisional Tax Act accounting by the fourth quarter.
- The company agreed to acquire ILG, Inc. in a cash-and-stock transaction with an implied equity value of approximately $4.7 billion. ILG shareholders were to receive $14.75 in cash and 0.165 MVW shares per ILG share. The company expected closing by August 31, 2018, subject to approvals and other conditions, and planned to use cash and debt financing.
- Litigation matters included Kapalua Bay claims, Ritz-Carlton fractional-interest litigation, a putative class action concerning the Marriott Vacation Club Destinations program, and lawsuits challenging the ILG transaction. The company could not estimate potential liability for several matters.
- The company recorded a $10.6 million accrual for a settlement in the Petrick litigation and additional settlement accruals for Lake Tahoe and Europe matters.
- In June 2018, unauthorized third-party access to the company’s email system resulted in $9.9 million of fraudulent electronic disbursements. The company had recovered $3.2 million and expected to recover a significant portion of the remaining $6.7 million through fund recovery and insurance, but the investigation remained ongoing.
- Management concluded that controls over improper electronic funds transfers were not designed effectively and reported a material weakness in internal control over financial reporting. Disclosure controls were deemed ineffective at June 30, 2018; enhanced procedures were implemented, with remediation expected potentially in the third quarter.
- 2017 hurricanes continued to affect St. Thomas and other operations. The company expected to submit insurance claims for business interruption and property damage but could not quantify potential recoveries.
- Material commitments included approximately $495.2 million of purchase obligations, including commitments for New York, San Francisco, Marco Island and Bali properties. Total contractual obligations were approximately $2.15 billion.
- Other risks included vacation ownership loan defaults, reliance on securitization markets, acquisition financing and integration, cybersecurity and data privacy, Spanish timeshare litigation, foreign currency exposure, and the effects of seasonality.
Most important facts for investors to verify
- Whether the ILG acquisition closed on the expected timetable, and the resulting cash, debt, share-count and integration effects.
- Progress in remediating the material weakness and the amount ultimately recovered from the $9.9 million fraudulent-payment incident.
- Whether development margins recover from the Q2 decline and whether higher marketing costs and inventory mix continue to pressure profitability.
- Performance of vacation ownership notes receivable, including delinquency, default, reserve adequacy and future securitization capacity.
- Final Tax Act accounting, the effective tax rate and any transition-tax liability.
- Potential exposure from outstanding litigation, including Kapalua Bay, fractional-interest claims, Spanish timeshare matters and lawsuits challenging the ILG transaction.
- Funding requirements for the $495.2 million of purchase obligations and the impact of acquisition financing on leverage and liquidity.