MARRIOTT VACATIONS WORLDWIDE Corp quarterly report, Q3 FY2018

Business Context and Reporting Period

Marriott Vacations Worldwide Corporation filed this unaudited Form 10-Q for the quarter and nine months ended September 30, 2018. The company operates vacation ownership, resort management, rental, financing, exchange and third-party management businesses through its Vacation Ownership and Exchange & Third-Party Management segments.

On September 1, 2018, the company completed its acquisition of ILG, LLC for approximately $4.6 billion of aggregate consideration, including approximately $2.4 billion of cash consideration, $2.5 billion of MVW stock issued and assumed or converted equity awards. The reported results include only 30 days of Legacy-ILG operations.

Financial Performance and Key Metrics

Metric	Q3 2018	Q3 2017	9M 2018	9M 2017
Total revenue	$750 million	$530 million	$1.916 billion	$1.621 billion
Net income attributable to common shareholders	$(58) million	$40 million	$(11) million	$116 million
Diluted EPS	$(1.75)	$1.45	$(0.37)	$4.18
Operating cash flow	Not separately provided	Not separately provided	$67 million	$71 million
Adjusted EBITDA	$100 million	$74 million	$239 million	$211 million
Development margin percentage	22.5%	23.8%	19.3%	22.1%

Q3 revenue increased 42%, while nine-month revenue increased 18%. Excluding Legacy-ILG, management reported revenue growth of 16% in Q3 and 10% for the nine-month period.
Vacation Ownership revenue was $709 million in Q3 and $1.875 billion for nine months. Exchange & Third-Party Management contributed $40 million in each period, reflecting one month of ILG activity.
Q3 revenue included $252 million from vacation ownership product sales, $126 million from management and exchange, $90 million from rental, $48 million from financing and $234 million of cost reimbursements.
Q3 net loss included $108 million of ILG acquisition-related costs, $17 million of litigation settlements, $14 million of interest expense and a $10 million tax benefit. Nine-month acquisition-related costs were $128 million and litigation settlements were $33 million.
Q3 Adjusted EBITDA increased $26 million to $100 million; nine-month Adjusted EBITDA increased $28 million to $239 million. These are non-GAAP measures and exclude specified acquisition, litigation, share-based compensation and other items.
Contract sales increased 18% to $283 million in Q3 and 9% to $719 million for nine months. Excluding ILG, contract sales increased 18% in Q3 and 9% for nine months.
Legacy-MVW North America volume per guest increased 9% to $3,781 in Q3 and 4% to $3,727 for nine months. North America tour flow increased 7% in Q3 and 5% for nine months.
Cash, cash equivalents and restricted cash totaled $806 million at September 30, 2018, including $441 million of unrestricted cash and $365 million of restricted cash.
Total assets increased to $9.013 billion from $2.845 billion at December 31, 2017, primarily because of the ILG acquisition. Goodwill was $2.747 billion and intangible assets were $1.216 billion, both primarily acquired from ILG.
Vacation ownership notes receivable, net, increased to $1.959 billion from $1.115 billion. Inventory increased to $829 million from $398 million.
Total debt on the balance sheet was $3.923 billion, consisting of $1.688 billion of securitized debt and $2.235 billion of other debt. Management reported approximately $4.0 billion of gross debt, including $1.7 billion of non-recourse securitized debt.
Operating cash flow was $67 million, investing cash flow was $(1.423) billion, and financing cash flow was $1.671 billion for the first nine months. Investing cash flow included $1.393 billion for the ILG acquisition.
The company paid $32 million of dividends and declared $0.40 per common share for each of the first three quarters. Future dividends remain subject to board approval and debt covenant restrictions.

Material Changes Versus the Prior Comparable Period

The ILG acquisition materially expanded the company’s scale, adding the Hyatt, Westin and Sheraton vacation ownership businesses, Interval International and other exchange and management operations. ILG contributed $135 million of revenue and a $25 million net loss during the 30 days after acquisition.
Debt increased substantially from $260 million at year-end 2017 to $2.235 billion of non-securitized debt and $1.688 billion of securitized debt at September 30, 2018. New financing included $750 million of 6.5% senior notes due 2026 and a $900 million term loan.
Net income attributable to common shareholders declined from $40 million to a $58 million loss in Q3 and from $116 million to an $11 million loss for nine months, primarily because of acquisition costs, higher interest expense, litigation settlements and purchase-accounting effects.
Development margin percentage declined 1.3 percentage points in Q3 and 2.8 percentage points for nine months, reflecting revenue-reportability timing, an unfavorable inventory mix and the inclusion of Legacy-ILG.
Interest expense increased to $14 million in Q3 from $2 million and to $23 million for nine months from $5 million, primarily because of acquisition-related borrowings and convertible-note interest.
The company adopted ASC 606 retrospectively on January 1, 2018. The adoption changed the timing and presentation of vacation ownership revenue and caused cost reimbursements to be reported gross; prior periods were restated.
Q3 litigation settlement expense increased to $17 million from $2 million, including $16 million related to a previously owned Hawaii project and $11 million related to a San Francisco project for the nine-month period.

Guidance, Outlook, Commentary, Risks and Unusual Items

Management stated that cash on hand, operating cash flow, securitizations, the Warehouse Credit Facility and the $600 million revolving corporate credit facility were expected to be adequate for liquidity, debt service, growth and shareholder returns. No cash borrowings were outstanding under the revolving facility at September 30, 2018, and approximately $594 million was available excluding letters of credit.
Management expected the full-year inventory spending to be lower than inventory costs and planned to pursue capital-efficient inventory transactions and selective growth in North America and Asia Pacific.
Management expected an approximately 45.98% annual effective tax rate for 2018, but Tax Cuts and Jobs Act accounting remained provisional. The filing stated that the company expected to finalize the related tax accounting in the fourth quarter of 2018.
Hurricanes Irma, Maria, Lane and Florence affected resort operations, sales activity and rentals. Management estimated that hurricanes reduced Legacy-MVW contract sales by $5 million in Q3 and $14 million for the first nine months.
Westin St. John remained closed following Hurricane Irma, with reopening targeted for January 2019. The company reported a $10 million insurance claim receivable related to storm damage and stated that the balance was subject to change.
The company identified $10 million of fraudulently induced electronic payment disbursements resulting from unauthorized email access. It had recovered $6 million by September 30 and expected insurance recovery for much of the remaining $4 million.
The company reported that a previously disclosed material weakness related to controls over improper electronic funds transfers had been remediated as of September 30, 2018. Integration and assessment of ILG’s internal controls remained in process.
Material commitments included $170 million to purchase a New York operating property, $164 million for a San Francisco property in 2020–2021, $85 million for remaining Marco Island units, and approximately $37 million for Bali units.
Reported contractual obligations totaled $5.845 billion, including $5.039 billion of debt obligations, $515 million of purchase obligations, $224 million of operating leases and $59 million of other long-term obligations.
Key risks include high leverage, dependence on securitization and consumer credit markets, integration of ILG, vacation ownership defaults, hurricanes and other travel disruptions, litigation, regulatory and tax uncertainty, cybersecurity, foreign currency exposure, competition and reliance on Marriott, Hyatt, Starwood and other brand licenses.
The filing disclosed Hyatt-related transaction risk: Hyatt had specified remedies during the one-year period after the ILG acquisition, including potential termination of the license or loss of exclusivity, with a possible termination fee of up to $40 million.
At September 30, 2018, no securitized loan pools were out of compliance with their performance parameters. However, deterioration in default or delinquency rates could redirect excess spread to debt investors and restrict liquidity.

Most Important Facts for Investors to Verify

Reconcile reported earnings and cash generation excluding the $128 million of nine-month acquisition costs, $33 million of litigation settlements and other unusual items.
Assess post-acquisition operating trends for Legacy-ILG beyond the one month included in this filing, including exchange membership, management fees, rental performance and integration costs.
Monitor leverage, required debt amortization, floating-rate exposure and compliance with Corporate Credit Facility covenants.
Evaluate the quality, default trends and securitization eligibility of the $1.959 billion vacation ownership notes receivable portfolio.
Confirm the final purchase-price allocation for ILG, including goodwill, intangibles, acquired notes receivable and deferred taxes, because the reported values were preliminary and could change materially.
Track the resolution and cash impact of outstanding litigation, including the Kapalua Bay, Aspen, St. Regis, MVCD class-action and other matters for which potential exposure was not estimable.
Verify completion of the remaining hurricane insurance recoveries, the status of closed resorts and the effects of future storms on sales, rental activity and inventory.
Review the remediation and continuing effectiveness of electronic-payment controls and the integration of ILG’s internal control framework.