Good morning, and welcome to Hilton Grand Vacations' Second Quarter 2018 Earnings Conference Call. Today's call is being recorded and is available for replay beginning at 2:00 p.m. Eastern today. The dial-in number is (888) 203-1112 and enter the PIN number 656130. [Operator Instructions] I would now like to turn the call over to Robert LaFleur, Vice President of Investor Relations. Please go ahead, sir.

Thank you, Evanie. Welcome to Hilton Grand Vacations' Second Quarter 2018 Earnings Call. Before we get started, I'd like to remind you that our discussion this morning will include forward-looking statements. Actual results could differ materially from those indicated by these forward-looking statements and the forward-looking statements made today are effective as of today. We undertake no obligation to publicly update or revise these statements. For discussion of the factors that could cause actual results to differ, please see the Risk Factor section of our previously filed 10-K or our 10-Q, which we will file later today. In addition, we will refer to certain non-GAAP financial measures in our call this morning. You can find definitions and components of such non-GAAP numbers as well as reconciliations of non-GAAP and GAAP financial measures discussed today in our earnings press release and on our website at investors.hgv.com. This morning, Mark Wang, our President and Chief Executive Officer, will provide highlights from the second quarter 2018 in addition to an overview of current operations and company strategy. Jim Mikolaichik, our Executive Vice President and Chief Financial Officer, will then provide more details on our second quarter and expectations for the balance of the year. Following their remarks, we will open the line for questions. Before I turn the call over to Mark, you may have noticed we have filed a revision to our earnings release this morning corrects a transposition error on our guidance table in the high end of our range for license fees and segment EBITDA. It affected no other areas of the release or guidance. And with that, let me turn the call over to Mark.

Well, thank you, Bob, and good morning. And it's great to be with you today the strong trends that we saw earlier in the year caried over into the quarter, as our teams continued to execute and deliver exceptional growth with contract sales increasing 10.5% in the quarter, with capital-efficient inventory making up 78% of these sales. Our resort and club segment also had another great quarter with expanding margins and double-digit EBITDA growth. With this continued momentum, we are raising our full year contract sales guidance to 9% to 11% from 8% to 10% as well as increasing our adjusted EBITDA and adjusted free cash flow guidance. Jim will provide additional details during his overview. Other highlights for the quarter. We opened The Residences in New York and announced Quinn and Cabo acquisition, started sales at our fee-for-service property Ocean Enclave and began presales in Odawara. I'm especially pleased to announce that HGV is entering the Chicago market with a partial conversion of the DoubleTree Chicago Magnificent Mile. I'll provide more details on this exciting opportunity later in my remarks. In our real estate business, first-time buyers and ownership showed continued confidence in our brand as each segment posted impressive results for the quarter. We continued to lead the industry in engaging new customers with first-time buyers generating half of our [indiscernible] contract sales. Double-digit tour growth and higher conversion rates in this segment helped drive 7% NOG. In fact, just last week, HGV hit a major milestone when our club membership surpassed 300,000. In 10 years, we've more than doubled our member base and no one has come close to this organic growth that we've achieved in the last decade. And we know that today's new buyers become tomorrow's highly engaged owners. But our selling efficiency with owners,…

Thank you, Mark, and good morning, everyone. We understand that AT&T is having some global issues with the call, so everything may not be coming through exactly clear for the listeners. We'll work through right afterwards to get a raw transcript posted to our IR site so that everybody has it, once the call concludes. As Mark highlighted, second quarter results were solid across the board. Volumes increased in our real estate business for both new buyers and existing owners with strong margins and bottom line growth in our finance, resort, club and rental businesses. Our momentum continues and we're again raising guidance. We now expect contract sales to increase by 9% to 11% and we've tightened our [adjusted EBITDA] the range. As a reminder, our results reflect new accounting rules under ASC 606. For better comparability and as required in this transition year, I will also discuss our results under the previous percentage of completion accounting or POC. Tables T-18 through 23 in the press release reconcile our results between the old and new accounting views. We completed construction on The Residences project in New York City. Under 606, we recognize all the deferred revenues and expenses on this project in the quarter. Ocean Tower in Hawaii remains under construction. So we're continuing to defer revenues and expenses related to that project. Under POC, total company revenues increased 9% in the second quarter to $478 million, reflecting growth in all business lines and total company revenue increased [28%] under 606. Under POC, net income increased 29.4% as this year's lower tax rate amplified the benefit of a 9% increase in pretax income. With 606, second quarter net income more than doubled to [$107 million]. Under POC, total segment adjusted EBITDA increased 12% and margin expanded [ 60 ] basis…

[Operator Instructions] And we will take our first question from Brandt Montour with JPMorgan.

Thanks for the incremental color on the long-term growth outlook. That's helpful. I have a question on the accounting changes. Just kind of given this -- the impacts that we're seeing, has this changed the way that you're potentially planning some deals? I'll put it another way, are you doing anything to sort of try and minimize the future reportability nuances at all?

Yes, this is Mark. We're not changing the way we run our business. We've had this reportability nuances in the past. But obviously, these new changes created some bigger swings. The impact is more timing-related and it's not related to value. So our focus is to continue using the same discipline around growth and returns on investment. And so we're not going to sacrifice and invest in high-return deals based on timing. That said, there are some opportunities to try to time some things better. But at the end of the day, we're not going to shy away from really good investments. I mean, if the timing [indiscernible] doesn't fall within a [indiscernible] completion doesn't fall within a particular quarter.

I think as we move forward, we are required to reconcile this year between POC and 606. Everything will be out in the wash by the end of the end of the year and all deferrals will be recognized, and removing the $67 million that I referenced from the 606 guidance should give you a good jumping off point for 2019 moving forward. As we get that all through the system, our intention is probably to come out with something that is more of an economic model so that any construction that we do that has the opportunity to potentially carry over a year doesn't at all impact the way you look at the business, which is the way we basically look at the business internally.

That's helpful. And just broadly on capital allocation, I was wondering if you could just give us an update on your capital allocation strategy, kind of more broadly on investment spend now that you're 1.5 years as a stand-alone company. And would you, I guess, the board potentially revisit [indiscernible] the weakness you've seen in your shares recently?

Well, I think, Brandt, we continue to believe that our strategy for growth is on the right track. And I think I'm not sure what's happening with the share price. As you can see from this quarter's results, we've had really great operating performance and execution. And I think when you -- I think when you look back -- and some of the questions we're getting is, are we investing into potential end of the cycle or shift in the macro conditions? And I think historically, our industry has done a lot better in downturns. And we've demonstrated -- we demonstrated, HGV demonstrated the resiliency through the worst conditions, in '09 and '10, we actually grew through the financial crisis. And probably the best example I can provide is our peak investment inventory prior this year was 2007 when we had $400 million in 3 projects in Hawaii, New York and Orlando, all of which were very successful and ultimately met our financial goals. And they also contributed substantial cash flow that went up to Hilton during that period of time. And in fact, in that period of time, our business outpaced the lodging side of Hilton from '09 to '12. So there's a big difference in our models. And they tend to get kind of bunched together with the, I'd say, lodging model, crews, casinos are kind of bunched more into the traditional supply-and-demand model. And the big difference for us is we're built around demand creation. And so it's not the conventional supply-and-demand model. And I think we're in a much better place today than we were in 2008. And we're really well set up for the future. And I think we'll be able to endure any type of downturn and I actually think we'll be able to…

[Operator Instructions] And we'll take our first question from Stephen Grambling with Goldman Sachs.

Thanks again for free cash flow commentary. As we think about the $300 million to $400 million run rate, which I think you said was in 2022, is that a stabilized free cash flow number? Or are there other investment and one-time items in there? And can you maybe help reconcile that range with the nearly $300 million in free cash flow in 2017, think about the incremental return on the $500 million-plus you're putting out?

The $300 million in 2017 was -- essentially, it had a couple of things embedded in it. There's tax deferrals. And as Mark said earlier, we pushed some inventory spend from '17 to '18. So '17 was an elevated amount. And what we said at the start of Investor Day in 2016 is that a steady state run rate in the current business environment, absent the investments we're making, was about $150 million to $200 million, which is approximately what we would have had if you change that inventory scenario from the tax deferrals last year. After making the investments, we think we're going to ramp free cash flow and adjusted free cash flow on the back end to a steady state with [indiscernible] $300 million to $400 million and potentially above that as we push forward. So we do think that's a steady-state run rate on a bigger business after we make these investments.

That's very helpful. And then you alluded to having some flexibility in the inventory that you're deploying. I guess, how much of the inventory investment to get that step-up in free cash flow has already been spent? And how much of what is still to come is just-in-time or has looser kind of capital commitments?

Most of the upfront commitments happening this year, so you -- we just announced the Quin and we have one or two other projects that would increase the spend to $500 million that we quoted. The spend that we have in the next few years is partially related to construction on developed projects and partially related to just-in-time phased inventory. And it's probably -- it's a mix, but there is some flexibility on the construction side and we do have things paced out on the just-in-time side in the next several years.

Yes. And just to follow up, Steve, I think one important thing that hopefully people are hearing out there is that we're not making a move away from capital efficiency. We're still -- we still believe that these 4 pipeline, I think I mentioned 78% of our sales in the first -- the second quarter were capital-efficient. Our pipeline is building to a very capital-efficient pipeline. What we're really looking at is we're looking at shifting some of these fee deals that we've been doing and shifting them into just-in-time deals. And as we've alluded to, we think there's some really strong benefits of mix shift. And it makes a lot of sense for us at this point in time.

Great. Maybe one last one. Are you seeing any change in consumer behavior or even any change in trends among the new customers, the new owners, I guess, that you're signing up by market?

Yes. Look, I think trends right now are really good across the board. This year, not only are we seeing improvements in just flow-through of more customers coming through the door, but we're seeing conversion rates go up. We're seeing transaction rates go up. The performance in our Hawaii and Japan region has been extremely strong. But I'd say across the board, it's been really strong. I think the one exception is New York, it's been flat. We've talked about that. That's really due to the inventory. We see that fixing itself towards the end of [2018]. But all in all, if anything, we've seen a trend up in the add-on sales for buyers who bought over the last 5 years. I think at Investor Day, we're talking $1 for $1. Now we're seeing -- we saw a trend up to $1.10 for $1. And it's actually still trending up a bit from there. So the consumer side is really, really good. And our demand strategy continues to play out really well.

And our next question will come from Patrick Scholes with SunTrust.

Just a couple of questions here. Why don't you consider share repurchases at this level? Certainly, the stock gets a little overdone today and [indiscernible] you have the balance sheet there to add more leverage. What's stopping you?

Yes. Look, I think, Patrick, we said from the beginning the first couple of years that we were going to put our money into the business to help grow the business. And right now, as you've heard, we're investing in growth and we continue to be very disciplined around that. So we're looking at deals today that are generating 15% to 20% after-tax unlevered IRRs. So these are really, really good deals. And a lot of them are just-in-time. So we see the investment that we're making now is really going to be a catalyst for strong growth. That being said, as we ramp up our cash flow, and Jim put it to this more stable state of $300 million to $400 million, at that point, we're going to be a much bigger business with a lot more cash flow and we have the flexibility. And clearly, our board and, I think, management will be open to that conversation at that point.

Okay. Second question, and you may have touched on this earlier in the call, Hawaii didn't sound like to date really as far as sales, the volcano has impacted things. But how about future tour volumes and reservations made for that property on the Big Island? How is -- how have those been tracking?

Really well. And I think that's -- I was trying to really to get across that the volcano, while it is -- that volcano has been active for 25 years, the activity has really stepped up. But the business has been exceptional. And when we look forward, we continue to see forward bookings remain strong. And this success we're having with Ocean Tower, Patrick, we had a budget of $64 million for the year of Ocean Tower. And we're sitting here midyear at $125 million. We're actually very, very pleased with how that's going. And so all in all, I can tell you that, I think, business on the Big Island is well. Air traffic is up year-over-year and tourism seems to be strong there. So at the end of the day, we think right now, unless something changes, it will continue to be strong in the rest of the year.

We'll move to our next question, which comes from Cameron McKnight with Crédit Suisse.

Questions for Mark, perhaps, to start. When you sit down with your third-party developers, are they starting to see financial terms tighten for development? And is that perhaps why you're bringing some of this inventory spend forward?

No, we haven't heard any of that out there. And I know -- we're hearing some of that on the lodging side. I think the economics in our projects are different. It's a different profile. And when they underwrite deals, the model is really generating a lot more cash flow upfront. And we've had such success with our third-party partners. We're really excited to be working with the Related group and Chartres on this new deal in Chicago. So I guess, to answer your question, we have not had any pushback or hearing that at this point in time.

The inventory spend we're making, it's really because we found some really good values. We're able to be opportunistic in a couple areas and we jumped on them.

Yes. And I'd follow up on Chicago, a really great point for us is we're seeing opportunities on conversions where replacement cost is higher than what we can convert at. So there's an opportunity for us to take advantage of that right now.

Fantastic. And then one follow-up if I may, slightly bigger picture. I mean, the upper-upscale segment of timeshare is going from the 3 companies to 2. Are there any changes or impacts that you foresee?

We don't see really any changes at all. I mean, we were competing against those 2 [businesses] as separate companies. And again, we're in this demand creation business that we basically control the demand creation. And Marriott and ILG together, they're basically working off their database, the combined [Marriott] and Starwood and we have our own database. We have tremendous amount of data out there. I think I mentioned earlier, we've only kind of traded at 0.5% of the Honors members today. So the opportunities in front of us are strong. So we don't see that, the 3 going out to 2, having any impact on us at all.

We'll take our next question from Jared Shojaian with Wolfe Research.

So can you just remind me, at the end of this year, after you spend the $520 million on inventory, how many years of contract sales will you have in fee-for-service inventory and also in owned inventory?

Yes, you broke up a little bit. I think we're looking at right now, we've got about [5.8] years of sales. That bakes in pretty much -- that bakes in everything we've announced. I think when we spun [5] years, so we've been actually absorbing because of our limited spending over the first 18 months, we've been absorbing inventory.

Okay. Yes, I'm sorry, we're just having some phone issues. It's still breaking up. But I think if I heard you correctly, you said 5 years in total for both owned and fee-for-service. Is that correct?

Yes, it's 5.8 for both. That's correct. And that's based on our current sales pace. It's based on our trailing 12-month pace. So in reality, it's less than that because our sales continue to accelerate.

Got it. And is there a specific targeted level that you guys want to be at? I mean, how do we think about that over the longer term?

I think for us, one of the benefits we have is 35%, 40% of the inventory sits on somebody else's balance sheet. That being said, in these core markets, we need to make sure, we're -- in these core markets, we're selling $200 million, $300 million a year, we need to make sure we have enough inventory out in front of us. And so we pro forma these to make sure that we have enough inventory upfront. So I don't know that there's any magic number on that. But we continue to pursue a flexible spectrum of just-in-time, fee-for-service, hybrid deals. So we feel good about our balance now. We'll probably add a little bit more to that. As we're adding more, we're burning inventory off.

I think with what we guided in terms of cash flow and inventory spending through the next few years with what we see earmarked on developed just-in-time deals. On the back of that, I think you can look for us to be turning back towards our fee-for-service as a couple of our bigger projects will start to sell. So we've always kept it at about [50-50] mix. Historically, we see that continuing for the next couple of years. And then as the projects come on and the spending normalizes, we can turn back to fee-for-service and try to place inventory out, there are a couple of big projects in Hawaii and Las Vegas start to sell off. So we should be set up really well for a number of years off of the spend that we have earmarked for the next few years and see a really good crescendo to our free cash -- adjusted free cash flow off of the back end, leveraging our inventory models in a really balanced way going forward.

Okay. And I may have missed this earlier on the call as it was cutting in and out. But how are you thinking about the cadence of contract sales growth next year and into the following years? And if we go back to Analyst Day before the spend, you were talking about sort of a 5% to 7% sort of 3-year outlook. You've obviously surpassed that, running at around 9% in the last 2 years. So maybe you can just help me understand the new 3-year outlook as this cadence sort of ramps with the inventory spending.

Our [indiscernible] is to give a new 3-year and 5-year look at the Investor Day later in the year. But given the growth rates that Mark and I illustrated, you can expect contract sales to pose a similar model with what we're saying on the adjusted EBITDA side. So that 6% to 8%, getting 100 to 200 basis points, 300 to 400 basis points again in the outer years. And I would expect contract sales to follow a similar model, maybe even a slightly elevated model because some of the new products that we're bringing on has slightly higher cost of product. So we may need to generate a little bit more on the contract sales side to generate the growth. But all in, it should follow a similar trajectory to what we're saying on the bottom line.

[Operator Instructions] And we will take our next question with Edward Engel with Macquarie.

Regarding your discussions with the development partners, how are they feeling about like the current economic cycle and their future development plans? And has that interest in new deals changed at all over the past, say, a year or 2?

Yes, I think we've got a lot of opportunities that we're looking at and talking about. We're being very, very selective on deals because at the end of the day, we talk a lot about inventory, but it's really about the demand creation matching up to new inventory and to new markets, right? And so I think, as I said earlier, we've got a couple negotiations that are going on. I think people feel pretty good. And those that understand our business and understand it's not the normal supply and demand model that we control a lot more the destiny of how a project performs, they're very comfortable with the discussion of continuing to do new deals with us.

And we just announced the Charleston deal. And as Mark said, we have a few other fee deals that we're currently negotiating. And ultimately, if we do see some headwind or recessionary indicators, I think those are the times where we make [indiscernible] because those are times when our partners step in and have the capital because of who they are, to work with us on deals that create broken deals and even cheaper sources of inventory. So I think the fact that we're spending sort of on our own balance sheet today with the backstop on the fee side to have our partners step in, similar to what we did in the last recession, can step in on some broken deals and generate even more inventory opportunities.

And then have you seen any shift in preference from fee-for-service to JIT as your developers kind of get more comfortable with them?

No, I think at the end of the day, these deals come to us. We have a couple developers that we've been exclusive fee partner. And we've -- now shift to this hybrid, where we're doing fee deals and then investing side-by-side with them, [indiscernible] benefit from some of the real estate and financing economics. But our preference again is in some new markets where there's more risk, we prefer to initially go in as a fee deal. And then markets that are more core, more proven with less risk, really put more of our money into those markets.

That's helpful. And then lastly, does the strong dollar have any impact on your sales to your Japanese client base?

We haven't seen any impact. We've been selling to Japanese for 18 years and we've kind of sold through the -- a fairly wide range, from the [ 80s to 125s ]. And so right now, as I said earlier, our sales in APAC, which is partially in Japan. And then we also sell to a lot of the Japanese that are traveling to Hawaii. It remained very, very strong.

And there are no further telephone questions at this time. Ladies and gentlemen, this does conclude the question-and-answer session. I would now like to turn call back to Mark Wang for any additional or closing remarks.

Well, thank you, everyone, for joining us this morning. We're having a great 2018. The business is performing well and our growth strategy is unfolding as we expected. We believe that capital-efficient investment we are making today and exciting new projects are going to yield meaningful in our EBITDA growth and free cash flow production. And as always, we appreciate your continued interest in HGV and look forward to speaking to you next quarter.

And this concludes the call. Thank you for your participation. You may now disconnect.