Wyndham Worldwide (WYN) Stephen P. Holmes on Q2 2016 Results - Earnings Call Transcript

| About: Wyndham Worldwide (WYN)

Wyndham Worldwide Corp. (NYSE:WYN)

Q2 2016 Earnings Call

July 27, 2016 8:30 am ET

Executives

Margo C. Happer - Senior Vice President-Investor Relations

Stephen P. Holmes - Chairman & Chief Executive Officer

Thomas G. Conforti - Chief Financial Officer & Executive Vice President

Analysts

Joseph R. Greff - JPMorgan Securities LLC

Patrick Scholes - SunTrust Robinson Humphrey, Inc.

Christopher Agnew - MKM Partners LLC

David Katz - Telsey Advisory Group LLC

Jared Shojaian - Wolfe Research LLC

Harry C. Curtis - Nomura Securities International, Inc.

Carlo Santarelli - Deutsche Bank Securities, Inc.

Operator

Welcome to the Wyndham Worldwide Second Quarter Earnings Conference Call. Your lines have been placed on listen-only until the question-and-answer session. Today's conference is being recorded. If you have any objections, you may disconnect at this time.

I will now turn the call over to Margo Happer, Senior Vice President of Investor Relations. Please go ahead, ma'am.

Margo C. Happer - Senior Vice President-Investor Relations

Thank you. Good morning. Thank you for joining us. With me today are Steve Holmes, our CEO and Tom Conforti, our CFO.

Before we get started, I want to remind you that our remarks today contain forward-looking statements. These statements are subject to risk factors that may cause our actual results to differ materially from those expressed or implied. These risk factors are discussed in detail in our Form 10-K filed February 12, 2016 with the SEC.

We will also be referring to a number of non-GAAP measures. Corresponding GAAP measures and the reconciliation of these non-GAAP measures to GAAP are provided in the press release and the tables to the press release, which are available on the Investor Relations section of our website at wyndhamworldwide.com. Steve?

Stephen P. Holmes - Chairman & Chief Executive Officer

Thanks, Margo. Good morning and thank you for joining us. Second quarter results were in line with our expectations. There's great energy across our businesses. While we execute on near-term objectives, we're also looking ahead, making sure we are continually innovating and making prudent investments to ensure strong, continued growth in the years to come. Let's take a look at the key initiatives in each of our businesses.

Wyndham Hotel Group is making investments in three key areas to ensure the business is well positioned for the future. First, we are redefining what technology means for economy in midscale hotels. Second, as we discussed in recent quarters, we are taking a fresh look at our brands and the guest experience. And third, we are reinventing hotel loyalty with some industry-leading improvements to Wyndham Rewards. Our goals are to continue to increase our value proposition to both our hotel owners and consumers and to drive higher contribution for our hotel owners. We are convinced that this direction is absolutely the correct path to take even though we are implementing these plans in a decelerating RevPAR environment.

As you might recall, effective January 1 of this year, Wyndham Exchange & Rental became Wyndham Destination Network. The name reflects our expanded vision for the business. We are leveraging the strengths of a portfolio of unique vacation accommodations to provide our worldwide customer base with the options to vacation the way they want.

We believe that executing this vision will result in higher combined growth than exchange growth or Vacation Rental growth alone. On a practical level, that means we're enhancing technology, continuing to leverage our yield management capabilities and strengthening our marketing across brands. In addition, we recently launched a project to develop the next generation of RCI product offerings. This business continues to deliver on its strategy, despite modest growth in the exchange industry and potential FX headwinds in Europe, resulting from Brexit.

Finally, in Wyndham Vacation Ownership, we spent the past couple of years transforming our sales process to ensure a great experience for new and existing owners. We've opened new sales centers in key vacation destinations, which will be important to bring new owners into our system. That's our focus. We're increasing our new owner growth target to mid-teens this year, and we're on track to hit that number with a 13% increase recorded in the second quarter. In setting this goal, we realized the short-term margin impact, but the lifetime value of a timeshare buyer remains highly compelling. Also, as we discussed in our last call, our progress is being somewhat muted by the unexpected increase in third-party guided defaults.

Let me take a moment here to update you on that topic, we are vigorously pursuing legal alternatives against individuals and companies that might improperly be targeting our owners. We've filed the lawsuit and discovery is underway. But at this point, there are no silver bullets. While we're aggressively exploring all options, we think this situation maybe a situation that we lap before we solve.

Given its size, we believe it is manageable situation as evidenced by our maintaining EBITDA guidance for the year. So stepping back, let me say that as usual, while headwinds do exist, we believe our operational agenda establishes the correct long-term direction for our company.

Now turning to the quarter, let me point out a few operating highlights in each of the business units. Let's start with the Hotel Group. And as the world's largest hotel franchisor with a concentration in the economy segment, we see a unique opportunity to leverage our strength to enhance the economy hotel experience for both hotel owners and consumers in new ways and on an unprecedented scale.

While much of the industry's recent development and innovation has been focused in the upscale – upper upscale and luxury segments, 40% of all rooms are purchased in economy and midscale hotels. We expect this number to continue growing as the global middle class increases from 2 billion to 5 billion over the next 15 years.

Many of our brands Days Inn, Ramada, Travelodge, and Super 8 have a rich heritage in U.S. brand awareness of over 90%. We are working to enhance the guest experience and tap the full potential of our brands to ensure that we resonate with the next generation of travelers. We initiated this effort a little over a year ago with the transformation of the Wyndham Rewards program. We eliminated award tiers, blackout dates, and other features that make loyalty programs frustrating, confusing and unattainable for many customers. The result of this transformation is that redemptions are up over 90% and nearly 6 million people have joined the program since its re-launch.

Our goal is to create the industry's top rank loyalty program. To support that effort, our summer umbrella marketing campaign is underway now, through the busy Labor Day week, bolstered by a $20 million national advertising campaign featuring the Wyndham Reward Wyzard. Of course, the best loyalty program in the world is irrelevant without a strong consumer value proposition. So, we recently completed a global research study to help us enhance the guest experience and better define the value and positioning of each one of our hotel brands. Based on this research, we're developing new marketing campaigns, digital experiences, websites, on-property amenities, travel perks, and marketing partnerships.

On the technology front, our transformational cloud-based property management and central reservation system installations are proceeding on schedule. We recently completed a flawless migration of the Wyndham Hotel and Resorts, Wyndham Garden, and Wyndham Grand Hotels to the Sabre central reservation system. And our migration to the Sabre property management system is progressing equally well. We now have nearly 1,600 of our economy and midscale hotels operating on the new PMS system, utilizing or preparing to utilize the new automated revenue management tools, the first for the economy space.

Supporting all of this is our continued focus on quality as we work to remove properties that are no longer up to our brand standards. These efforts have helped raise our overall customer satisfaction and net promoter scores across our brands

Now let's turn to Wyndham Destination Network. We continue to add to our scale, geographic reach and diversity of experiences within our portfolio. This year, RCI announced new affiliations in China, Japan, the Czech Republic, Portugal, the Canary Islands, England and Mexico. These affiliations include one-of-a-kind experiences such as the family-themed Nickelodeon Hotels & Resorts in Punta Cana and two resorts within the first Cirque du Soleil themed park, which is now under development in Nuevo Vallarta.

All told, Wyndham Destination Network offers more than 112,000 properties to the everyday traveler in over 100 countries. We're seeing strong transaction growth in Croatia, Spain, Belgium and the Netherlands, and the outlook is strong for the summer season with third quarter Vacation Rental bookings up 8% compared to 2015.

Now, I'd like to take a moment here to briefly comment on Brexit and why we don't expect any operational effect on our business. 13% of Wyndham Worldwide revenues comes from Europe, the majority of this from Vacation Rentals. While we are predominantly domestic drive-to vacations, 90% of our Vacation Rental transactions in the UK are made by UK consumers. The same applies in Continental Europe, where over 90% of transactions are made by Continental Europeans, primarily German, Dutch and Danish consumers traveling to Continental European destinations.

Our Rental brands have traditionally performed well in periods of economic and political turmoil because of our outstanding drive-to locations and strong value proposition. And our large inventory in the UK and nearly 40,000 units positions us well should demand for UK vacations increase due to the depreciation of the pound. So, while we may experience some additional FX headwinds resulting from the Brexit decision, which Tom will discuss in a moment, we do not expect any change in overall demand or impact on bookings.

Now moving on to Wyndham Vacation Ownership. As I mentioned earlier, the team is doing a great job of executing their plan to bring in new owners. Our new sales centers in New York, St. Thomas, Puerto Rico, Southern California and Las Vegas are performing well, generating strong growth in new owner tour flow. About half of our new owner tours are sourced through our community marketing programs and alliances, which put the Wyndham Vacation Ownership product front and center in desirable vacation locations.

Our community marketing programs include local outreach at malls and representation at events such as NASCAR. We focus on venue and alliance partners whose customers match our timeshare owner demographics. Our alliance partners share a commitment to truly knowing their customers and providing great experiences for them. These partnerships provide Wyndham Vacation Ownership with access to potential tours, while enabling existing owners to use their points for new services, benefits or products offered by our alliance partners. Our partners typically benefit from increased product exposure and incremental income, while we gain scalable access to large segments of consumers. It's a win for us, for our partners and for our owners.

We've enjoyed much success over the years partnering with major brands to fuel our growth and expansion in markets such as Caesars in Las Vegas, Outrigger in Hawaii and Margaritaville in the Caribbean. Of course, we also continue to connect our hotels and Vacation Ownership brands through Wyndham Rewards. We're constantly improving and enhancing our marketing efforts for distribution and efficiency. One great recent example of a new alliance is Norwegian Cruise Lines. Potential new owners can purchase land and sea vacations combining a cruise with a stay at a nearby Wyndham resort.

Another is our alliance with Avis Budget Group, which includes a call transfer program and also enables our owners to rent a car using their timeshare points. And we've recently signed a new alliance with a major tour operator in New York. Individually, none of these sources is intended to account more than 5% of our tour flow, but collectively, they serve to broaden our marketing reach and grow our pipeline of prospective new owners.

Now let me turn the call over to Tom for details on the quarter's results. Tom?

Thomas G. Conforti - Chief Financial Officer & Executive Vice President

Thanks, Steve. Good morning, everyone. As Steve mentioned, results for the second quarter were in line with our expectations. On a currency-neutral basis and excluding acquisitions, adjusted EBITDA increased 3% in the quarter, as higher revenues at our businesses were muted by higher provision for loan loss at Vacation Ownership, which while large was in line with our expectations.

We generated $616 million of free cash flow in the first six months of the year compared to $625 million over the first six months of 2015. Now recall that 2016 results include the negative effect of an unanticipated Venezuelan currency devaluation in the first quarter, which reduced free cash flow by $24 million.

In total, our free cash flow has been adversely affected by $35 million of unexpected foreign exchange headwinds over the first six months of 2016, including the impact from Venezuela and an additional $11 million, primarily from a devaluation of the British pound. During the quarter, we repurchased 2.1 million shares of stock for $150 million. We've reduced our weighted average share count by 7% year-over-year through share repurchases made during the last 12 months. In addition, we've repurchased 600,000 shares for $42 million so far in the third quarter of 2016.

Now let's take a look at the performance of each of our business units. At our Hotel Group, revenues were flat, reflecting difficult year-over-year comparisons. Higher royalties and growth in the Wyndham Rewards Credit Card program were offset by the absence of $3 million of global conference fees and $2 million in termination fees from two large properties that left the system in the second quarter of 2015. Adjusted EBITDA increased 4%, reflecting higher royalties and growth in the Wyndham Rewards Credit Card program, as well as cost containment measures, offset somewhat by the lower termination fees.

Domestic RevPAR increased 2%; that increase reflects higher room rates. Excluding oil producing-regions, domestic RevPAR actually grew 3.3%. RevPAR in the oil-producing markets was down 16%. Remember that RevPAR in these regions was down 28% in the first quarter, so we're happy to see some sequential improvement. System-wide RevPAR was flat in constant currency, pressured by the continued unit growth of lower RevPAR hotels in China, which has also been experiencing some market softness and continued weakness in the Canadian oil markets.

Excluding China and in constant currency, global RevPAR increased 1.6%, which includes about 120 basis points unfavorable impact from domestic and Canadian oil markets.

Net system size grew 2.2% year-over-year, which is net of the impact of our continued focus on improving the overall quality of our system. Our development pipeline is nearly 128,000 rooms. That's a 10% increase over prior year, which includes a 21% increase in domestic new construction activity with a concentration in our higher-end brands, particularly our Wyndham brand.

Moving on to our Destination Network segment, on a currency-neutral basis and excluding acquisitions, revenues increased 1% and EBITDA 2%. At RCI, exchange revenues increased 1% in constant currency, reflecting a 0.7% increase in the average number of members and a 0.3% increase in revenue per member. Vacation Rentals' revenue for the quarter was also up 1% in constant currency and excluding the impact of acquisitions. A 4% increase in volume was offset by a 3.3% decline in the average net price per rental.

Transaction growth was particularly strong in the UK-based Hoseasons business, as well as our Denmark-based Novasol brands, and was reduced a bit due to the shift of the Easter holiday into the first quarter of 2016. Faster growth in our more moderate product offerings adversely impacted the average net price per rental.

At our Vacation Ownership business, revenues increased 1% and EBITDA 3%. Results benefited from an increase in gross VOI sales and property management fees, partially offset by a higher provision for loan losses.

EBITDA further benefited from lower cost of goods sold. Gross VOI sales increased 3% in constant currency and the number of new owners increased 13%, in line with our previously-stated goal of increasing new owner sales. Sales to existing owners was flat. The growth in gross VOI sales reflected a 3.4% increase in tour flow, offset by a 0.8% constant currency decline of VPG.

Now VPG was impacted by higher sales to new owners, which are generally less efficient than upgrade sales, while tour flow benefited from higher arrivals in tours at both our newer and existing sale centers. Second quarter consumer finance portfolio performance was in line with our expectations at the end of the first quarter, which included the activity by third parties, encouraging our owners to cancel their contracts.

Our average FICO score of originations during the quarter was 727, and that's consistent with our underwriting standards of the past year. Defaults for the quarter were $74 million. That's an increase of $14 million, which was almost entirely due to the organized third-party efforts. Both of these numbers were consistent with our expectations. The provision for loan loss was $90 million in the second quarter, resulting in an overall reserve level of 17.7%, consistent with recent levels over the past three years.

It's worth emphasizing that the increase in the provision is in line with our expectations when we last spoke to you in April, with the breakdown as follows. $12 million from third parties causing our owners to default, $8 million from higher sales volume and financing propensity, and $10 million from comparisons to favorable performance trends in the second quarter of 2015. Remember that the provision flow-through to EBITDA is approximately 60%.

As Steve said, we're continuing to work on the third-party issue and in the meantime, the situation is tracking to our expectations. We calculate that the EBITDA impact in the first six months has been around $15 million. We estimate the third quarter EBITDA effect to be $8 million.

Company-wide, net interest expense increased by $4 million in the second quarter compared with the same period of 2015, reflecting higher levels of debt, including the $350 million 5.1% bonds issued last September, as well as the absence of a fixed to floating interest rate swap that we terminated in the second quarter of 2015. Depreciation also increased as we brought new long-term projects into service.

Corporate expenses increased by $2 million, largely due to higher stock-based compensation expenses. And these expenses were offset somewhat by cost-cutting initiatives. At Vacation Ownership, we completed our second term securitization of the year in July, the $375 million Sierra 2016-2 transaction had a 90% advance rate and a 2.42% weighted average coupon. That's nearly 80 basis points below our prior 2016-1 transaction, as we benefited from lower post-Brexit interest rates and generally improved market conditions.

Now, let's turn to guidance, which will be posted on the website after the call. As you saw from the press release, we're increasing our adjusted diluted EPS guidance to $5.68 to $5.82 for the full year. And diluted share count goes to 111.8 million shares, reflecting the benefit of our second quarter share repurchases.

We're fine-tuning our revenue guidance, lowering the overall range by $150 million. Approximately $50 million of the adjustment relates primarily to a forecast correction in our hotel management gross up at the Hotel Group, which has no EBITDA impact. The remainder is at Vacation Ownership and primarily reflects our best view of the impact of third party prompted defaults.

Just a reminder, in timeshare accounting, the provision for anticipated defaults is a contra-revenue account. Our adjusted EBITDA guidance remains unchanged at $1.375 billion to $1.400 billion. Note that this guidance incorporates a negative $17 million year-over-year EBITDA impact from changes in foreign exchange rates, $6 million higher than in the full-year guidance that we issued in April, largely due to the impact of Brexit on the British pound.

We expect the EBITDA impact from third-party defaults to be around $30 million this year. But we are holding our adjusted EBITDA guidance range for Vacation Ownership and the overall company. However, given these headwinds, we are more comfortable at the lower end of our EBITDA guidance range. There are no changes to drive our guidance, although remember we said on the last call that RevPAR would be at the lower end of our guidance range, which implies flat global RevPAR.

Our neighborhood target for 2016 free cash flow remains $800 million. As always, keep in mind that there can be variability in cash flow in any given quarter or any given year, so we view $800 million as a neighborhood target rather than an exact figure. In addition, we are facing two free cash flow headwinds this year. First, as discussed, we have $35 million of unexpected foreign exchange headwinds year-to-date. Second, remember that as part of our strategy to drive new owner growth at timeshare, we are increasing financing to creditworthy customers, which will have an adverse short-term impact on free cash flow in 2016. However, we regain around 90% of that spend in financing activities from the receivables we securitize, and that is outside of our free cash flow definition. Typically, our receivables age four to five months before they enter a term securitization, so this is a short-term investment and not a long-term investment in the business.

Now, turning to the third quarter, we expect adjusted diluted earnings per share of $1.84 to $1.87, which includes an $8 million foreign exchange impact. You'll note seasonality differences between our expectations and current analyst estimates. Our results are heavily weighted to the fourth quarter this year, reflecting expected revenue improvements in timeshare, as new sales sites become fully operational, and then, our hotel business as the oil impact comparisons moderate. In addition, we expect increased benefit from disciplined cost management in the fourth quarter. Remember that we don't budget repurchases into our guidance either.

So with that, I'll turn the call back to Steve. Steve?

Stephen P. Holmes - Chairman & Chief Executive Officer

Thanks, Tom. Monday will mark our 10-year anniversary of Wyndham Worldwide's listing on the New York Stock Exchange. Before we close, I'd like to take a moment to comment on our performance since then. Between dividends and share repurchases, we have returned nearly $6 billion to our shareholders. The accumulative impact of our share repurchase activity over this period has been a 45% reduction in our share count. This combined with the strong operating performance in growth has driven significant increases in key metrics.

Just to put a few numbers around it, adjusted EBITDA is up over 80% and adjusted EPS is up over 225%. Looking forward, we see great opportunities in all of our businesses for future growth. We remain relentlessly focused on continuous innovation and execution of strategies that will deliver a compelling value to our customers and great returns for our shareholders, both now and in the future.

I am extremely proud of the culture we've built and the team we have, delivering value to our customers and our shareholders every day. And the passion of our 39,000 associates is also a source of great pride. Thanks for your continued support, enjoy the summer, travel and remember to tune into the Wyndham Championship August 18 to August 21 on the Golf Channel in CBS.

And with that, Erica, we can now open the call for questions.

Question-and-Answer Session

Operator

Thank you. We'll go first to the side of Joe Greff from JPMorgan. Please go ahead. Your line is open.

Joseph R. Greff - JPMorgan Securities LLC

Good morning, everybody.

Stephen P. Holmes - Chairman & Chief Executive Officer

Good morning, Joe.

Joseph R. Greff - JPMorgan Securities LLC

Maybe not surprisingly, I have a bunch of questions on loan loss provisioning and you gave a lot of data on this call and I just want to make sure I'm understanding this correctly. So, revenue is off $150 million this guidance versus the prior quarter's full-year guidance. $50 million relates to hotel pass-throughs, that leaves us with $100 million. Of that $100 million, the majority of that relates to loan loss provision in Vacation Ownership. And then you mentioned about 60% flow through on that impact which would generate $60 million of EBITDA. And I think you said the impact from the third-party activity is $30 million for this year. So, I'm missing something. Can you just explain maybe what I'm missing there?

Thomas G. Conforti - Chief Financial Officer & Executive Vice President

Yeah. So, Joe, it's $50 million for hotel. That brings it down to $100 million for timeshare. If you take the $30 million to EBITDA and assume that number is 60% of the revenue number that means that the lost revenue associated with the higher provision is $50 million. So, that leaves us another $50 million. And that other $50 million is we're bringing our gross VOI expectations down to the lower end of our gross VOI range. And that's how we get the $150 million.

Joseph R. Greff - JPMorgan Securities LLC

Got it. Okay, an extra $50 million for lower growth VOI sales. And what's driving that $50 million delta in growth VOI sales now versus a quarter ago?

Stephen P. Holmes - Chairman & Chief Executive Officer

Hi, Joe, I think we're just getting better visibility into how the new sales centers are operating. We are driving more new owner growth, which is what we're really focused on. And it does come at the expense of some gross VOI. If you imagine a sales center where we have 30 sales associates, we're putting more new owners in front of those sales associates. So that means they're selling new owners versus upgrade owners. Upgrade owners produce more in a sale than a new owner does. So, I think it's just us kind of getting our arms around the balancing of that and what it looks like.

Again, we're not changing EBITDA because we're managing through it, but it means that each sales office might be a little bit lighter than we thought on – as a result of the new owner generation. We like the outcome, it's what we're shooting for. It just means a very minor modification on the top.

Joseph R. Greff - JPMorgan Securities LLC

Thank you. And, Steve, your comment leads me to my next question where you're managing for EBITDA and you're managing through some of these buckets of revenue headwinds. Where are you extracting cost savings or expense management? What are the big buckets across the reportable segments? I'd imagine much like the 2Q, it's across all three reportable segments, not just in VO.

Stephen P. Holmes - Chairman & Chief Executive Officer

Yeah. I mean, it – we run a, as you know, a pretty lean shop here. But there's always opportunities to look at our cost base and so we are taking a very hard look at our costs and making sure we are as efficient as we could possibly be. The other thing is we have cost of goods sales which we have been able to manage down through some efficient inventory acquisition methods, and so that's helping us get there. But in the end of the day, we're dedicated to hitting our number, and one of the costs we have is variable costs at the end of the year related to bonuses and things that if we're not at our number, that's going to be something that will have to be considered.

Joseph R. Greff - JPMorgan Securities LLC

Okay. And then my final question kind of going back to the loan loss provisioning and your comments that the flow through at 60%, why isn't it 100% and what does that 40% delta relate to?

Stephen P. Holmes - Chairman & Chief Executive Officer

It relates to the recapture of inventory. When we take back inventory, there's a value to it and that value is recaptured. So, it's not 100% loss.

Joseph R. Greff - JPMorgan Securities LLC

Okay. So, is that a function of prior reserves against that incremental loan loss?

Stephen P. Holmes - Chairman & Chief Executive Officer

No, it means if you have a loan and there's a piece of timeshare associated with it, which there would be, if you default on the loan, we'll take back that inventory. And as you know, Joe, we're going to sell it for more than we probably originally sold it for because there's no depreciation in that asset. It's one of the wonderful things about the timeshare model.

So, as we take it back in, we're required to put that on our balance sheet at a value and the net result is it's a flow-through of about 60%. Am I describing that right?

Thomas G. Conforti - Chief Financial Officer & Executive Vice President

Correct, Steve.

Joseph R. Greff - JPMorgan Securities LLC

Great. Thank you, guys.

Stephen P. Holmes - Chairman & Chief Executive Officer

Thanks, Joe.

Operator

And we'll take our next question from the site of Patrick Scholes from SunTrust. Please go ahead.

Patrick Scholes - SunTrust Robinson Humphrey, Inc.

Hi. Good morning. A couple of questions here. What exactly is for the hotel segment, you had a $50 million revenue forecast correction. What exactly is that? I haven't heard that term before.

Thomas G. Conforti - Chief Financial Officer & Executive Vice President

Yeah. Patrick, it's a simple thing. When we set our budgets at the beginning of the year, we knew that there were certain managed properties that were going to leave our system. The business unit budgeted for the inclusion of those units for the full year. And so, what we did is the pass through, so the cost that we incur in managing that, we also offset that dollar-for-dollar with revenue recognition. And so, simply, it was the inclusion of hotels that shouldn't have been included for the full year on revenue that has zero margin.

Patrick Scholes - SunTrust Robinson Humphrey, Inc.

Okay, so a higher degree that some of the managed properties. Now, as I recall, you don't have a lot of managed properties to start with; how many are you losing?

Thomas G. Conforti - Chief Financial Officer & Executive Vice President

In this case, it was three particularly important or three larger managed properties.

Patrick Scholes - SunTrust Robinson Humphrey, Inc.

Okay. Are those the FelCor properties?

Stephen P. Holmes - Chairman & Chief Executive Officer

No, no. These are – two of them were Dolce properties that departed as a result of the acquisition. We knew they were leaving. And another is a property in Florida. We – this was probably the simpler vernacular for it is we blew the forecast on this. They should not have been included in the budget initially. We didn't include the income from the management fees, but we did include the pass through costs. So, it was just kind of a correction of that missed budget.

Patrick Scholes - SunTrust Robinson Humphrey, Inc.

Okay, let's move on here. Then my next question, when you talked about the provision change breakdown, the third category was – correct me if I am wrong – was $10 million from comparison or favorable comparisons from good performance. What exactly is that, how is that not just more defaults or is it more defaults?

Thomas G. Conforti - Chief Financial Officer & Executive Vice President

No. No. No. So, the last $10 million, in 2015, you might recall that our provision on a relative basis was declining. And the reason was we had favorable default trends. And so, we were just simply reflecting in the second quarter of last year favorable default trends, which led to lower provision of about $10 million and those trends were – those positive trends obviously, in this particular environment, we weren't able to recognize those same benefits in 2016. So, it's simply favorable default trends in 2015 that were reflected by a lower provision rate.

Patrick Scholes - SunTrust Robinson Humphrey, Inc.

Okay. So as I understand it, this is separate from the third-party defaults and it's just a higher belief that outside of those third-party defaults that you will have more defaults, correct?

Thomas G. Conforti - Chief Financial Officer & Executive Vice President

Well, so, the $12 million we cited was the effect of third-party guided defaults. That is component number one. The second number that I quoted reflected higher volume and greater financing propensity. We've talked about our commitment to lower the down payment. And so, those two factors were the second number. And the third factor for year-to-year comparisons was that in 2015, we had favorable default trends and we were able to lower our provision in 2015. We're not able to make a similar reduction in 2016. So, for year-to-year comparisons, we didn't have that benefit that we had in 2015.

Patrick Scholes - SunTrust Robinson Humphrey, Inc.

Okay. Last question on the Diamond Resorts financials that came out a couple of days ago concerning the pending acquisition, it listed in there a public company that had made an offer. Can you comment on that or confirm or deny it was or wasn't you folks?

Stephen P. Holmes - Chairman & Chief Executive Officer

No, we don't. As you know, Patrick, we don't comment on M&A activity. And so, I won't make a comment about that.

Patrick Scholes - SunTrust Robinson Humphrey, Inc.

Okay. Fair enough. Thank you.

Stephen P. Holmes - Chairman & Chief Executive Officer

All right.

Operator

Thank you. And we'll go next to the side of Chris Agnew from MKM Partners. Please go ahead.

Christopher Agnew - MKM Partners LLC

Thanks very much. Good morning.

Stephen P. Holmes - Chairman & Chief Executive Officer

Hi, Chris.

Christopher Agnew - MKM Partners LLC

Your revenue guidance assumes acceleration and growth in the second half of the year. What gives you confidence in revenues accelerating and what would get you to the high-end of your guidance range? Thanks.

Thomas G. Conforti - Chief Financial Officer & Executive Vice President

Chris, I cited two things that we were counting on for improved revenue performance. One is – and we know this will materialize, the effect of the disruption in the oil-producing regions, we saw an improvement quarter-to-quarter. Last quarter, we had a 28% reduction. This quarter, we only had a 16%. By the end of the year, that number should be fully mitigated. So, we'll pick up revenue there in the Hotel Group.

And in the timeshare business, we cited particularly importantly, the sort of the maturing of the new sales centers that we've opened and the additional use of lower down payments. So, we're optimistic that both of those factors will lead to an improvement in the timeshare business.

Steve, do you want to add any color to that?

Stephen P. Holmes - Chairman & Chief Executive Officer

No. That's basically it. We scrub these forecasts very carefully and push to make sure that we know where our sources are coming from and we're comfortable.

Christopher Agnew - MKM Partners LLC

Got you. Thanks. Can you give any color on the progression of the oil-producing or the impact from oil-producing states through the quarter, monthly, sequential progression, see how you ended up coming out of the quarter?

Stephen P. Holmes - Chairman & Chief Executive Officer

You mean month-by-month progression?

Christopher Agnew - MKM Partners LLC

Yeah, just the color the improvement.

Thomas G. Conforti - Chief Financial Officer & Executive Vice President

Well, the improvement was – I don't remember if June was better than May, but certainly May and June were better than April on a comparative basis. So, there was sequential improvement. The – so where we think ultimately we're going to lap this downturn, but we think that there probably is some lessening of the impact.

Christopher Agnew - MKM Partners LLC

Okay. Thank you. And then last question, some of the other timeshare companies have not been impacted by third-party guided defaults or have a very limited impact. Have any thoughts on why you've been targeted or why this is a bigger impact for you rather than other companies?

Thomas G. Conforti - Chief Financial Officer & Executive Vice President

Well, Chris, I would dispute the opening part of that statement because I was down at the conference for the timeshare industry, and even mid-sized players have seen an increase in this activity and I've – all the large players I talked to have seen this activity. It's a question of how much is there. And when you're the largest in the industry, you obviously have the largest opportunity for people to make money based on your customer base. And so I think that we probably are a little bit more of a soft target for people because we're so much bigger. But I think everybody is seeing it. And we've had to deal with this before and we'll shut it down. I think, importantly, as I said, we see us being able to tackle this problem, but we probably won't get it beat back until we start lapping it, which is next year. But we feel even with what we're seeing, we're covering it and we're keeping our EBITDA guidance the same.

The fact is, it came in this quarter right online with our expectation. I could not have said that about the first quarter because we weren't really sure what was going to happen. We were – we had a broader estimate. This quarter, we were pretty accurate with what we saw coming in. So, we feel like we've got our arms around this, it's not what we would like, which is for it just to go away. But these guys, they don't just go away, they're making money and they're going to keep playing the game for as long until some of them go to jail.

Christopher Agnew - MKM Partners LLC

Got you. Thank you very much.

Operator

Thank you. We'll go next to David Katz from Telsey Group. Please go ahead.

David Katz - Telsey Advisory Group LLC

Hi. Good morning.

Stephen P. Holmes - Chairman & Chief Executive Officer

Good morning, David.

Thomas G. Conforti - Chief Financial Officer & Executive Vice President

Hey, Dave.

David Katz - Telsey Advisory Group LLC

I'll apologize for going back to this issue given all the other interesting business dynamics you have going on here, but with respect to the lawsuits and your legal actions with this, I believe at a public conference a couple of months ago or a month or so ago there was discussion about injunctions, which I assume are intended to put a stop, right, or to mitigate what's going on today. And I would just be curious sort of where that stands? And to the degree that you're launching lawsuits, are they in pursuit of remedies or getting money back or are we suing for injunctions? What are we hoping to accomplish with some of these legal actions? And I did notice lastly that it grew by $1 million for the third quarter expectation. Are we really comfortable that it's not going to continue to grow through the remainder of the year? And then I really do have a business-related question.

Stephen P. Holmes - Chairman & Chief Executive Officer

Okay. Well, I'm not going to go into too much comment about lawsuits because it's something that we shouldn't be talking a lot about. Basically – let me give you as an example what we've done in the past. We want to shut this down. It's something illegal is happening because our customer information is getting put into other people's hands and it's being used to aggressively pursue our customers. And that's something that we need to stop.

So, the only way you can stop it is to find out who's doing it and how's it happening. And in order to go through that discovery process, the best way to go about it is to file a lawsuit and start looking inside the inner workings of some of these enterprises. And that's what we did last time. And that's the way lawsuits usually progress. I don't know what you're referring to with the injunctions. I don't – that's not something I'm familiar with, it may have been somebody else's comment. But that's not something that I'm familiar with.

David Katz - Telsey Advisory Group LLC

Okay. With respect to the Hotel Group, you mentioned in your comments about removing rooms from the system. Are we able to tell from the very copious disclosure that we have, how many rooms did you remove and are they oriented toward some brands more than others? And what expectation do you have in terms of removing rooms going forward, cleansing the system?

Stephen P. Holmes - Chairman & Chief Executive Officer

Okay. Thanks, David. There's always been a certain level of churn in our system with these economy hotels. Generally and I don't know about percentages for the quarters. But generally, we add about 6%. We take out about 3% or 4%, which gives us a net 3% growth roughly. That's rough numbers. That varies by brands, but it's in all of our brands. Our largest brands are Days Inn, Super 8 and, obviously, there's a number that leave from there. But there's a number that leave from Howard Johnson, Ramada and Travelodge and all of our brands. So, it's a normal activity of our business that for the 20-plus years I've been involved with it has been kind of the standard operating procedure. You love to have to not to kick out anyone, but quality is something that we will not compromise on.

David Katz - Telsey Advisory Group LLC

Understand. Thank you very much.

Stephen P. Holmes - Chairman & Chief Executive Officer

Sure.

Operator

We'll go next to Jared Shojaian from Wolfe Research. Please go ahead.

Jared Shojaian - Wolfe Research LLC

Hi. Good morning. Thank you.

Stephen P. Holmes - Chairman & Chief Executive Officer

Jared.

Jared Shojaian - Wolfe Research LLC

So, I appreciate all the color here on the loan losses, but it sounds like that 50% growth rate here in the second quarter is the right run rate for the back half of the year. But just want to make sure I'm understanding you correctly, is your expectation that this is completely lapped by 1Q 2017 or could we see more trickle effect into next year?

Stephen P. Holmes - Chairman & Chief Executive Officer

I think we'll probably see an impact of lapping and reduction in 2017, yes. So, I guess, the answer to your question is yes.

Jared Shojaian - Wolfe Research LLC

Okay. And then what's driving the 32% decline in timeshare expenses in the quarter? Is that just the expenses associated with the revenue forecast adjustment or is any of that from the Ovation program and what's the right run rate here going forward?

Thomas G. Conforti - Chief Financial Officer & Executive Vice President

I'm not quite sure, Jared. It's Tom. I'm not quite sure what the 32% reduction that you're referring to. Is it something specific?

Jared Shojaian - Wolfe Research LLC

Yes, the cost of Vacation Ownership interest.

Stephen P. Holmes - Chairman & Chief Executive Officer

Oh, VOI sales, the cost of goods sold.

Thomas G. Conforti - Chief Financial Officer & Executive Vice President

The cost of goods sold.

Jared Shojaian - Wolfe Research LLC

Right.

Thomas G. Conforti - Chief Financial Officer & Executive Vice President

Yeah. The cost of goods sold is coming about from two sources. One is the – has to do with the recycling of inventory. And we're able to take in lower-cost inventory that way. I think that's the largest piece of it. And there's some other costs in one of our brands that are – we're putting lower-cost inventory into one of our brands than we had in previous periods. It's a bit of a technical term, but that's what it basically comes down to. We're sourcing lower-cost inventory through cycled inventory and some of the new inventory we're putting into one of our brands is of lower cost.

Jared Shojaian - Wolfe Research LLC

Got it. Okay. Thank you.

Thomas G. Conforti - Chief Financial Officer & Executive Vice President

You're welcome.

Operator

And we will go next to Harry Curtis from Nomura. Please go ahead.

Harry C. Curtis - Nomura Securities International, Inc.

Hi. Good morning. I'll just add – or ask one other quick question, Steve, about the provision. You sound pretty confident that in 2017 you'll reduce the provision. What needs to happen to actually get a reduction in the provision? It sounds like you're kind of anticipating a positive legal outcome to achieve that.

Stephen P. Holmes - Chairman & Chief Executive Officer

No, Harry. I never handicap lawsuits. It's too hard to do that. So, I wouldn't say we're going to get a positive income – outcome. I think we're going to become more educated and we'll understand what these people are doing, and if they're doing illegal activities, we do expect to be able to point prosecution in the right direction. That's what we've done in the past. I think my confidence comes as much from lapping the problem as it does solving the problem. As I said, there's no silver bullet here. What I think we have the ability to do is – I think we do have the ability to turn it back and we have done that in the past, but I also think that by Q1, we will be lapping the issue. So, it won't be an increase in the provision anymore, in the absence of an increase, will be flat or reduced provision. That's more of what I'm talking about for Q1.

Thomas G. Conforti - Chief Financial Officer & Executive Vice President

Harry, it's Tom. Let me add just a thought. And there is a school of thought that says what we're seeing now is sort of an acceleration of defaults that may have taken place at some point in time. We saw that in 2012 when we had a similar type of issue, that there was a spike in defaults in the near term, and then the loss curve leveled out much quicker. And so, to Steve's point, there is a school of thought that says what we're seeing now is a bit of an acceleration of the activity that might have happened in the future, that won't happen in the future because it's happening now. And that might be an optimistic view of it, but that's the experience we had in 2012 and 2013.

Harry C. Curtis - Nomura Securities International, Inc.

Okay. That's helpful. And then my second question is between the – increasing your financing to creditworthy customers, I guess the first part of the question is, why are you doing that now? And then the lower down payments, it seems like you're getting more aggressive to generate incremental sales; again, why have you changed your sales techniques, if you will, or getting more aggressive?

Stephen P. Holmes - Chairman & Chief Executive Officer

Well, it's not really getting more aggressive, Harry, it's actually getting somewhat opportunistic. We manage the amount of down payment that we require from customers based on basically our compensation model with our sales people. We incentivize them to get certain levels of down payments. When we stood back and looked at this during our strategic planning, we said we're actually leaving a lot of money on the table because we have very, very good credit worthy customers that we're not allowing to borrow more than X amount of dollars.

So, what if we allowed them to borrow a little bit more? Would that give us an opportunity to actually grow our EBITDA in the future, as we're going to be driving more interest income, and as you know, the spread there is pretty good. So, this was more – this had nothing to do with defaults or anything, this has everything to do with us strategically taking advantage of what we've thought was a real opportunity. And we still feel that way, evidenced by the fact that our FICO scores are the same as they were before and we're kind of opening the spigot a little bit.

This is not big movement; this is relatively small movement. And as I said, I think, the last quarter, we probably wouldn't even talk about it if it didn't have a free cash flow impact. It potentially does have a current period free cash flow impact because we don't recover those – the cash that we put out for those receivables until we go through a securitization, which generally takes three to four months. So, it's really just a – if not for the cash flow thing, you probably wouldn't even notice it. But, it's – I think, it's the right – strategically the right thing for us to do for the company for the long term. And that's why we made the decision to do it.

One other thing I'd say on your first question, Harry, is don't lose sight of the fact that this business is still hitting its numbers, its EBITDA number, despite this pressure from the provision. So, these guys are really good at managing their business, they're very thoughtful, and when they see pressures like this as we did with the cease and desist a few years ago, we adapt and adjust and we make our numbers. And that's one thing we're very committed to do at this business, and we've done it successfully for 10 years now.

Harry C. Curtis - Nomura Securities International, Inc.

Okay. That's very helpful. Thank you.

Stephen P. Holmes - Chairman & Chief Executive Officer

Sure.

Operator

And we'll go next to Carlo Santarelli from Deutsche Bank.

Carlo Santarelli - Deutsche Bank Securities, Inc.

Hey, everyone. Good morning and thanks for taking my questions.

Stephen P. Holmes - Chairman & Chief Executive Officer

Hi, Carlo.

Carlo Santarelli - Deutsche Bank Securities, Inc.

With respect to the new sales centers that you guys have opened and are starting to kind of get some traction and with respect to the attempt to drive kind of a mid-teens growth within the new owner base, what are you guys doing to target kind of the millennials at this stage?

Stephen P. Holmes - Chairman & Chief Executive Officer

Well, we gather them in our basket of consumers that we talk to because in essence, what we're doing is we're capturing the traveling public into our tour flow mix. And just looking at the statistics of what's happening in the industry overall, there's been a dramatic decline in the average age of buyer from 54, maybe five years ago, 54 was the average age, to now the average age is 39 years old according to ARDA. Is that right, 39?

Thomas G. Conforti - Chief Financial Officer & Executive Vice President

39.

Stephen P. Holmes - Chairman & Chief Executive Officer

Yeah, 39, which is a remarkable decline. Well that means that there's younger people buying the product than there used to be, and yet, our numbers and others in the industry continue to increase. So, I think the fact is, we are capturing them in our marketing net and they are buying. We do stress different things with our sales pitches. For example, we'll talk more about experiences because millennials tend to lean towards experiences. So, we make it more experiential of what you'll have with these trips, and which we can take advantage of with timeshare. But that's just describing the product differently to suit the desires of the buyer. It doesn't change necessarily our product. It's just pointing out what you can do with your timeshare.

And I think the fact is the flexibility we gave timeshare buyers, both us and the rest of the industry by going to a points based product really addressed much of what a millennial will want to see, which is, I want more flexibility, I want more ability to make my vacations the way I want them to be. And so, that is what we're delivering.

We're obviously increasing our ability to do more bookings online. That's something that's been very important. We actually have been talking about this for several years. We're launching a new program called Voyager that is building that capability that'll make it easier for people to go on their iPhone to make decisions about their vacation planning. So, we're doing – there's a lot that we're doing, but we're seeing the capture happen just across the industry, not just us.

Carlo Santarelli - Deutsche Bank Securities, Inc.

Great. Thank you. And then if I may just one quick follow-up. As it pertains to your current guidance, Tom, correct me if I'm wrong but the FX impacts that you are seeing right now, how are they being contemplated for the back half of the year within the current guide?

Thomas G. Conforti - Chief Financial Officer & Executive Vice President

So, the assumptions we've made are based on current foreign exchange rates. We don't project going forward, Carlo, what direction rates might take. So whatever the rates are at the end of the second quarter, those are the rates that we include in all of our forecasts going forward. And that's where we got to $17 million number for EBITDA. And the year-to-date number on cash flow was a little bigger, $35 million, because of the Venezuelan situation that happened in the first quarter.

Carlo Santarelli - Deutsche Bank Securities, Inc.

Right.

Thomas G. Conforti - Chief Financial Officer & Executive Vice President

So, we're just using second quarter ended FX rates..

Carlo Santarelli - Deutsche Bank Securities, Inc.

Great. That's perfect. Thank you both very much.

Thomas G. Conforti - Chief Financial Officer & Executive Vice President

You're welcome.

Operator

And we'll take our final question from Patrick Scholes from SunTrust. Please go ahead.

Patrick Scholes - SunTrust Robinson Humphrey, Inc.

Hi. How are you? Just a follow-up question, one thing I guess hasn't been discussed here is when we talk about up-ticking and defaulting. What underlying causes are making these people defaulting in the first place here? What do you see and what may be changing of late?

Stephen P. Holmes - Chairman & Chief Executive Officer

Well, that, Patrick, we talked about that a little bit before. That's part of what we're investigating to understand more about. What we know is that people are – third parties are calling our owners and are encouraging them to default. Exactly what their pitch is to make them do that, we're not sure. We don't know what their promising them. We don't – because at that point that they come to us, our customers come to us and say that they don't want us to talk to them anymore because they're being represented. Then we can't talk to them anymore. And that's the wonderful consumer protections that we have.

So, we don't have the ability to dialogue with our customers to ask them what convinced you that you wanted to default? You've been taking vacations for the last 10 years and you've been enjoying yourself. What is making you default at this point? So, we're not sure what promises are being made. We're finding more about that and we will continue to find out more about that through our process. But the fact is we have hugely high customer satisfaction. We have probably record occupancy in our timeshare resorts this year. So, the product is being used. People are buying more of it. It's a very highly regarded product. So, we don't know exactly why, and remember, this is a very small number on a base of a million owners that are actually being addressed with this concern.

Patrick Scholes - SunTrust Robinson Humphrey, Inc.

As far as when you say a small number out of that million, what roughly, did you say in the past it was about 600 people?

Thomas G. Conforti - Chief Financial Officer & Executive Vice President

In that neighborhood, Patrick, it's measured in hundreds to Steve's point...

Patrick Scholes - SunTrust Robinson Humphrey, Inc.

Okay.

Thomas G. Conforti - Chief Financial Officer & Executive Vice President

...out of base of the million. So but we know it's a business of large numbers and some incremental shift, albeit, a small incremental shift, if that incremental shift equates to $15,000 or whatever the number is thereabouts that gets defaulted, that adds up to a lot of money in a hurry, so.

Patrick Scholes - SunTrust Robinson Humphrey, Inc.

Okay.

Thomas G. Conforti - Chief Financial Officer & Executive Vice President

But Steve said, the level of our owner enjoyment is exceptionally strong. And so, we're talking about sort of an incremental effect here.

Patrick Scholes - SunTrust Robinson Humphrey, Inc.

Okay. Thank you.

Operator

At this time, we have no further questions. I'd like to turn it back over to our speakers for any closing remarks.

Stephen P. Holmes - Chairman & Chief Executive Officer

Okay, Erica. Thank you very much. Well, thank you all for joining us today and we look forward to talking to you soon.

Operator

We'd like to thank everybody for their participation on today's conference call. Please feel free to disconnect your line at any time.

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