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Hilton Grand Vacations Inc. (HGV) Q4 2018 Earnings Conference Call Transcript

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Hilton Grand Vacations Inc.  (NYSE: HGV)
Q4 2018 Earnings Conference Call
Feb. 28, 2019, 11:00 a.m. ET

Contents:

  • Prepared Remarks
  • Questions and Answers
  • Call Participants

Prepared Remarks:

Operator

Good morning, and welcome to the Hilton Grand Vacations' Fourth Quarter 2018 Earnings Conference Call. Today's call is being recorded and will be available for replay beginning at 2:00 p.m. Eastern Time today. The dial-in number is (888) 203-1112, and the PIN number is 7540297. At this time, all participants have been placed in a listen-only mode and the floor will be open for your questions following the presentation. (Operator Instructions)

And I'd now like to turn the call over to Mr. Robert LaFleur, Vice President of Investor Relations. Please go ahead, sir.

Robert LaFleur -- Vice President of Investor Relations

Thank you, Greg, and welcome to the Hilton Grand Vacations' fourth quarter 2018 earnings call. Before we get started, we'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 only as of today. We undertake no obligation to publicly update or revise these statements.

For a discussion of some of the factors that could cause actual results to differ, please see risk factors in our previously filed 10-Qs or our 10-K, which we expect to file later today.

We will also 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.

As a reminder, our reported 2018 results reflect the new accounting rules under ASC 606. For ease of comparability and to simplify our financial discussion today and also as required in this transition year, our comments will focus unless noted, on this year's results adjusted to the previous accounting view, which we also refer to as Percentage of Completion or POC. Reconciliations to Percentage of Completion and GAAP are also available in the earnings release.

Also as a reminder, this is the final quarter of the transition year. So this is the last time we will bridge results between ASC 606 and POC. After today, POC goes away.

Finally, unless otherwise noted, the results discussed on this call, will refer to both the fourth quarter or full year 2018 and all comparisons will be against the comparable period of the prior year.

In a moment, Mark Wang, our President and Chief Executive Officer, will provide highlights from the quarter and the year, in addition to an update of our current operations and Company strategy. After Mark's comments, our Chief Financial Officer, Dan Mathewes will go through the financial details of the quarter and year, and our expectations for the balance of 2019. After that, we will be available for questions.

With that, let me turn the call over to Mark.

Mark Wang -- Chief Executive Officer and President

Well, thanks, Bob, and good morning, and thank you for joining us. Q4 was a solid quarter, that capped off a great year for Hilton Grand Vacations, as our teams did an outstanding job executing against our strategic priorities.

So let me highlight some of our key accomplishments. We delivered on our financial commitments with strong contract sales, revenue, and earnings that met our growth objectives. We continue to grow our installed base of members with our 26th consecutive year of positive net owner growth. We expanded on our global footprint, launching new properties in Hawaii, Japan and Barbados. These are the leading edge of a multi-year product offensive that will drive contract sales and earnings growth for many years to come.

Our Resort and Club teams continue to win awards and accolades for the quality of our properties and the high level of service we provide. And importantly, we began returning cash to our shareholders under the capital allocation framework we outlined at our Investor Day in December.

Turning to results, 2018 was a really strong year with contract sales growing by 10.6%. We anticipated sales to moderate in the fourth quarter due to reduced availability of certain inventory types and given how front loaded sales were earlier in the year. With that and to a lesser extent, the elevated noise we saw in the financial markets, our pace moderated to 6.2%. Our earnings momentum remained on track and adjusted EBITDA came in at the high-end of our guidance.

Our sales team did amazing job of executing on our plan. For the year, we saw double-digit sales growth in Orlando, New York and Oahu demonstrating in our consistent execution and the resiliency of customer demand in these important legacy markets.

Newer distribution centers like Hilton Head and Washington, D.C. saw impressive contract sales growth in the 40% range. Our Japanese business remained strong, and we finished the year with over 61,000 Japanese owners and double-digit contract sales growth.

The key driver of our strong contract sales growth this year was our marketing teams ability to grow tours by 8%. We again finished the year with first-time buyers representing approximately half of our sales. And even with this industry-leading first time buyer mix, our VPGs grew 2.4% surpassing $3,700 for the first time in our history. We saw consistent growth in our high margin Resort and Club Management segment throughout the year, as revenues increased 15% adjusted EBITDA increased by 20% and margins topped 58%. We added 20,000 net owners and at year-end, our owner base stood at 309,000. By installing 7% more owners to our base, we've embedded significant future value into our business from the recurring stream of high margin fee income and from the highly predictable patterns of real estate upgrades.

Our Resort and Club team is responsible for keeping our members active and engaged, which helps support our net owner growth strategy. They booked over 1 million vacations for our members last year with self-service reservations on our website or app increasing by 29%. Last year, our properties achieved an overall quality assurance rating of 94.6%, which ranks us outstanding and is among the highest of all Hilton brands. And we're not just winning -- and being recognized within the Hilton ecosystem, AAA Four-Diamond rating to just 6% of the hotels that evaluate each year. And we're proud to say that nine of our properties have earned that distinction.

Our rental business had great years, the Quin and other new properties added more rooms to our rental pool. Rental revenues increased 22% on higher availability, a 1 point improvement in occupancy to 87%, and the 7 point gain in ADR.

As we move into this year, we're excited about our portfolio expansion with sequels(ph)Myrtle Beach, Hilton Head in New York, and new market rollouts in Charleston, Chicago and Cabo. Keep in mind that the timing of these introductions is more weighted to the back half of the year, so you should expect to see our sales momentum build as the year unfolds

Select properties will open in the back half of 2019 and are important sales catalysts for this year's sales plan, because they stimulate upgrade interest from existing owners and they open up access to pools of potential to new owners.

As we think about new owner growth, our working relationship with Hilton is as strong as its ever been. And our access to new Hilton loyalty customers continues to be robust. Two weeks ago, Hilton reported that their Honors Program grew 20% in '18 and reached 85 million members. Being fully aligned with the world's most valuable hotel brands and industry's fastest growing customer loyalty program is a clear competitive advantage.

Now looking a little farther out, over the last 20 years, our owners have rated Maui, as the number one market they would like us to(ph)enter. Last month we could finally answer that call as we announced Maui Bay villas. This 388 units resort is located on the island southwest coast, and will be our 10th property in Hawaii. We're very excited about this project and expect to start sales in early 2020 and complete the first stage of construction in '21.

In our first two years, we're making very good progress in identifying and making investments into the business to accelerate our growth. We remain the industry leader in capital efficient inventory sourcing, and we were able to translate that into a return on invested capital of over 25% last year.

In addition to developing our own inventory, we continue to leverage our relationships with partners like Blackstone, Goldman Sachs, Mori Trust and the related companies to source capital efficient inventory.

Having the ability to obtain inventory across multiple channels is a significant competitive advantage. Because we've been able to fund our growth without taxing our balance sheet, we were able to start returning capital to our shareholders last year. Under the $200 million share repurchase program, our Board approved in November, we bought back 2.5 million shares or about 2.6% of our shares outstanding.

Going forward, capital return will remain a priority. At our Investor Day, we introduced you to our new CFO, Dan Mathewes,. Dan has great experience across all finance functions and really hit the ground running and you'll hear from Dan here in a moment.

We also found the right COO in Gordon Gurnik. Gordon has more than 30 years of experience in the industry, and most recently served as a President of RCI and found is probably not the right word. Because I actually have known Gordon for 20 years, and he has a stellar reputation throughout the industry. I'm very pleased with how seamlessly Dan and Gordon have integrated into the management team.

As 2019 gets under way, we're well positioned for sustained growth. We reiterate our '19 guidance and we expect to start seeing financial benefits from the investments we've made making to take hold as the year progresses. And it's not just 2019 as we expect to build additional momentum heading into 2020 and '21, helping to accelerate our earnings and free cash flow, which is consistent with our long-term objectives.

You know we've talked at length at our recent Investor Day about our strategic growth priorities for '19 and beyond. So I'm not going to repeat myself, but if there is a theme to the next several years that I want to make sure is clear to everyone, it's one of

growth, innovation and resiliency.

We spent a lot of time internally and with our Board of Directors talking about the business, we're constantly analyzing the industry, assessing the financial markets, listening to our members and engaging our shareholders. As a result, we have full confidence in our growth strategy, which we believe positions us well to create meaningful value for our team members, owners and shareholders.

I'll now turn it over to Dan to walk you through our financial results in more detail. Dan?

Daniel J Mathewes -- Executive Vice President and Chief Financial Officer

Thank you, Mark, and good morning, everyone. Just a quick reminder before I get into the numbers. All comparisons I will discuss this morning are between 2017 results and 2018 results under POC accounting.

As Mark highlighted, we finished the year strong, hitting our contract sales, adjusted EBITDA and EPS guidance. We saw solid results in Real estate and Finance this quarter, and exceptional results in Resort and Club.

In Real estate, tours and contract sales volumes increased for both owners and first-time buyers, VPG declined slightly due to the inventory availability and market noise that Mark talked about earlier. Segment revenues increased 13% to $365 million, while segment adjusted EBITDA increased 5% to $101 million.

For the quarter, Resort Operations and Club Management segment revenues increased 23% to $119 million, while segment adjusted EBITDA increased 29% to $66 million. Segment margins expanded by 290 basis points to 55.5%. Companywide adjusted EBITDA increased by 13% for the quarter to $114 million and by 10% for the year to $435 million.

Now let's go through the details and highlights for the quarter and year. Total company revenue in Q4 increased 15% to $513 million, reflecting growth in all business lines. Net income was $66 million and diluted EPS was $0.69.

Compared to Q4, 2017 net income did decreased 64%, and as you'll recall, we received $132 million deferred tax benefit last year under the new tax law. Our effective tax rate for 2018 normalized in the 26% range.

Fourth quarter Real estate results were solid, as contract sales increased 6.2% to $360 million. Strong demand for Grand Islander helped drive 8.6% fee-for-service contract sales growth in Q4, while owned contract sales grew by 3.3%.

The fee-for-service mix was 56% in Q4, up slightly from 55% last year. Our full year fee-for-service mix was 55%, which was in line with the high end of our guidance. In the Real Estate business line, Q4 revenues increased 14% to $285 million and margin increased 10% to $88 million. The real estate margin percentage came in at 30.9%, down 120 basis points from Q4 2017. For the year, contract sales increased 10.6% to $1.4 billion. Real estate revenues increased 13% to $1.1 billion and margin increased 7.2% to $329 million.

The Real estate margin percentage came in at 30.8%, which is down 160 basis points from 2017. Margins were negatively impacted by the investments we've made in infrastructure to bring new markets into the portfolio, investments in building up our tour pipeline and higher product costs due to our sales mix.

Turning to the financing business. Margin was flat in quarter as the incremental interest expense from the $350 million ABS deal we completed in September offset the revenue benefit of portfolio growth and a slight improvement in the effective interest rate we're collecting.

For the year, financing margin increased 4.8% to $109 million. The financing margin percentage compressed 170 basis points, but still stood at a healthy 69%.

Looking at our year-end consumer portfolio, gross financing receivables increased by $80 million to $1.29 billion. Our average down payment increased to 12.2% from 11.7%, and our average interest rate increased by 13 basis points to 12.28%.

Our long-term allowance stood flat at 13.3% compared to 11.7 -- 11.6%(ph)at the end of last year, but it's worth noting that we seem to stabilize over the past two quarters.

Turning to our Resort and Club business line, NOG came in at 7%. Revenues for the quarter increased 12% to $56 million and margin increased 7.7% to $42 million. The Resort and Club margin percentage came in at 75%, which is down 300 basis points.

For the year, Resort and Club revenue increased 8.9% to $172 million and margin increased 8.7% to $125 million. The Resort and Club margin percentage was 72.7% in line with last year.

Rental and ancillary revenues increased 32% in Q4 to $54 million. This reflects system growth and the incremental contribution from the Quin in New York. We will continue to operate the Quin as a hotel through its conversion, but its contribution to rental should moderate later this year as rooms come out of service for renovation.

Q4 rental and ancillary margin more than doubled to $16 million and margin percentage expanded to 29.6% from 17.1%.

For the year, rental and ancillary revenue increased 22% to $218 million, and margin increased 49% to $85 million. Rental and ancillary margin percentage for the year was 39%, a 720 basis point expansion over 2017.

Bridging the gap for Q4 between segment adjusted EBITDA and total Company adjusted EBITDA, G&A increased by $4 million, license fees increased by $3 million, and our JVs generated $1 million of adjusted EBITDA.

Q4 adjusted EBITDA was $114 million at a margin of 22.2%. For the year, total adjusted EBITDA increased 10.1% to $435 million at a margin of 22.8%.

Turning to the balance sheet. Mark mentioned, but it's worth repeating, we repurchased 2.5 million shares in the quarter at an average price of $28.62. In aggregate, we spent $71 million, which leaves $129 million of capacity left under our current $200 million authorization. We look forward to updating you on Q1 repurchase progress on our next earnings call in early May.

We funded the repurchases with cash on hand and borrowings under our revolver. As you'll recall, we refinanced our credit facility in late November, refinancing our $200 million term loan and expanding our revolver to $800 million. We drew $16 million off the new revolver to fund the buybacks. At quarter-end, corporate leverage was 1.1 times on a net basis. As we outlined during our Investor Day, we are ready to use our balance sheet with up to 1.5 to 2 times of net leverage to support our capital allocation priorities. We believe that this gives us the ability to fund capital returns, while still preserving adequate balance sheet flexibility to adapt to a variety of economic circumstances.

Looking at our liquidity position, we ended the year with $108 million of unrestricted cash and capacity at roughly $684 million on our revolver and $330 million on our warehouse. Corporate debt was $604 million and our non-recourse debt balance was $759 million. Adjusted free cash flow was negative $44 million for the year, which was in line with our expectations.

Now turning to guidance. With the exception of EPS, we are reiterating the full-year 2019 guidance that we provided at Investor Day. We expect contract sales growth of 9% to 11% with a fee-for-service mix of 48% to 54%. We're forecasting adjusted EBITDA of $450 million to $470 million, and net income of $260 million to $275 million.

Adjusting our share count for the 2.5 million shares we repurchased in the fourth quarter, we are raising our EPS guidance range to $2.74 to $2.89 from our original estimate of $2.68 to $2.84. No additional share repurchases are assumed in our guidance.

Please note that the Percentage Of Completion or POC was retired at the end of 2018. As such, beginning in the first quarter, we will no longer bridge GAAP results to POC. So just to be clear, 2019 guidance is in ASC 606.

As many of you have likely already seen, we have provided supplemental data on the construction-related deferrals and recognitions included in our reported results. This information for 2018 is provided in supplemental tables in our current earnings release. A file with the historical quarterly data through 2015, is posted on our Investor Relations website. Going forward, we will update this file every quarter.

This information should help you look at the business the way we look at the business and more clearly assess period-over-period growth rates. For example, the $503 million of adjusted EBITDA under ASC 606 we reported in 2018 included a $79 million benefit from net construction-related recognitions. So internally, when we think about growth between 2018 and 2019, our 2018 base is our adjusted EBITDA of $503 million less the $79 million of recognitions, which gives us $424 million. Off this base, our 2019 adjusted EBITDA guidance of $450 million to $470 million, represents growth in the range of 6% to 11% or 8.5% at the midpoint.

Our 2019 guidance does not assume any full year deferrals or recognitions. That being said, depending on project timing, we may see some intra-quarter deferrals within the year. We will guide you accordingly to those as we anticipate them. We do not anticipate any deferrals in Q1.

On the topic of Q1, I wanted to walk you through a quick example of how to use the supplemental tables we posted on the IR site. If you look at Q1, 2018, we reported adjusted EBITDA of $62 million, that included $37 million of net deferrals. So the right way to think about your base for modeling Q1 2019 is $99 million. So you can just repeat this process for the balance of the quarters and the years.

Finally, just a few comments about the cadence of the quarters this year, while we don't provide quarterly guidance, there's a few things to keep in mind as you think about 2019. First, 2018, got off to a very strong start with Ocean Tower. Second, our 2019 projects will come in line in the mid to latter part of the year. If you look at our adjusted EBITDA over the past two years without the deferral noise, it splits roughly 50-50 between the front and back half of the year. Given our timing expectations in 2019, our split is likely to be a couple of points heavier in the back half of the year.

Feel free to give Bob a call to work through these details. This completes our prepared remarks, we'll now turn the call over to the operator, and we look forward to your questions. Greg?

Questions and Answers:

Operator

Thank you, sir. (Operator Instructions) All right. And first, from Goldman Sachs, we have Stephen Grambling.

Stephen Grambling -- Goldman Sachs -- Analyst

Hey. Thanks. I guess, first starting with the buyback, what are the key things you are evaluating when thinking about starting the buyback, and will the future deployment be opportunistic or systematic?

Daniel J Mathewes -- Executive Vice President and Chief Financial Officer

Thanks, Stephen. When we were thinking about the buyback, I mean I think the best place to search is to reiterate what we said on the Investor Day back in December. From a capital allocation strategy, we were very focused on organic growth, and we've obviously laid out the investments over the next few years on that very front. Our next priority was definitely repurchasing shares, returning capital to shareholders via a repurchase share program.

I think everybody agree where we are in a growth strategy that is a better -- gives us more optionality, it's a better option for us now from where we stand from a dividend -- versus a dividend perspective. Going forward, we constantly and routinely look at different options to repurchase shares, but our focus is to be very disciplined, but at the same time, very measured. So we're looking to make sure that we have the flexibility with our balance sheet as we move forward. So we will leverage our balance sheet to the tune of 1.5 to 2 times as we mentioned on Investor Day. But from a -- how do we do that on the repurchase share front, that's something we'll update you on as we progress.

Stephen Grambling -- Goldman Sachs -- Analyst

And maybe changing gears as a follow-up. You gave a lot of good detail on the deferrals, but how should we think about the fee-for-service upgrades and the net impact to EBITDA in '19 (sic) and going forward?

Daniel J Mathewes -- Executive Vice President and Chief Financial Officer

I think the easiest way to think about the fee-for-service upgrade is take that into consideration where our mix is today. So when we look at 2019, we're looking at a mix that's coming down a hair. It's not dropping dramatically, but it is shifting more to owned contract. So as we shift to more owned contract -- owned inventory, excuse me, sales that will naturally come down. So in 2019, I would assume that would be of a similar level to slightly less and then as that shift is more pronounced in 2020, where will be sub 50% in 2021 where will be sub 40%. You'll see more of a shift on that front.

Stephen Grambling -- Goldman Sachs -- Analyst

Great. And then one last one, I'll sneak in is on the loan loss provision. It looks like it was relatively unchanged from 3Q. I guess normally, I would have expect that to kind of tick down from 4Q to 3Q. Are you seeing any changes in delinquencies or write-offs? Has there been any response to requiring higher down payments on upgrade sales?

Daniel J Mathewes -- Executive Vice President and Chief Financial Officer

Well, I think first and foremost, the first thing to address is, any push back if you would or any impacted to sales by requiring additional down payments on those larger balances. And we're very happy to say it's de minimis, there's really no impact on the sales front, so that's positive from our perspective. And then when we think about our portfolio, we look at the default rate. Year-over-year, the default rate is up. Last year, I think it was little bit over 4.1% and this year, it's under 4.8%, it's right at 4.7%. But we've seen some good movement from the aspect as we just mentioned that sales are not impacting by requiring additional down payments that we hope -- hopefully that will strengthen it and some of that degradation is, as we mentioned on our last call from some of the higher credit-worthy customers from Japan, how upgrading out of our paper into our fee-for-service partner's paper. So that's where we see some of that, but there's really no material change that we've seen in the recent months on that front.

And keep in mind, there is additional down payments that we're going to -- that we'd required on those larger balance loans and upgrades. That's going to take time to whittle through our portfolio. So the real benefit we probably won't see for a couple of quarters from now.

Stephen Grambling -- Goldman Sachs -- Analyst

Helpful. Thanks. I'll jump back in the queue.

Operator

And moving on we have Brandt Montour with JPMorgan.

Brandt Montour -- JPMorgan -- Analyst

Good morning, everyone. Thanks for taking my question. So net owner growth continues to be really impressive even stronger than maybe the levels that you said in the past is where you think it's sort of needs to be or kind of over that 5% growth mark. So is that outperformance back to line(ph)or how do you continue to be so successful there?

Mark Wang -- Chief Executive Officer and President

Well, Yeah, Brandt, anyways, good morning. But first, I'd say, it is core to our strategy. It is absolutely the number one thing that we focus on as we develop our initiatives every year, because we understand that the value that a new customer brings into our system.

And so I'd say, number one, we are very pleased with the relationship we have with Hilton, and how we've been able to engage Hilton and access the Hilton customers our relationship right now with them. We have the leading call transfer program. We were the first ones that started doing that in the branded space.

We have comprehensive exclusive rights for marketing with the branded hotels and any Hilton-branded hotel. So no one else can move into those hotels, other than us. And then, we're actively moving on the innovation side and developing new initiatives, especially around digital. And I haven't spoken much about those, because I'd rather get them done and proven and -- before I get out in front of it, but millennials and Gen-Xers are majority of our buyers today. And we're enhancing our digital capabilities. We know it's critical especially with this the new generation of customers coming in.

And it's not just in our marketing, it's around our brand interaction, it's around our customer service channels and we're adding capabilities for our owners as I talked about in my prepared remarks, as you saw both digital and web reservations move up. But there's a lot of opportunity, we believe and increase in the number of leads that we get from Hilton through digital channels and partnering closely with them, and it's a good time for us as Hilton is also investing heavily in those areas. And so the relationship is good, we've got initiatives that Hilton has with us that are -- that they're collaborating with us on. And so I think over time, you're going to see our business continue to expand using what I would call kind of more new age marketing.

Brandt Montour -- JPMorgan -- Analyst

Got it. That's helpful. And then second question just given the choppiness that we all saw in the macro last year, I think most people are happy enough to see you guys reaffirm contract sales guidance. And so I don't want to seem like I'm nitpicking here, but just looking at the guidance for contract sales of 9% to 11%, which at the midpoint is kind of right in line with what you ended up doing last year and yet you have several projects opening this year. So I guess my question is are you baking in any conservatism into that range or is there -- there are tough comparisons from Ocean Tower maybe, but your thoughts around that would be helpful. And that's it from me. Thank you.

Mark Wang -- Chief Executive Officer and President

Yeah, thanks. First of all, there is no conservatism in that range, it is an aggressive range. And I'm saying that I'm being upfront with people, it's -- we really outperformed last year. If you think about our 10.5% growth for the full year, it had outpaced the whole industry. No one had that level of growth.

And as you mentioned, we launched the first phase of Ocean Tower. It was a strong catalyst for us, and while we expected it to be well received, it was -- more than tripled our expectations with most of those sales occurring in the first half of the year and what made Ocean Tower so appealing was, it equally met demand from our new buyers as well as our existing owners.

So I would say that the guidance we put out there is it gives us based on the visibility we have today provides us the best view and we did see some impact from some -- some of the impact from the financial markets that happened last year. But that was minor. And if we look at the fourth quarter, the fourth quarter sales contracted some, that was more inventory-related, and as we talk about new projects for this year and inventory we're really excited about the expansion of our portfolio. But it is back loaded.

And so you should expect that our sales momentum will build as the year goes forward and we're also coming off of 14.5% comparable in Q1. So especially in Q1, the comparable would makes it more difficult for strong growth. But we are excited about the expansion and these will be meaningful for us toward the back half of '19 but actually more meaningful as we move into '20 and '21.

Brandt Montour -- JPMorgan -- Analyst

Thanks, guys. Good results.

Operator

We'll move on to Brian Dobson with Nomura Instinet.

Brian Dobson -- Nomura Instinet -- Analyst

Hi, good morning. So to what extent does your free cash flow ramp into 2023 give you confidence to draw down on your revolver to pull forward some of that capital return? And also, could you maybe just highlight some of the high level puts and takes that are driving that steep ramp into '22, '23. Thank you.

Mark Wang -- Chief Executive Officer and President

Yes. So I think as we provided in our Investor Day, what gives us confidence is really the new properties that we're going to be putting in place. And as we talked about when we get to '20, when we get out to the outer years, our free cash flow in 2022, 2023 is in the low fours to $500 million average range. So I don't know if Dan, if you have anything else you want to add to that.

Daniel J Mathewes -- Executive Vice President and Chief Financial Officer

No, I mean, I think that, that's it. I mean, the real thing and I think we communicated fairly well on Investor Day is the investment we're making in inventory today is really resetting the level of the business. So when we get into the out years you're looking at adjusted EBITDA, that is north of $650 million(ph)which translates into the adjusted free cash flow of $425 million to $500 million that we discussed.

Mark Wang -- Chief Executive Officer and President

Yeah. I'd also say it's just another reflection on the fact that we continue to drive positive NOG which we -- we know embeds significant amount of value into the business, and is that NOG as we embed value we're also extracting that value. And last year, if you look at transactions from new buyers that are up 10%, so very, very strong and that's coming off multiple years of really strong growth to new buyers. So I think we're really well set up to be able to perform against the new investments that we're putting into inventory with the embedment of new customers that we've added.

Daniel J Mathewes -- Executive Vice President and Chief Financial Officer

Yeah. I think the only thing I'd add on that front is with this new inventory coming online and where we see growing, that's what's giving us a lot of confidence in drawing on our revolver and levering up to repurchase shares in a reasonable amount of timeframe. I know we discussed earlier, not -- yeah we're looking at different avenues to do that and we very well may stay with an open market program, but again, that leverage target of 1.5 to 2 times, that's something that we anticipate getting to sooner than later, just to be clear on that part.

Brian Dobson -- Nomura Instinet -- Analyst

Sounds good. Thanks very much.

Operator

Next from SunTrust, we have Patrick Scholes.

Patrick Scholes -- SunTrust -- Analyst

Hi, good morning. I want to ask about your seven years of inventory, I would say that's probably about the most that I can ever recall or at least been publicly disclosed by a company. And certainly -- it's certainly not a bad thing. But what is the right amount? I mean would you see that whittling down over time and what would you see as perhaps your target for number of years of inventory?

Mark Wang -- Chief Executive Officer and President

Yeah. Patrick, this is Mark. Look, I think when you define our pipeline, first of all, we only have approximately 1.4 years of inventory today that's available for sale, right. So that pipeline is really it evolves through multiple stages, right. We've got design, we got construction, we have government approvals for registration. So we define our pipeline with anything that we see that we have either commitments to or future commitments to. So to be clear, it's seven years of inventory sitting unoccupied waiting to be sold, it's not all ready for sales today.

So some sitting on our fee-for-service partners balance sheets, some of it's sitting on our balance sheets, but it's in various stages. So we're unique right now in our space, and that we continue to strong net on our growth, which requires us to add inventory, we're not getting the kind of inventory deck from our members to support the kind of growth we have. And so the right amount, it's really hard to pin point that, but I feel really comfortable that the pipeline we have in front of us, gives us ample inventory to meet the growth objectives that we've laid out in Investor Day in December.

Patrick Scholes -- SunTrust -- Analyst

Very good. Thank you. That was actually very interesting on -- not getting inventory back from your customers, which is a good thing. That's it from me. Thank you.

Operator

And next from Wolfe Research, we have Jared Shojaian.

Jared H. Shojaian -- Wolfe Research -- Analyst

Hey. Good morning, everyone, and thanks for taking my question. So maybe can you just elaborate a little bit more on the contract sales growth in the fourth quarter being a little bit lighter, and specifically the VPG component, what did you see with conversion rates specifically parsed out between first-time buyers and existing owner upgrades? And then can you talk about the trends so far year-to-date that you've seen with, I guess, the volatility in the market calming down?

Mark Wang -- Chief Executive Officer and President

Sure. Yeah. So I would say, number one, when you look at the fourth quarter, our owner behavior buy and take behavior patterns remained very strong. We had double-digit growth there. Where we did see some apprehension or maybe reduced commitment levels was from our new buyers.

And so, but again, we had anticipated sales were going to contract in the fourth quarter, and it was more of an inventory mix. It was more debt, and it was -- I think the noise that was in the market. But when you think about the type of customers that we're selling. If I just look at our owner base today and let's translate that into the customers we're trying to sell, the majority of our owners have net worth of over $1 million. And so I assume that most of them have 401k plan. So there was a lot of noise that converged at one particular time. And so I don't -- I guess I'm not surprised that there was some impact, but again, -- our belief, it was more inventory-related as -- when we built our model every year, there is a number of factors that go into that.

And so with really tour flow and inventory being the key drivers. And once we match those two metrics up, we project the VPG, which translates in the contract sales. So we expect strong customer traffic. And I think as we look forward with these new sales centers and inventory coming in Chicago, Cabo and Charleston and the expanded presence in the Myrtle Beach and Hilton Head, in New York market. We expect most of our growth really to come out toward the back half of the year.

Jared H. Shojaian -- Wolfe Research -- Analyst

That's helpful. Thank you. And I guess as a segue to your last comment. I mean, if the quarterly cadence is ramping quarter-to-quarter in 2019, then we could be looking at a scenario when the fourth quarter is nicely ahead of the full year guidance. Is that the right way to think about, I guess the right run rate going into 2020 in terms of how contract sales could accelerate in 2020 versus 2019. Is that how you're thinking about it right now?

Daniel J Mathewes -- Executive Vice President and Chief Financial Officer

Well, I think when it comes to -- Hi, Jared it's Dan. I think when we look into 2020, that's going to be another evolution, if you will, on how projects unfold. Because remember a lot of the inventory spend that we're committed to, those projects are in different phases of development. So there's always a timing element, where it could shift between quarters. So I wouldn't start with a run rate in Q4 of 2019. I think you're going to have to look to us to provide a little bit more color as we get closer to that point in time. Hope that's somewhat helpful.

Jared H. Shojaian -- Wolfe Research -- Analyst

Okay. Thank you. And one more from me if I may, the fee-for-service mix came up a little bit of your guidance for 2019. Can you talk about that and then I guess separately due to higher product costs that you've called out, does that have anything to do with just general and inflationary trends and tighter construction supplier or anything of that nature.

Mark Wang -- Chief Executive Officer and President

Yeah, I'll take the first part of that question, then I'll pass it to Dan on the COP costs. Yeah, from a guidance standpoint, we're guiding 48% to 54% on our fee this year. And in 2020, it drops just below 50% and then 2021 it drops below 40%, now that's how we have it structured today, that's how we're guiding to it today. We have the ability to pivot and do more fee should an opportunity come about or should the market dictate that. So and then as far as the cost goes --

Daniel J Mathewes -- Executive Vice President and Chief Financial Officer

Yeah. As long as the -- as far as the cost go Jared from a cost of product perspective, it's not really inflationary, it's really it truly is the mix of sales more than anything else. And as we progress and that pendulum shifts from fee-for-service to owned inventory, the margin percentage will get compressed of the actual dollars that you see running through our P&L revenue and translating into EBITDA will include. So it's really more of a sales mix more than anything else to be perfectly honest.

Jared H. Shojaian -- Wolfe Research -- Analyst

Got it. Thank you very much for the time.

Mark Wang -- Chief Executive Officer and President

Thank you.

Operator

Next from Jefferies, we have David Katz.

David Katz -- Jefferies -- Analyst

Hi, thanks for taking my question. I'm just curious thinking long term. I think we've all maybe gotten sort of sucked(ph)into quarters and thinking about cadence and so forth. If we were to draw kind of a long term trend line for how you think the business can grow the next several years. How would you sort of help us think about that, you obviously do take a long-term view on the business.

Mark Wang -- Chief Executive Officer and President

Yeah. Look, I think as we talked about back in December, we're expecting sales growth in that 9% to 11%, 9% to 12% range. And in both contract sales and in adjusted EBITDA, adjusted free cash flow, we're expecting to ramp up to $250 million to $300 million by 2021 and if you take a look at, the individual projects view as we illustrated at Investor Day, the cash flow will continue to grow beyond five years, so I think that's what we've talked about here most recently.

David Katz -- Jefferies -- Analyst

And I apologize if I sort of missed any commentary on this, but just thinking about more geographies and which ones are at or near the top of the list or how long the list that is. I know expanding into new geographies an important part of that growth. How are you thinking about that? And that's it from me.

Mark Wang -- Chief Executive Officer and President

Well, it's -- no, that's it could get great question, and of course, we talked about the ones today that are more immediate '19 and '20. We announced Sesoko in Japan, really excited about that opportunity. That'll be the -- really the first big property that we're going to be able to expand into and to what I consider to be a really comparable market potentially to Hawaii for the Japanese market and also some of the other Asian customers out there China and Korea, in particular.

So beyond that, we've got a number of different markets that we're looking at. We're not going to talk about in any detail today what they are, but West Coast continues to be an opportunity for us. And as we look at our member base, we've got 50000 members in California alone. So the West Coast is a -- and California in particular is a market of great interest.

And Texas is also another very interesting market for us. It's -- Texas is our third highest number of owners reside in Texas. So I think geographically, there's a number of opportunities we're looking at right now, but we're not going to provide you any specifics at this point.

David Katz -- Jefferies -- Analyst

Thank you. Very nice quarter.

Mark Wang -- Chief Executive Officer and President

Thank you.

Operator

(Operator instructions) Moving on, we have a follow-up from Stephen Grambling with Goldman Sachs.

Stephen Grambling -- Goldman Sachs -- Analyst

Hey, thanks for sneaking me back. On the -- I guess on upgrades and the amount of money being put down or the down payment, I guess what percentage of upgrades put money down? And what is the typical amount that's put down on average for upgrades?

Mark Wang -- Chief Executive Officer and President

Yeah. Well we've instituted additional 10%. So previous to that change in our underwriting guidelines, we were just allowing them to use our equity for their upgrade sales. So I don't know if that answers your question or not.

Daniel J Mathewes -- Executive Vice President and Chief Financial Officer

Yes. And just to add further color, I mean, we've started the institute that and now we're getting close to 90% of upgrades are putting down new money.

Mark Wang -- Chief Executive Officer and President

Okay.

Stephen Grambling -- Goldman Sachs -- Analyst

That's helpful. And one other one is just, what's the minimum kind of cash commitment on inventory required in '19 and '20?

Daniel J Mathewes -- Executive Vice President and Chief Financial Officer

Well the tax commitment on the inventory that we talked about on Investor Day was $315 million to $365 million in '19 and $375 million to $425 million in '20.

Stephen Grambling -- Goldman Sachs -- Analyst

Thanks, again.

Daniel J Mathewes -- Executive Vice President and Chief Financial Officer

Thank you.

Operator

And ladies and gentlemen, at this time we will conclude the question-and-answer session. I would now like to turn the call back to Mr. Mark Wang for any additional comments or closing remarks.

Mark Wang -- Chief Executive Officer and President

Well thanks again everyone for joining us this morning. We had a great 2018 and '19 is off to a solid start. As always, we appreciate your continued interest in HGV, and I look forward to speaking to you -- all of you again in just a few months on our first quarter call. Thank you.

Operator

Ladies gentlemen, that does conclude today's call. Thank you for your participation. You may now disconnect.

Duration: 40 minutes

Call participants:

Robert LaFleur -- Vice President of Investor Relations

Mark Wang -- Chief Executive Officer and President

Daniel J Mathewes -- Executive Vice President and Chief Financial Officer

Stephen Grambling -- Goldman Sachs -- Analyst

Brandt Montour -- JPMorgan -- Analyst

Brian Dobson -- Nomura Instinet -- Analyst

Patrick Scholes -- SunTrust -- Analyst

Jared H. Shojaian -- Wolfe Research -- Analyst

David Katz -- Jefferies -- Analyst

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