Marriott International Inc. Q1 2008 Earnings Call Transcript

Apr.17.08 | About: Marriott International, (MAR)

Marriott International Inc (NASDAQ:MAR)

Q1 2008 Earnings Call

April 17, 2008 10:00 am ET

Executives

Laura Paugh, Senior Vice President, Investor Relations

Arne M. Sorenson - Chief Financial Officer and Exec. VP

Carl Berquist, Executive Vice President Financial Information and Enterprise Risk Management

Betsy Daum, Senior Director Investor Relations

Analysts

Jesse Scholas – Bear Stearns

Felicia Hendrix – Lehman Brothers

Patrick Sholes - JP Morgan

Steven Kent – Goldman Sachs

Michelle Ko - UBS

Bill Crowe – Raymond James

Chris Woronka – Deutsche Bank

Celeste Brown - Morgan Stanley

Wan Kim - JMP Securities

Jeff Randall – Black Creek Capital

George Sakellaris - Garp Research & Securities

Robert Lafleur - Susquehanna Financial Group

William Crow - Raymond James

Paul Puryear - Raymond James

John Staszak - Argus Research Company

Smedes Rose - Keefe, Bruyette & Woods

William Truelove - UBS

Operator

Good day everyone and welcome to this Marriott International First Quarter 2008 Earnings Conference Call. As a reminder today’s call is being recorded. At this time for opening remarks and introductions, I would like to turn the call over to the Executive Vice President, Chief Financial Officer and President of Continental European Lodging, Mr. Arne Sorenson, please go ahead sir.

Arne Sorenson

Thank you. Good morning everyone. Welcome to our First Quarter 2008 Earnings Conference Call. Joining me today are Laura Paugh, Senior Vice President, Investor Relations, Carl Berquist, Executive Vice President Financial Information and Enterprise Risk Management, and Betsy Dahm, Senior Director Investor Relations.

Before I get into the discussion of our results, let me first remind everyone that many of our comments today are not historical facts and are considered forward-looking statements under Federal Securities Laws. These statements are subject to numerous risks and uncertainties as described in our SEC filings which could cause future results to differ materially form those expressed in or implied by our comments. Forward-looking statements in the press release that we issued this morning along with our comments today are effective only today April 17, 2008, and will not be updated as actual events unfold. You can find a reconciliation of non GAAP financial measures referred to in our remarks at our website at www.marriott.com/investor.

Before moving to the specifics, let me make a few general comments about our results in the quarter. As expected slower US economic growth impacted the lodging industry in the first quarter as our RevPAR growth trailed inflation. Although we estimate that our 2.3% US managed RevPAR growth number was depressed by roughly 1.5 percentage points, by the timing of the Easter Holiday and the impact of renovations. In contrast international demand was strong, yielding international double digit RevPAR growth.

First quarter North American house profit margins declined about 7/10 of a percentage point, and world wide house profit margins were up about 4/10, reflecting the strong RevPAR at our international hotels and good cost controlled and contingency planning in our US markets. Not surprisingly the economy is also impacted in our timeshare business. During the quarter marketing incentives helped the top line and our focus on cost controls kept profits on tract versus expectations.

The securitization markets remain unsettled. Based on the feedback from investors and bankers, we feel reasonably confident of our ability to complete note sales during the year, but we continue to look at the market day to day. Today’s full year guidance assumes that we complete the sale of $550 million to $600 million of Timeshare notes in 2008. However, with historically wide spreads, we have rolled in higher cost to our forecast, reducing our expected note sale gains by about $20 million compared to our prior guidance.

Given today’s thin market, we are also planning to sell mortgage notes over the next three quarters to reduce the size of the average deal. Including reducing the first two note sales to about half of what we normally would sell in a given quarter. Our second quarter guidance assumes the sale of approximately $150 million in timeshare mortgage notes, probably through a conduit deal, a term deal, or a private placement. Of course there is a risk here, but this is our best estimate given the information we have.

All in all, as we approach this challenging environment, we are encouraged by our financial flexibility and liquidity. We have a $2.5 billion bank revolver with a 4-year term remaining, modest debt maturities over the next 5 years and strong expected cash flows in 2008 and beyond.

Our philosophy in an environment like this is very simple; while we can not make our lodging business immune to a weaker economy, we can strive to outperform our competitors. Our goal is first to expand or at a minimum maintain our substantial RevPAR premiums over our competitors. Second, despite rising cost and modest RevPAR increases, we focus on our operating margins, and of course above all we remain dedicated to our successful business strategy to remain the leading hotel management and franchise company. The strategy protects us when times are tougher, and delivers great returns when times are better.

So let us turn to the details. As we reported earlier this morning, our results for the first quarter were again solid. EPS from continuing operations totaled $0.33 for the quarter within our guidance provided a quarter ago. During the quarter we opened up our fantastic new Boston Renaissance Waterfront Hotel, but we gave up a bit more than a penny of earnings to the Bath Hotel’s construction cost overruns, and increased pre-opening costs driven by a delayed opening. With its proximity to the convention center, we believe this new hotel is going to do just great.

Our composite North American company operated comparable RevPAR rose 2.3% for the quarter. RevPAR at our limited service brands increased 1.5%, while full service hotels including Ritz Carlton in North America had stronger performance with RevPAR up 2.7%. International company operated RevPAR, which includes only the calendar months of January and February, including the Ritz Carlton brand, rose a bullish 18.5% or 11.5% excluding the impact of foreign exchange. Even international markets that typically derive a great deal of business from US travelers did well, markets such as Paris and the Caribbean. While the US Leisure traveler maybe cautious, most of the rest of the world is hitting the road.

In fact the number of international traveler’s tour hotels in the US increased at a double digit rate for the first time in 3 years. Luxury lodging was particularly strong, Ritz Carlton’s world wide comparable RevPAR rose 11.9% including the impact of foreign exchange for the quarter. As you know the Easter Holiday fell early this year, highly unusual, and in fact the earliest such instance of this in about 95 years. This generated some noise for our US results. If you remove the week before Easter from our first quarter, our RevPAR would have been up over 3% for our North American company operated hotels.

While the early Easter was part of the story, the weaker US economy also had an impact on RevPAR, but the impact was not evenly distributed across our business. Leisure transient business was very soft; at the Marriott brand, weekend RevPAR declined 0.5%, while midweek RevPAR improved 3%. Business transient demand was stronger than leisure, but varied by industry. Demand from guests employed by professional services firms, defense contractors, and even consumer goods companies continued to show solid increases in room nights and revenue. Guests associated with the automotive and pharmaceutical industries traveled less than last year.

Turning to groups, room revenue at the Marriott Hotels and Resorts brand increased about 2% in the quarter, consistent with our expectations. We were pleased to see good attendance at group meetings during the quarter and cancellations remained below 2007 levels. Looking at our significant markets, we also saw a variation in performance largely related to year-over-year group city wide comparisons, renovation impacts at our hotels and new local supply additions. We have seen a record amount of public space and guest room renovations in our system in recent years.

At the Orlando World Center new exhibit space drove RevPAR significantly higher in the first quarter. However across the Marriott Hotel and Resorts system, the negative impact of hotels undergoing renovations was greater in the quarter than the positive effect of hotels coming out of renovation.

Cities with significant hotel renovations included Boston, Washington, Baltimore, New York, and Chicago. In fact we estimate that first quarter renovations reduced RevPAR at company operated Marriott Hotels by nearly half a percentage point. Fewer city wide conferences impacted hotels in Chicago, Atlanta, and San Diego. Although the second quarter looks better in those cities. Philadelphia and San Francisco reported strong group business in the quarter. Net supply continues to impact hotels in Orlando, Detroit, and Chicago. Although across most major markets supply growth remains modest.

Overall across the US, while occupancy rates were under pressure, we have seen little transient or group discounting and average daily rates have increased 3 to 4% year-over-year.

As we look at our international portfolio, the UK was a bit soft, particularly in areas outside London. But we continue to see great results everywhere else. In our South Central Asia region, several of our resorts reported RevPAR of well over 35% growth. India continues to do well, while our China growth story is just terrific, with 25 hotels opening up in the next 3 years. There are 34 million Chinese traveling outside the country each year, and we suspect there is lots of pent up demand as a result of the growing wealth in China.

Results were great in continental Europe during the first quarter. In Paris for example, RevPAR was up over 11%. In Russia, the strength of the country’s energy sector continues to power the economy. In Kazakhstan, also buoyed by the rising energy sector, RevPAR rose 50%. The Middle East continued to be strong particularly in Dubai and Cairo, with strong demand from both European and Mid East travelers.

The Caribbean and Latin American regions reported impressive results, and the Dominican Republic continues to deliver stellar RevPAR increases of nearly 35%. In Panama, RevPAR was up 40%, benefiting from lots of activities surrounding the expansion of the Panama Canal. And in Mexico we are glad to see that Cancun is back.

Turning to the cost side worldwide house profit margins, we are up 4/10 of a percentage point during the quarter, while house profit dollars increased about 7%. In North America, house profit margins declined 7/10 of a percentage point, and house profit dollars increased 1%. Our US labor rates are running up 3 to 4%, and our cost of utilities is up only 1 to 2%, reflecting our energy hedging at many of our North American properties.

We are working aggressively to hold house profit margins in the slower demand environment in North America. Given the significant variability and hotel performance, we have put in place three levels of contingency plans designed to address each individual hotels circumstances. All our company operated hotels have implemented at least the most modest cost savings, and all of our limited service hotels are in mid-level contingency cost control. Sixty five of our full service hotels have implemented the tightest cost controls.

Our revenue efforts rival are cost containment plans. We began reorganizing our group sales effort last year and are pleased with our progress to deliver better service to our customers and stronger bookings for our hotels. In addition, we are adding languages to Marriott.com and we have enabled guests to click on hand held devices to check on reservations and directions. Small groups can now even book online. Our free weekend breakfasts, special packages where kids eat free and exciting contests, such as “win a million points and a million miles.” Marriott rewards promotions are attracting guests.

Further, we are preparing nee sales promotions that focus on weekend leisure and group business, coordinating our Marriott rewards program, email promotions, internet travel partners, and marriott.com. So we are deploying fresh new product and experience opportunities to drive revenues, not discounting rates.

Sales RevPAR and house profit margins are only part of the story. We added over 5,900 rooms in the first quarter and nearly a quarter of those openings were conversions from other brands. One conversion to our Renaissance brand was the Black Stone in Chicago, opening after $128 million renovation. Appropriate to this Presidential election year, the Black Stone is the stuff of political legend, where President Warren Harding was said to have been picked by those in a smoke filled, suite 404. Needless to say, the hotel has opened as a non smoking facility.

In addition to our Boston Renaissance, the fully renovated Renaissance Hotel Time Square in New York has drawn much attention. Our system grew to nearly 538,000 rooms and our pipeline of hotels and development or under construction was at just over 130,000 rooms at quarter end. Of those, 55,000 are already under construction. Over 60% of our pipeline of full service rooms is located outside North America. Over 3000 rooms exited our system during the first quarter, primarily as a result of our prune and plant strategy which has been very successful.

Reflecting the planting side of our limited service strategy, our limited service component of the hotel pipeline is now at about 79,000 rooms, compared to 74,000 a quarter ago. Many of our larger limited service franchisees are well positioned to reinvest in the sector. They are able to secure financing through local banks with which they have relationships and are optimistic about the business and about Marriott brands.

We continue to enhance our brands and just a few weeks ago, we launched our extreme makeover of our courtyard lobbies. The brand has redefined the lobby experience with an open, bright and contemporary new courtyard hotel lobby, beginning with more private check-in podiums upon arrival. Guests can choose from seating at communal tables in the middle of the action, to more private media booths with high definition televisions. The signature element of the lobby is the courtyard go board. A 52 inch LCD touch screen packed with local information, maps, weather, news, business, and sports headlines. Guests can navigate using the touch screen to find restaurants, local attractions and directions. Check out gocourtyard.com for an idea of what we are doing.

On February 26, we held our first Timeshare Analyst Day, our slides and speech, transcripts are still available on marriott.com/investor. We talked quite a bit that day about the challenge in evaluating performance of the business on a quarter-to-quarter basis, given Timeshare’s accounting methodology and evolving mix of projects, but we spent a lot of time on forecast for 2008, 2010, and we even provided a 10 year look at accumulative contract sales, development profits and segment results as well as long term valuation.

In the first quarter Timeshare pricing was firm and contract sales were consistent with expectation. New resorts draw sales higher, but were offset by projects reaching sellout. Overall, our contract sales were up about 2%. While Timeshare sales were on target, sales of fractional units were slow, as customers were reluctant to buy in a soft real estate market. Perhaps surprisingly though our residential sales were stronger than last year, especially at our resort in Kapalua.

Timeshare segment profits were substantially lower than the prior year as expected, largely due to start up costs and reportability at the new resorts and tough comparisons to significant reportable projects in the year ago quarter. We have stepped up time share marketing incentives to attract customers and close sales especially in the relatively softer markets in the western U.S. Overall reported results are expected to materially improve as the year progresses which I will get to in a moment.

Despite the weak economy delinquency rates on our U.S. financial loans continue to run about 6.5%, slightly above a year ago but the recent trend has been favorable. Delinquency has fell from 6.7% in January and February to 6.4% in March. However, as we discuss during our time share analyst stay, wee would not be surprised to see delinquencies trend a bit higher over the course of the year. Our first quarter tax rate was 38.4% and included an $8 million charge associated with our deferred compensation plan on an EPS basis, deferred comp is immaterial, since there is a dollar-for-dollar offset on the G&A line. For the remainder of the year we estimate our tax rate will total 35% to 36%.

To summarize our outlook, we hold pretty much the same view about 2008 as when we last talked in February. For the remainder of the year group bookings at the Marriott brand are up over 8%, with group food and beverage revenue expected to rise at a low double digit rate. With a strong group business, occupancy rates should be stronger and hotel should be better able to book the most profitable transient business. We are encouraged that first quarter cancellations were below last year and group meeting attendance held up. Price sensitivity was low in the first quarter which also gives us assurance that we can hold rate. Renovations are generally on schedule and despite the impact we reported on the first quarter, they should not depress RevPAR materially over the balance of the year. And again supplied growth in most markets this year remains modest.

Looking farther out 2009 group room revenue on the books is up by about 5% with the exception of housing and financial related institutions, meeting planners are still planning meetings and expect good turn out. As we think about our total fees, recall that base and franchise fees are derived from RevPAR and unit growth. We are continuing the forecast 3% to 5% worldwide RevPAR growth, and over 30,000 gross room additions in 2008. And therefore we continue to believe we can achieve a $1.49 billion to $1.52 billion in total fee revenue in 2008, a forecast unchanged from February. This is not just wishful thinking. While we remain cautious about U.S. RevPAR trends going forward, we expect international RevPAR to remain strong and with growing interest in brand conversions, we have increasing confidence in our unit growth goals. And the progress we have made on the cost side also gives us more confidence in our incentive fee outlet.

In addition, strong international performance is also good news for future incentive fees. In 2000 only 15% of our incentive fees were earned outside of North America compared to over 35% in 2007. Further as you know, incentive fees earned at most of our hotel in Asia, in the Middle East did not stand behind the owner priority returns and are therefore more secure and in a downturn. Roughly speaking, nearly 60% of international incentive fees came from those markets in the first quarter, with the balance drawn from Europe, the Caribbean and Latin America.

While our fee line guidance is unchanged, the challenges of the financial markets have prompted other changes on our forecast on P&L. As I mentioned earlier, we are planning to complete our Timeshare mortgage note sales but to spread them over the next three quarters. This means that our second quarter volume of the notes sold should be lower than last year. With spreads very high, we expect note sale gains to be about $15 million in the second quarter and approximately $70 million for the full year or about $20 million lower than last forecast. Our time share sales in services net line reflects this decline in note sale gains.

We also expect higher sales and marketing cost and continued softness in the fractional market place, offset by above property contingency cost savings. In our guidance, this brings down our time share sales and services net line by $15 million to total between $300 million and $315 million. Our time share segment profit forecast declines by $20 million to between $280 million and $295 million, reflecting more modest craft profit reportability from our joint venture projects.

For the full year we continued to expect to increase contract sales by 15% to 20% as four new projects begin sales in 2008. Contract sales are expected to be particularly strong in the third and fourth quarter. For the second quarter contract sales are expected to increase approximately 5%, constrained by the sell out of existing time share projects. Given the soft economic climate and difficult financing environment, we are currently estimating only about $100 to $150 million in asset sales, with some sales shifting into 2009. As a result we have lowered our estimate for gains by about $10 million.

Finally lower interest rates should lower net interest expense by about $20 million in 2008 compared to our prior forecast. All in all, our new forecast lowers our earnings per share outlook by about $0.02. Before closing, you have heard us talked frequently about our connection to our costumers and associates as well as the plans we have been implementing to remain relevant. Well a little later today I am heading to our green fair here at our headquarters, where our associates can learn about ways so we can be greener at work. We are all very excited and engaged in this effort.

Just last week, our company took a very bold step at the Amazonia Exhibit at the National Zoo in Washington. We joined together with the governor of the Brazillian state of Amazonas to announce that we were going to work together to protect 1.4 million acres of the Amazon rain forest—a piece of land just about the size of state of Delaware, this will help us offset our carbon emissions and give us a tool to connect to our customers and allow them to do the same.

The Amazon project is just a one part of an integrated environmental strategy. To us this is leadership, and it is the kind of forward thinking that from Bill Marriott on through our ranks, our company as demonstrated over the years. It is the kind of leadership that we work everyday to bring to our industry, which brings me back to the economy and our business. While we can not know which certainty, which direction the economy or our business will go next month or next year, we do know the economic cycles do have beginnings and ends, tops and bottoms. As we said before, we are especially well position to prosper.

As been noted humorous actor and financial columnists Ben Stein has said, ‘The indispensable first step to getting the things that you want out of life is this, ‘decide what you want.’ We know what we want and where we are going. We are taking the steps everyday to remain a leader and to deliver value to customers, shareholders, owners, franchisees and associates. As always thanks for listening and will take your questions now.

Question and Answer Session

Operator

(Operator Instructions)

We will take our first question from Jess Scholas (ph) with Bear Stearns

Jesse Scholas – Bear Stearns

It is another quarter where your development pipeline sequentially increased. Can you just talk a little about that sequential increase and I am presuming your going to tell me it is more international more conversions. Are you seeing any domestic, either new build or conversions fall out, and maybe just talk qualitatively the fancy environment and how that might be impacting going forward the developing pipeline

Arne Sorenson

Great questions, and I think when we see this numbers roll up to, we keep looking to see whether there is a pronounced sign that financing market is calling back the pipeline. And it really has not yet. It is clear that the greatest growth in the pipeline and the greatest strength is in international and in the relatively smaller domestic limited service hotels. The hotels that are under $25 million dollars in the U.S., Courtyards, Springhouse suits residence and the like seem to be getting financed well still. And in fact those are projects continue to come in the door as we speak from our franchise partners. I think many of our franchise partners did extremely well the last few years in selling a number of hotels that they have built before, so they are flush with equity to invest. And again for the smaller projects are are not finding it is difficult to get financing.

Internationals obviously a very different story but there they are driven by better operating fundamentals, stronger economies, a continued good performance. Obviously some differences in market to market but generally those are stronger environments. As far as the full service in the US, which we would say as probably the place we have the greatest concern, we are seeing some delays. We are seeing some of our partners find it difficult to move, get their financings finalized as quickly as they would have liked. Clearly, generally, where financing is not in place already, we are seeing equity requirements come up and we are seeing spreads expand from what would have been expected a year ago.

We think roughly and we do fairly close tabs on this. We think roughly three-quarters of our full service pipeline, to include the international piece, is fully financed. And in a sense you could think about that as being the openings for the balance of probably for the next 24 months or so I suppose. The balance is the full service hotels where we would say the financing markets will provide the greatest risk about whether those projects get killed. and mAny of them have not yet because it is just too soon. But whether they ultimately could get killed or delayed because of the finance markets.

Jesse Scholas – Bear Stearns

Ok, Good enough. And then one final question Arne. You actually maintained the full year RevPAR growth on the worldwide basis. As you think about the mix of that between North America and International, has that changed in the last three months? I guess I am asking, International,stronger and more than upsetting a lower domestic result?

Arne M. Sorenson

No, modestly maybe. I mean, first quarter, international numbers were great, obviously and probably a bit better than we anticipated. You can see from our domestic report that we were within the range of what had got into quarter ago, but at the lower end of that range. And so we are probably a little more optimistic about International, little less optimistic about Domestic but that is a pretty marginal change. Remember our first quarter results we announced only two months ago and we were then looking at a lot of the same signals of weakness in the economy that we are looking at today. And we really have not changed our expectation of fundamentally, the 3.5% RevPAR guidance that we are reaffirming today, is buttressed by the roughly 8% RevPAR growth that we have got on the books for group business in Q2, 3, and 4 in the United States. And that gives us as much confidence as we can. Though to be sure, we are going to be heavily dependent on performance of the economy over the next number of orders.

Operator

We will take our next question from Felicia Hendrix with Lehman Brothers

Felicia Hendrix – Lehman Brothers

I am just wondering, how much of your US business is now being driven by international customers and how does that compare to historical?

Arne M. Sorenson

Well, we are up double digits from a year ago. It is going to depend dramatically on the market, you know, and New York and Miami. Particularly those two would probably be the highest portion of international visits. You get to the middle of the country and even the West, I think it will be dramatically lower. I cannot give you a percentage. I suspect when it is looked at as a national average, it is a pretty small percentage, single digit.

Felicia Hendrix

Ok, thank you. And one more question. For timeshare guidance, excluding the securitization gains, it looks like it was up about $5 million for the year. Just wondering, is there anything behind that?

Arne M. Sorenson

It is about, actually we brought down our timeshare note gains by about $20 million and we brought down the segment results by about $20 million.

Felicia Hendrix

So I guess, I was looking at the timeshare revenues, not of expenses.

Yes, that is right. And that is down about 15. And so, the difference there is going to be on, by in large, cost focused effort to offset some of that loss that we expect relative to [inaudible.}

Felicia Hendrix

Ok, thank you.

Operator

We will take our next question from Patrick Sholes (ph) with JP Morgan

Patrick Sholes - JP Morgan

Can I get a little more color on the performance of domestic incentive management fees versus international during the quarter and also what is your outlook for those two for the remainder of 2008?

Arne M. Sorenson

Yes, we have not surprisingly, the best growth in international incentive fees, first quarter 2008 versus first quarter 2007. You can see our global incentive fees are up 4%. I think it is fair to characterize that as roughly flat. The poorest performing contribution, not surprisingly is in the US limited service management portfolio. A few of those portfolios of Residence Inns and Courtyard hotels, particularly that have been in place for you know, sometimes 15 years or more, are good incentive fee contributors to us historically. You can see from the RevPAR numbers we reported in the quarter that our weakest RevPAR was in US limited service hotels.

And so the year-over-year performance of those incentive fees are down a few million dollars, which in percentage terms is pretty significant from what we saw a year ago. I think the US full service would be next, but would characterize that as flat-ish, maybe down a touch, but generally flat-ish when you look at adjusting for renovation and the like. And the International piece up big, up 30%, maybe something like that. All of which foretells a larger likely contribution than we even experienced in 2007 for international hotels as a percentage of total Incentive Fee contribution.

Just a reminder to everybody, the law of small numbers is at work here in the first quarter. The first quarter is the least significant in terms of Incentive Fee contributions for the system as a whole. And as a consequence, you can get an impact in a high Incentive Fee contributing hotel of a million bucks or a few hundred thousand bucks, and have it be, percentages wise, a fairly significant impact

Laura Paugh

Is is also the least participating from our international hotels because they only have two months of performance here. So International should be more important going forward.

Patrick Sholes - JP Morgan

Ok, one more question. You know, on your timeshare notes, what sort of spreads are you seeing out there in the market right now on your notes?

Arne M. Sorenson

That is the right question to ask. We are talking to the folks who will help us and look at varying approaches that we can do with this. And one of the main things we are asking and talking to them everyday about is what the spreads are going to be. I can tell you for certain that they will be higher than the last quarter that we did. But beyond that, I am not going to speculate at what those spreads will be in part because we are hoping to get them lower than some of the guidance we are getting from folks outside. We hope that two-handle spreads but we will have to see how that goes. Reminder the last deal we did in the fourth quarter of 2007 was 125, 136, 130 bases points spreads and so with the two-handle, we are quite a bit worst than we would have been a quarter ago.

Operator

We will take our next question from Steve Kent with Goldman Sachs.

Steven Kent – Goldman Sachs

Hi, good morning. I have a couple of questions. First Arne, could you just talk about what level of RevPAR you need in order to maintain this Profit Margin? I guess it is roughly with what you are reporting or forecasting but it just seems to me with labor growing expenses 3-4%. That is pretty tight to sort of sustain these margins. Why not just go to DEFCON 3 on all of your expenses for all of your hotels right now, rather than you went through that whole exercise of saying you know, some of your hotels are cutting expenses, some aren’t, or have gone to different levels. Why not just roll it out across the board? And then finally Laura, could you just remind us what percentage of timeshare is from residential and fractional. So in your forecast or in your revenues, I think it is roughly 20% is from that, but I wanted to make sure I was right on that.

Arne M. Sorenson

That is about right, I think.

Laura Paugh

I think for the full year, that is correct and I will have to look up the number for the quarter. But for the full year, that is about the number we presented on timeshares. That had not been changed.

Arne M. Sorenson

So, let us see. Margins, I guess the question goes to the, I think it is one of the things we deliberately put in the prepared remarks. You can see that US managed margins were down 7/10 of a points. And even with the modest RevPAR growth of +2.3%, that produced a 1% increase in dollars of house profit. I think, pretty interesting actual illustration of the dynamic that we are all looking at here, which is that what RevPAR number you need to post either float margins or flat dollars of profit contribution, which is relevant both to the owners of those hotels and obviously to us in terms of its Incentive Fee contribution.

So at 2.3% RevPAR we are not able to support flat margins in percentage terms but we are able to support flatish, a little bit better actually, margins in dollar terms. Some place between that 2.3% and probably 3.5% RevPAR growth I suppose, we would see the margins move towards being flat in percentage terms as well. And therefore profits being up the same amount as RevPAR is up itself.

Why not go to DefCon 4 did you say for margin focus? That is something of that the most extreme cost savings initiatives at the hotel level, we can not say will be unobserved by our costumers. And so we really do not want to implement those stages, unless the hotel is suffering from meaningfully down business already.

The tier one cost control issues by contrast probably are not much more revolutionary than things that should have been done anyway. And as a consequence we think will never be seen by the costumers. You start to get to tier 2 and tier 3, and there you are starting to talk about maybe not filling some open positions, or having a little less entertainment and in the lobby and in the lounge. Those sorts of things which probably are not radical and I suspect most of our managed hotels today are in to the tier 2.

Tier 3, we have quite a number of hotels that have already moved to tier 3. But tier 3 is starting to do things which are likely to be noticed. They might be shortening the hours of and FB operation. And probably being a little harder on not filling positions even though those positions in normal times would be needed.

And we do not to go too far. We do not want to compromise the costumer expectation because business performance is really not that bad. Remember we continue to believe we are going to see 3 to 5% RevPAR growth this year. That is not the environment in which we think we should be compromising the experience of our costumers.

Laura Paugh

I would like you to add to the answer to your Timeshare number question on contract sales basis. In the first quarter, we were about 85% of contract sales came from Timeshare with the balance in residential in fractional. Of course that includes joint ventures, and so that is not necessarily the percentage that you should see flowing thorough the reported number.

Steven Kent – Goldman Sachs

And then Laura, so for the balance of the year, the residential part is the one that I have been concerned about. You still feel comfortable I guess, with that part of the business.

Laura Paugh

The residential sales in Q1 were stronger. We are up from the prior year, and they are chugging along.

Arne M. Sorenson

Yes, that is a little bit the law of small numbers because there is not much out there. Steve, obviously we given the best guidance we can so we thing that what we have built into the numbers for full year including around residential are the best numbers we have got.

I think as you can tell from the Timeshare guidance we have given for Q2, we have some pretty powerful numbers being contributed by that business in Q3 and Q4 for us. You look at Q1 actuals, Q2 guidance and our full year numbers, and we think that is the right set of expectations, but there will be some risk around that to be sure.

The residential and fractional are a relatively larger portion of the contribution in Q3 and Q4, which puts some more color on that flesh. But it is not all just guess work because we have often got activity which is underway today, which gives us confidence about what that recognition of those sales would be like when we get down to the balance of the year.

Steven Kent – Goldman Sachs

Okay, thank you.

Operator

We will take our next question from Michelle Ko with UBS.

Michelle Ko – UBS

Hi, good morning. I was wondering if you could tell me what proportion of the incentive fees were from international for Q1 and where you expect that to be next year? And also if you could tell us roughly how many of your hotels are in the various stages of contingency, tier 1, versus tier 2, versus tier 3?

Arne M. Sorenson

The international incentive fee contribution was 43% in Q1. That compares to 33% in Q1 2007, and again that is percentage of total incentive fee dollars that came form international sources.

Last year full year incentive contribution from international hotels was 35%. I do not suspect we will end up seeing a 10% increase on the full year basis, but we will probably see that 35 number move towards 40, I suppose when we look at this year full year.

And then what else did you ask Michelle?

Michelle Ko - UBS

In terms of the number of hotels roughly, could you give us a break down for how many hotels are in the different stages of contingency, like tier 1, versus tier 2, versus tier 3?

Arne M. Sorenson

Well I think the generally the managed limited service hotels are going to be all at tier 2. Tier 3 is going to be driven by market performance and I suspect that we have a higher percentage of those that are in tier 3 than we do of any other product class.

I think when you look at the full service hotels in the US, you probably have 50ish, I suppose that are in the tier 2 and tier 3 range. And virtually every hotel is at tier 1, every hotel is at tier 1.

Michelle Ko - UBS

Okay, great, thank you.

Arne M. Sorenson

You bet.

Operator

We will here next from Bill Crow with Raymond James.

Bill Crow – Raymond James

Good morning, couple of questions here. First of all, is it fair to assume that you are seeing an accelerating number of hotels that had been paying instead of management fees that are no longer paying incentive management fees because of local market conditions or what not. And specifically I am talking about North America.

Arne M. Sorenson

I would not put it the way you have put it. We have a total number of hotels paying incentive fees this year compared to last year, is down a bit, but it is down a few percentage points. It is not a dramatic decline. And you can see why. And that decline by the way, is driven by either a limited service hotels, where we have had the lowest RevPAR growth or by renovation activity.

When you look at the numbers as a whole, you can see that even with 7/10 decline in margins, that is driving an increase in dollars of house profits. And it is dollars of house profits which pay our incentive fees.

Bill Crowe – Raymond James

Right and how does the compare or contrast of where we were in early 2001, the pre 9/11 kind of downturn?

Arne Sorenson

I do not know the first quarter numbers for 2001, but we could certainly get that for you.

Bill Crowe – Raymond James

But it feels better I am sure, than it did back then, is that fair?

Arne Sorenson

Yes, first quarter of 2001 RevPAR performance was…

Laura Paugh

We were up 2.5%...

Arne Sorenson

We were up a few points in the first quarter.

Laura Paugh

We were up 2.5% RevPAR and we had seen a lot of cancellations. We had seen terrible turn out of group meetings. You would have basically seen a very group focused down turn and business transient focused downturn, and leisure business was very strong and courtyard was very strong.

This is a very different circumstance, and since we are primarily a business oriented hotel, this is a much friendlier environment.

Bill Crowe – Raymond James

Okay great. And then Arne could you talk about your capital allocation, is there a chance with acquisition opportunities perhaps getting more attractive that maybe you focus more of your capital output into acquiring hotels where you can put your brands on them, as opposed to share ward purchases, or other alternative use.

Arne Sorenson

Yes, that is a great question. What we have talked about over the years is that our preference would be to invest every dollar of available capacity we have in growing our business. And it is really only the residual in a philosophical sense that we use to repurchase stock and in that way return cash to our share holder.

We do think it is imperative from a capital allocation perspective to distribute that cash to our share holders in that way if we do not have a use for it, in investing in our business. And that is really what has driven our performance here in share purchases over the last few years.

As we look now into 2008 and 2009 to the extent the opportunities to invest in growing our business become more compelling and that maybe driven by prices coming down or maybe driven by fewer of the aggressive buyers that we have seen competing for us and others in the last couple of years. I have seen those people seed the field a little bit. That may present more opportunities for us

My guess is those opportunities are less about today than they might be about nine months or 12 months from now. The places where the best opportunities are going to present themselves are probably the deals which were done with relatively high and cheap leverage. And as they get closer to maturity of that debt, they are probably going to feel more pressure to reduce their project expectations and see about selling them at different levels.

We are still not seeing incredible bargains out there in the market today by and large because nobody is under the duress to sell these hotels.

Bill Crowe – Raymond James

And then one final question and thank you for the answer. Have you seen more requests for mezzanine financing on the development pipeline than you have from the past now that other alternatives might not be available.

Arne Sorenson

We are certainly seeing many more conversations about what do we do about the relatively lower levels of leverage that are available today. And we are talking with our partners about that. Sometimes that is phrased in the context of ‘Marriott,will you participate in someway or another in our effort to put together this financing package,’ which could be about mezzanine debt or could be about some other approach. And in some circumstances I am sure we will find opportunities to participate in that way, which is value enhancing for us. We will not generally though step in to fill the gap between whatever the leverage levels available where a year ago and whatever they are today.

Operator

We will take our next question from Chris Woronka of Deutsche Bank.

Chris Woronka – Deutsche Bank

A couple of quick ones. One is, any color on kinda the decline in owned and leased margins. I think it was down about 550 BPs. And then the second one is, on the timeshare sales that get launched later this year, is it fair to assume you guys are expecting most of that to become reportable in 2009?

Carl T. Berquist

I would guess that not until we get to the third or fourth quarter where we have a significant amount of those sales, which are actually being recognized in 2009. You probably have an average of three to six months I suppose, of lag. And it is a relatively unusual product would have lag more than that, though there are a few. So what we are selling today by enlarge will be recognized today. We did have an increase in our essentially unrecognized contract sales from the beginning of the year to the end of the first quarter from about $100 million to about a $150 million. And so those were contract sales done in the first quarter which we have yet to recognize.

So let us see, owned leased. I think probably the single biggest impact there is Boston seaport which we talked about. That hotel cost us a little over a penny in two different places, or a little over a penny total, but showing up primarily in two different places in our P&L, one on the owned and leased line. This is a hotel which we have sold but will be under a lease format for the first three years and then we will convert to a simple management contract. And we had some free opening expense, primarily driven by delayed opening for that hotel because the construction noise at the end, which was probably $3 million or $4 million I suppose, of a net pretax and then about the same number which showed up in the gains line because we had some construction cost here that we did not anticipate, which because we already sold that hotel we ended up having to eat ourselves.

We got Camelback, we ended up with a descent contribution on owned leased as well. There we have got a significant renovation under way. I suppose that would be another significant thing that would have impacted those margins.

Chris Woronka – Deutsche Bank

One more if I could, on the leisure side of the business, which we know is probably a bigger contribution in the third quarter, what kind of booking windows do you have on that. And kind of imbedded in the guidance, are you assuming that current trends stay the same or there is deceleration or just how should we look at that for especially for the third quarter?

Carl T. Berquist

I think we are assuming that they stay the same. Weekend business which is really what leisure is during most parts of the year and obviously you get towards the summer and it is a full week dynamic. But we are down more in that segment than any other. Both in terms of the first quarter and when we look at the next 28 days, we got some visibility there but not a lot really. And what we are seeing is probably on average three to four point decline in leisure room nights. And I think our forecast assumes that it is probably going to continue at about that pace for the balance of the year.

Operator

We will take our next question from Celeste Brown with Morgan Stanley.

Celeste Brown - Morgan Stanley

A couple of questions on timeshare, Arne you are talking about spreads probably being higher, why not just wait until the end of the year or just do one big timeshare note share. Tere doesn’t seem to be any pressure on your balance sheet. There does not seem to be any pressure to get them off your balance sheet in the near term.

Arne Sorenson

I think it is going to depend on the pricing. That is one of the factors that we will go into it depending on where these spreads are. I think it is possible we would decide not to do any second quarter deal and see how the markets develop over the balance of the year. To do one deal in the fourth quarter would be $600 million portfolio. I think our budget, which we probably scaled back our expectations a bit, with over $600 million for our full year. That is a bigger deal than we have really ever done and it would present some incremental risk simply based on the sidez of it. I think the other thing, to state the obvious, we are building our own internal expectations when we are running our business against those expectations. At the same time the financing are less certain than I think any of us have seen them in some time. There is no guarantee that 2 or 3 or 4 quarters from now, we are going to have a market in which we can easily and swimmingly do the deals that we might decide to defer today.

So that is one of the risks that we will factor in. And if the economics, even though maybe a little bit worsw than what we have hoped for, what we have experienced in the years past are acceptable to us, I suspect we will proceed with them.

Celeste Brown - Morgan Stanley

So sell them while you can and that’s it essentially?

Arne Sorenson

Yes but not at any price. If you think about for example increase in a hundred basis points in the spread, you see what is happened with underlying interest rates, and how they have come down. We are talking probably about an all in return to the investors in the 6% range give or take.

So at that range, really the decision not to sell is a decision by us that we think that is too much to give to the investors, and we want to fight to keep that. We do not have an interest in keeping assets on our balance sheet long term to get an incremental 6% return.

Now if we had confidence that a quarter later, we could keep a point of that forever, and only giveaway 5%, well that would be something. And we will have to factor in whether or not we have that confidence. But thinking about all of the factors in place, if the spreads are within the range of reason, and therefore we’re are keeping the majority of that profitability associated with the high interest rates, and giving up something which is meaningfully less than our cost capital, that is something we will choose to do.

Celeste Brown - Morgan Stanley

How important is your ability to finance to your ability to sell? So for example if you stop financing your sales tomorrow, which I do not see as a risk anytime soon, but how far do you think your sales would decline, or the demand would decline?

Arne Sorenson

I do not know. I can not give you a percentage number. This is mostly about the traditional Timeshare buyer, the buyer of the one week product. It is not about fractional product or the higher end stuff. And there the propensity to finance is high. I mean you are talking about 70% to 80% of buyers of Timeshare finance through us, which tells you that it is a significant factor in the way this product is sold.

There is really no near term risk that we will end up changing our approach to financing. I think theoretically if we concluded that we would never be able to market this paper at attractive economic terms. That’s obviously something that we could factor in, but we do not think the markets are in that position even today. And we think that the deals that we could get of today are attractive enough that we can continue on with business the way we are doing it.

Operator

Okay, thank you. We will take our next question from Wan Kim with JMP Securities.

Wan Kim - JMP Securities

Hi, good morning. I have a question about your share repurchases this quarter? It looks like the pace slowed down considerably compared to the 2007. I was just wondering if you could talk about that a little bit on what decision making process is?

Arne Sorenson

Yes, our decision making process is really, we talked about it in the context of anther question a minute ago, is to use our capacity within our target leverage levels, to invest in our business and to the extent we are not doing that to return to shareholders through share repurchases.

Our target leverage levels are 3 to 3 ¼ debt to EBITDA when adjusted appropriately for leases and other contingent liabilities and alike. And we think we are about at that level today Rev at about 3 times. So as a consequence our excess capacity is going to be driven by the ins and outs of operating cash flow, assetdispositions, including Timeshare note sales, and investing in our business.

As we look at the year, there is obviously more risks this year that we will not sell the things that we had targeted and planned to sell. Those numbers are not huge because we do not have that much left to sell. But today we have less confidence about our ability to sell them we would have had certainly 6 or 9 months ago.

Similarly I think the investing that we are doing in some of the projects. We are probably deferring a bit of that and pulling it back, so we will probably invest a little bit. Now that could be offset by opportunities which come in over the transom and we will look at those and try to understand them.

Operating cash flows continue to perform quite well. So, so far so good on that. Is the 200 slower than last year? Is the 208, I think our first quarter number. It is slower than last year, but remember last year we purchased $1.7 billion, I think on a full year basis. We told you a quarter ago to anticipate roughly a billion dollars of purchases full year this year. And that number in the first quarter is about at that pace.

So it is about what I think you should have expected. The risks going forward for the balance of the year, I think are that we end up spending less on share repurchases based on risk around Timeshare note sale deals, and financing markets, than that sort of thing, then that we will spend more than we have got towards, which happened in 2006 and 2007.

And we will take one more if there is somebody in the queue?

Operator

We will take our final question from Jeff Randall with Black Creek Capital.

Jeff Randall – Black Creek Capital

Hi, good morning Arne, good morning Laura.

Laura Paugh

Hi Jeff, how are you doing?

Jeff Randall – Black Creek Capital

Hey, Arne, I wanted to get your thoughts on the recent airline consolidation bankruptcies that we have seen. I guess four airlines have filed in the last three weeks, and it would seem like fares are going to rise in flight options, particularly in secondary destinations, than would decline. I just wanted how you think about the impact to that on your business longer term.

Arne Sorenson

Yes, we are going to watch it really closely. We have clearly benefited as an industry from the lack of pricing power that the airlines have went through over the last number of years. And so the cost of air travel has been meaningfully less as a percentage of total travel than it was in 1998, 1999, 2000.

To the extent these mergers and maybe fuel prices foretell an increase of significance in airline travel. That will increase the cost of total travel. That is not good for us. Generally we think for business travel that is something which is not likely to be cataclysmic. It is more likely to be impactful on the leisure markets. Think of the leisure market, maybe that is Hawaii, or maybe that is some of the Florida markets. We will just have to see and have to watch that.

To the extent the mergers allow for these companies to build some more efficiency in the system, net that is probably positive for us.

Jeff Randall – Black Creek Capital

Do you think that in the non gateway cities in more of the, I guess, limited service segment, you see more of an impact as they maybe trim flight options to some of those cities.

Arne Sorenson

It is possible, although remember the more you get to those sorts of markets, the less important airline travel is for them generally. They are going to have a higher percentage of drive business than they would have flight business. And so you get into those somewhat more rural or suburban markets, you will probably looking more at regional travel or sales focused travel which is done by folks who are using a lot of cars.

Jeff Randall – Black Creek Capital

One last question on the green topic, can you comment on what percentage of the development pipeline is either green or I guess lead certified?

Arne Sorenson

Very low. We have one open lead hotel in the US today, which is University of Maryland Marriott Brand Conference Center. And it is one of maybe one or two or three, in the country as a whole in the industry.

Jeff Randall – Black Creek Capital

So really nothing in say the limited service…

Arne Sorenson

No we have got a limited service hotel in Baltimore, which is lead certified, which is under construction. We are working with our franchisees on lead certified prototypes for most of our limited service brands. There is a lot of activity around this space. You have seen probably in the last couple of weeks decisions out of Dubai and Abu Dhabi, both that all construction will be lead certified.

We are seen in a number of municipalities that there is significantly greater likelihood in the ease in getting building permits or lead certified urban projects. And so as a consequence we will see a dramatic increase in the number lead hotels.

But it is going to be slow in coming. I think it is not as if we will see 90% of our hotels in the development of pipeline lead certified in the next 12 months, but we will see it increase a lot.

Jeff Randall – Black Creek Capital

Do you think it is just a matter of time before zoning requirements dictate that and then I guess if it does. And how would that impact hotels that are farther out at the 3 year end of your pipeline, if those requirements would be instituted.

Arne Sorenson

We do not think it is, clearly the requirements will head only in one direction here. So it is more and more likely that lead or other sustainable approachs to the development is going to have to happen.

We think actually the incremental cost associated with this are coming down. This gets in the more level of detail than you would like, but we had a breakthrough with one of our conditioning suppliers the other day, where with them we figure out a way to do a lead certified air conditioning approach, which dramatically less expensive than the solutions that were offered before.

Jeff Randall – Black Creek Capital

So with cost coming down, it does not sound like you are really concerned about hotels falling out of the pipeline if standards are instituted?

Arne Sorenson

That is a much less significant risk than the financing markets are. A lot less.

Alright, well we thank you all very much for your time this morning and as always. And maybe especially in this market, we encourage you to get on the road and travel. Hope to see you soon.

Operator

That does conclude today’s conference call. We would like to thank you all for your participation, have a great day.

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