Marriott International, Inc. F3Q08 (Qtr End 09/05/08) Earnings Call Transcript

Oct.13.08 | About: Marriott International, (MAR)

Marriott International, Inc. (NASDAQ:MAR)

F3Q08 Earnings Call

October 2, 2008 10:00 am ET

Executives

Arne M. Sorenson - Chief Financial Officer, Executive Vice President, President - Continental European Lodging

Laura E. Paugh - Senior Vice President Investor Relations

Carl T. Berquist - Executive Vice President Financial Information & Enterprise Risk Management, Principal Accounting Officer

[Betsy Dahm] - Senior Director of Investor Relations

Analysts

C. Patrick Scholes – Friedman, Billings, Ramsey & Co.

Joseph Greff – J. P. Morgan

[Sue Lee Dapon] – Barclays Capital

Chris Woronka – Deutsche Banc North America

William Truelove - UBS

William Crow – Raymond James

Jeffrey Donnelly – Wachovia Securities

[Unidentified Executive – Wachovia Securities]

William Marks – JMP Securities

Operator

Welcome to the Marriott International third quarter 2008 earnings conference call. (Operator Instructions) At this time for opening remarks and introductions, I would like to turn the call over to Executive Vice President, Chief Financial Officer and President of Continental European Lodging, Arne Sorenson.

Arne M. Sorenson

Welcome to our third quarter 2008 earnings conference call. Joining me today are Laura Paugh, Senior Vice President of Investor Relations, Carl Berquist, Executive Vice President of Financial Information and Enterprise Risk Management, and Betsy Dahm, Senior Director of Investor Relations.

Before we begin we’d like to express our deep appreciation for the hundreds of messages we’ve received expressing support following the bombing of our franchised Marriott hotel in Islamabad, Pakistan. We honor our brave retail associates and the Pakistani security and aid staff for their incredible efforts to minimize the casualties from this horrible event. The latest information that we have is that there were 55 deaths caused by the bombing. While we work hard to maintain security at our hotels around the world and we pray that these events will remain rare, we also firmly believe in the role our hotels play in bringing people across the globe together to bridge cultures and to increase peace and understanding.

As usual, 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 from 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 October 2, 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 on our website at www.marriott.com/investor.

So let’s talk about the elephant in the room. We like all of you have been closely watching the capital markets and the economy. In recent weeks we have seen the capital markets dramatically constrict. Like many others we have a strong sense of frustration about the practices and transactions that created this mess but without action the resulting credit squeeze could threaten business in our industry and in many others. There are thousands, maybe tens of thousands of jobs at stake in our company alone and we are typical.

We urge the ranking members of both parties to work with Secretary Paulson and Chairman Bernenke to develop and enact a comprehensive stabilization plan. While the details are important, it is important that the plan be big and enacted very, very soon.

Given the extraordinary pace of change and uncertainty, it will come as no surprise that it is extremely difficult to provide much visibility for the balance of 2008 let alone 2009.

But we can start with what we do know, which is that our lodging model is functioning extremely well even in a difficult economic environment as unit growth offsets comparable hotel RevPAR declines to produce a resilient and substantial base management and franchise fee stream.

Our timeshare business on the other hand is much more challenged by the financial crisis impacting our timeshare note sales directly and indirectly the appetite of consumers to buy our fractional and whole ownership products in the face of declining real estate values and tight credit.

Let’s get to the details. For the third quarter we reported adjusted diluted EPS of $0.34 at the upper end of our guidance after excluding a non-cash tax item. We were on target with our RevPAR guidance provided a quarter ago and worldwide company operated hotels reported RevPAR gains of about 1% or 3.4% including the favorable foreign exchange impact.

Limited service hotels were slower due to a mix heavily dependent on weekend consumer travelers and weekday business transient travelers as well as relatively higher supply growth.

As expected full service hotels in New York, Orlando and Southern Florida benefited from completed renovations and good group business.

A few resort markets felt the impact of reduced airlift such as Hawaii, Las Vegas and Palm Springs.

For our Marriott hotels group revenue rose 2% despite the increased attrition in group meeting and attendance as well as slightly higher levels of cancellations.

Outside the United States and Canada company operated hotels reported 5.7% RevPAR growth for the quarter or 13.4% including the impact of foreign exchange. Weakeneing economic conditions seen in the US since early 2008 are beginning to impact other markets around the world. In the UK and Western Europe third quarter economic conditions resembled those in the US. Russia was better by and large with our Russian hotels benefiting from the strength of that energy fueled economy.

On the upside we continue to see considerable strength in the Middle East as well as elsewhere in Latin America and the Caribbean where RevPARs generally increased by double digits. Our South American hotels benefited from strong group and corporoate business. In China hotels in the Beijing and the nearby Tianjin markets did fine during the quarter which of course included the Olympics. But demand in China was impacted by temporary visa restrictions put into effect for the Olympics.

What are we doing to drive business in this environment? We know we are outperforming our competitors. We’ve already seen expansion in our RevPAR index. But it’s not enough to rely on preference.

We need the right tactics to put still more heads in beds. This quarter we rolled out a nationwide promotion called Rejuvenation to drive weekend business to our hotels offering discounts for advanced purchases. The promotion leveraged both our size and the Marriott Rewards database. The first day of that promotion yielded record reservation volume on www.marriott.com.

On the group side we’ve seen a significant shortening of the booking window as meeting planners are waiting; waiting for rates to drop, waiting for a reliable estimate of their meeting attendance, and waiting for budget approval. We’ve refocused our sales efforts rewarding both our sales associates and meeting planner customers with incentives to stop waiting and book. While demand is soft year-over-year, there is demand out there. It just needs to be realized.

Short-term group business largely corporate business has been hurt by the cost-cutting business environment so today it’s a share game and we believe we’re winning here as well. The reorganization of our sales force that began in early 2008 is helping us drive that market share as our sales force focuses on the most value-added customers.

Many of you are interested in the special rate negotiations just beginning for 2009. Not surprisingly in today’s business climate it’s very likely that rates will be up only modestly if at all, but we’ll just have to wait and see. Not everyone is cutting back. At the Ritz Carlton Central Park normally filled with investment bankers and their clients, the entertainment industry and diplomats are filling rooms and restaurants now. Other hotels are opening inventory to airline crews, government travelers, AAA and AARP. This business is typically at lower than corporate rates but it fills a portion of our hotels enabling the remainder of each property to sell at better rates.

Turning to margins. For company operated hotels inside North America, house profit margins declined only 130 basis points despite the 1% decline in RevPAR netting a 4% decline in house profit per available room. For properties outside North America, house profit margins increased 80 basis points.

Every hotel has a contingency plan and virtually all hotels have implemented those plans. Cost savings range from modified menus and restaurant hours to reviewing room amenities to imposing mandatory time off and hiring freezes. We continue to focus on operating efficiencies such as food procurement and were able to lock in cheaper energy supplies during this sharp price downswing a few weeks ago.

Energy costs in the third quarter were up 12% across our North American hotels and in the quarter energy costs alone drove a 50 basis point decline in our North American company operated property level margins. We’ve also cut above property costs by scaling back systems, processing and supporting areas that are allocated to the hotels so that they are roughly flat relative to revenue.

We opened about 6,500 new hotel rooms during the third quarter. Our development pipeline remains at 130,000 rooms despite a difficult financing environment. Today more than half of our pipeline is under construction and we estimate another 10% or so has construction financing in place giving us great confidence that nearly 2/3 of the pipeline will open almost no matter how weak the economy. A significant number of properties under construction gives us comfort in our 30,000 room estimate for openings in 2008 and the 30,000 to 35,000 rooms expected for 2009.

We are starting to see some slowdown in the pace of new development. For example in the United States although the number of year-to-date approvals for limited service franchise hotels are up, domestic franchise activity has slowed over the past few months. We anticipate fewer new projects will join the pipeline in the coming months and we are likely to see some portion of the existing projects get canceled or delayed, so we doubt our pipeline will remain at its current levels for long.

Longer term, giving the financing environment we would expect US lodging industry supply growth to slow from today’s levels by 2010 and 2011. We should note that in light of today’s financial markets we continue to evaluate projects where we have invested equity, debt or capitalized development costs but we cannot yet give you any guidance of the P&L impact, if any that may result from these reviews.

Although our lodging business is performing as planned, our timeshare business has been significantly impacted by the financial markets including the impact of weak residential markets and restricted credit. In July, we estimated our timeshare results would total $230 to $250 million for 2008. We now expect our full year results to be about $75 million lower.

So, what happened? As we look at the third quarter, contract sales at our fractional projects increased due to a good launch at our Lake Tahoe Ritz Carlton product. The continued solid growth of our Asia Pacific points program is another bright spot. However, on a net basis we booked no new residential sales during the quarter and contract sales at our core timeshare business declined 12% with declines in just about all US and European markets.

Cash marketing and selling costs rose as a percentage of lower sales volume. Reduced airlift to Hawaii has constrained performance of our two newer projects in that market and permitting delays have deferred closing of some residential sales. Not surprisingly fractional and residential sales are the weakest relative to our prior expectations especially with respect to one joint venture product.

In the third quarter we booked a $22 million pre-tax impairment charge, $10 million net of the minority interest benefit. We evaluate each of our projects for impairment at least once a year and more often if we suspect we may not be able to recover the carrying amount. The charge adjusts the carrying value of this real estate to its estimated fair market value. Today, the securitization market is meaningfully worse than we have ever seen but remember, we don’t sell our mortgage notes for liquidity. We sell notes to drive return on invested capital and the quality of our notes is good.

Delinquency rates on our US financed loans have risen a bit from 6.4% in March to 6.6% in June to 6.7% in August but still showing better statistics than the broad marketplace. This reflects the high credit scores of our borrowers. Based on these conditions, we now expect full year 2008 results for the timeshare segment to be $158 to $168 million. Compared to our outlook for the business last quarter, in rough terms, we have deferred about $25 million in timeshare note sale gains, $20 million in gains on residential sales, booked a $10 million net charge from the joint venture project impairment I mentioned earlier leaving our 2008 outlook only $20 million or so lower for the balance of our timeshare business.

Our 2008 estimate assumes flat contract sales in the fourth quarter, a continued soft economy and no mortgage note sales. Obviously, these adjustments are driving nearly two thirds of the decline in guidance for the company as a whole in the fourth quarter. We recognize however that timeshare is not a perishable product so the appropriate response to a difficult climate is to slow development not cut price.

Year-to-date our gross spending to construct timeshare inventory is down 20% from budgeted levels. We’ve been very aggressive cutting timeshare overhead. We’ve closed less productive sales offices and cut overhead throughout the business. My comments earlier about our lodging development pipeline apply to the timeshare business too. We are evaluating timeshare projects under development and we can see a P&L impact on the fourth quarter from delayed, cancelled or restructured construction projects.

Here again, our fourth quarter guidance does not reflect any impact from these decisions or related severance expenses. We’re pleased to be able to report that our balance sheet is in good shape. Since the end of the third quarter as the financing environment tightened we decided it was prudent to draw down about $900 million on our bank revolver to supplement the dramatically reduced liquidity in the commercial paper market. This is only the second time we have drawn under our revolver since the early 90s, the first time, shortly after September 11, 2001. As we wait for improved liquidity in the marketplace we have ample cushion under our $2.4 billion revolver which is effective until 2012.

Our lodging notes receivable balance at quarter end was about $200 million while timeshare note receivables totaled about $575 million and our guarantees where we are the primary obligor totaled only $320 million. We expect our investment spending to total $1 to $1.1 billion in 2008 but decline to $700 million or so in 2009 and additional reductions are possible. We are revisiting the assumptions behind our spending plans.

Long term debt totaled just over $3 billion at quarter end, relatively flat to second quarter levels. We bought back nearly $90 million in stock during the quarter but given today’s environment and our current leverage levels, we’ve discontinued the buyback. We are appropriately levered today near our 3.25 times debt to adjusted EBTIDA coverage target and we continue to be rated BBB.

Now, let’s turn to the rest of our outlook. Given soft transient and weak near term group bookings, we believe fourth quarter North American company operated RevPAR will decline 3% to 5%. While our team has done an outstanding job on cost control we still expect house profit margins to decline 200 to 300 basis points. In the US full service hotels are likely to continue to outperform limited service hotels.

Outside the US, we expect RevPAR and property level margins to be stronger in the US but noticeably weaker than year-to-date trends. While the properties have done a good job on cost control, we are also cutting spending at our corporate headquarters. We’ve consolidated positions and made cuts in development, systems and support areas with more to come. We will have some severance expenses in the fourth quarter that are not included in the guidance ranges that we are presenting today.

As we mentioned last quarter, our RevPAR guidance is based on a typical 52 week year. In fact, Marriott’s fiscal year 2008 ends on January 2, 2009 making this year a 53 week year for us. This is a very modest positive for profit comparisons during the year since we are comparing profits to a normal 52 week year in 2007 but when actual RevPAR statistics are reported for our fourth quarter it will be a cosmetic negative since we will be comparing a seasonally slow weak to a non-comparable period, so don’t be alarmed. The 52 week statistics represent the real operating trend. All our guidance comments are based on a normalized 52 week year. By the way, our last catch up 53 week year was in 2002.

Looking to 2009, we obviously are faced with considerably more uncertainty than normal given the current global economic and financial climate. At a minimum we expect business conditions to remain challenging for the full year. In the face of this uncertainty we are not prepared to provide a forecast as such. In fact, given the calendar, we haven’t yet prepared property level budgets.

Instead, we will share with you the top line assumptions we are using internally to manage our business and our balance sheet. For internal planning purposes we are assuming at least a 3% decline in North American RevPAR in 2009. Of course, RevPAR declines could be more severe. They are unlikely to be better than -3%. If we assume a 3% decline in North American RevPAR, this would likely yield a 250 to 300 basis point property level margin decline as well.

Outside the US we are even less certain of the future given a typically lower mix of group business. Still, with the continued relatively stronger international markets today, we are assuming flat constant dollar RevPAR for international hotels in 2009. This would also imply a roughly 125 to 175 basis point margin decline. For some time we’ve used a rule of thumb that one point of RevPAR was worth about $20 to $25 million in total fee revenue. Given the RevPAR outlook for 2009, we believe the downside risk is a bit less.

In 2009 one point of RevPAR should be worth only about $20 million of fee revenue. Our international incentive fees could account for about 70% of total incentive fees in 2009. About half of our international hotels do not have to meet owners’ priority hurtles before we earn incentive fees and international incentive fees tend to be widely dispersed. So, while our global fee revenues may decline to just under $1.4 billion in 2009 the further downside risk in fees lessens.

While our lodging business is relatively predictable and holds up reasonably well even with meaningfully lower demand, our timeshare segment is clearly more sensitive to the financial markets and the resulting impact on consumer spending. Timeshare deferred revenue totaled about $160 million at the end of the third quarter compared to about $100 million at the beginning of the year. We expect deferred revenue should total about $130 million at the end of this year which should help us a bit in 2009.

For planning purposes, we are assuming only $450 to $500 million of note sales in 2009 and only flat contract sales growth. While far from certain in this scenario timeshare segment profits could total $175 to $225 million and timeshare sales and services net of direct expenses could total $215 to $265 million. Across the company G&A spending is expected to be flat in 2008. Running these assumptions through our model implies 2009 earnings of $1.48 to $1.60 per share.

Like you, we are very concerned with earnings per share but in this environment we are also especially focused on cash flow. We are in a fortunate position that we can pull back on investing activities and share repurchases. This will allow us to keep our balance sheet strong so that we can take advantage of the unique opportunities that may be presented in this market. As I noted earlier, in 2008 we anticipate investment spending to total about $1 billion to $1.1 billion and $700 million or so in 2009 as we pair back gross timeshare spending, new unit capital expenditures and other investing activities.

Our internal models show debt declining modestly by yearend 2009 from roughly $3 billion today. We have operated in difficult times in the past. We not only recovered from the 2001 recession but we thrived and emerged a more powerful company. In 2001 Marriott was a player in distribution services and senior living services. Today, we are a leaner company focused on lodging and timeshare. In 2001 we operated or franchised 2,400 properties under long term agreements compared to more than 3,100 properties today.

Our lodging business generated nearly $800 million in fees in 2001 compared to over $1.4 billion expected in 2008 and relatively consistent growth trajectory based on our business strategy of managing and franchising hotels. Similarly we reported pre-tax income of less than $400 million in 2001 compared to more than $900 million expected in 2008. Over the seven years since 2001 we were able to repurchase more than 200 million shares of our stock. When we come out of this rough period we are confident that our growth will be every bit as exciting as it was in these last seven years.

The accomplishments in the past seven years didn’t just happen. We recognize that our associates and our long standing culture of service are our most important competitive advantages. It has been the result of our associates tremendous efforts that we have performed so well. Going forward this environment will undoubtedly offer some terrific opportunities and we expect our people will be there to seize them. And, despite the sober tone of this quarter’s tone, we’re not standing still; we never do.

For example, we continue to reinvent and redefine our brands such as Courtyard which celebrates its 25th anniversary this month. We have a short video describing some of these efforts that will be linked to these prepared remarks which we will post on Marriott.com/investor a bit later. This period of difficulty will abate over time and we will emerge an even more powerful company.

As I close out this quarter’s prepared remarks, there certainly remains a good deal of uncertainty about the economy and its impact on our business. While we may not know what tomorrow will bring, we are confident and optimistic about our future. Thanks very much and I’ll be happy to take any questions.

Question-and-Answer Session

Operator

(Operator Instructions) Our first question comes from C. Patrick Scholes – Friedman, Billings, Ramsey & Co.

C. Patrick Scholes – Friedman, Billings, Ramsey & Co.

I know certainly with your limited visibility my question may be difficult to answer but can you just give us a little bit of breakdown on how your bookings are looking for groups as far as RevPAR? And, if that’s about 40% of your business, what have the RevPARs been for the other part, that transient business especially in the fourth quarter coming up and the first quarter of next year?

Arne M. Sorenson

Probably the best indication on group business is bookings for 2009. For the Marriott Hotels & Resort brand we think about 40% of that brands’ business is group. You’ll recall a quarter ago we talked about group RevPAR for that brand being up about 4% to 5%, someplace in that range. When we look at it now at the end of the third quarter it’s flat so you can see there an impact of declining strength in the group business as we look forward towards 2009 quarter-to-quarter.

About half of that decline is the pace of new bookings and about half of that decline is attrition. Now, by attrition what we mean is that’s our hotels reducing the estimated size of the groups that are already on the books to show up for next year. Group is clearly trending down. What we’re seeing is our group customers we think are still committed to holding their events but deferring final commitment to booking it. Not terribly surprising in the sense that there’s a bit more uncertainty for everybody going around and I think there is probably less reason for them to have to rush than they might have thought a year ago certainly.

Net-net we think a bit over half of our group business for next year is fully on the books. When you look at transient and leisure you see the kinds of trends you’d expect. I don’t think there’s a category of business that we can look at and say is strong at the moment. I think we see weakness in corporate transient, we’ve seen weakness all year in leisure transient. We are seeing some mix shift in our hotels which is helping us and I talked about that in the prepared remarks where we’re going after some contract business or some discount business which in effect allows us to shrink a hotel and preserve strong rates in the balance of the hotel through our corporate business and the like.

C. Patrick Scholes – Friedman, Billings, Ramsey & Co.

Just one question on timeshare, I’m just trying to get a better understanding of how quickly the underlying demand is slowing down? One metric that we’ve used is tour flow, how has that been? The number of tours given, how has that been holding up? And, what are you expectations for 09 on the number of timeshare tours?

Arne M. Sorenson

Tour flow actually has maybe been the brightest spot, flat maybe even up a little bit. Closing percentages or the number of those visitors that we convert is probably down about a point and a half. In percentage terms that’s 7%, 8%, 9% decline in closing from a year ago so that’s really what’s driving – it’s probably the best indication of the weaker demand.

C. Patrick Scholes – Friedman, Billings, Ramsey & Co.

And is there more marketing spend to get that tour flow there?

Arne M. Sorenson

There are fewer dollars being spent but because the volume is down in percentage terms, it’s up.

Operator

Our next question comes from Joseph Greff – J. P. Morgan.

Joseph Greff – J. P. Morgan

You talked about some decisions in owners and franchisees to delay or cancel might lead to write offs of investments. At the end of the third quarter, what was your aggregate all in investment in the pipeline?

Arne M. Sorenson

That’s a good question. I don’t think I can give you that. The categories of the investing we have run the gamut so we have a few places where we probably own a piece of land that our intents would be to not proceed with a hotel until we’ve got an owner and financing for it so we can really do it with a way that is consistent with our model. The most dramatic example of that which we’ve talked about over the last year or two is the assemblage of land we put together in Las Vegas. We’ve got a quarter of a billion or so invested in that project alone on our balance sheet.

There are three operating hotels on that assemblage of land and they are providing the cash return to us that’s relatively equal to our cost of carry so in a sense that could be a whole lot worse if we didn’t have those performing hotels. But, it goes from there to some cash investments we’ve made in some of our partners’ projects where we maybe don’t own the land or don’t have anything sort of consolidated if you will on the balance sheet but we might have some key money or a loan that we funded with respect to one of our partners’ projects. Those are relatively few in number.

Then, we do have some capitalized development costs for projects that are developers and we spend money on lawyers and designers and other things where we may not own a piece of land, we may not own anything, but we’ve got some capitalized development costs on the balance sheet. I’m sure in the aggregate the total of that is a few hundred million. Most of those projects are quite well baked and will proceed and every quarter we look at those projects, not in this coming quarter but every quarter we look at those projects to have some view about whether or not they’re going to continue to proceed.

The warning here, and obviously the financing markets have deteriorated dramatically very recently and there will be some impact of these financial markets on those projects and our partners will decide. Maybe they will have some hope that they will continue, some of these projects, but we know of at least a couple where draws on existing debt facilities have not been forthcoming and construction has stopped. And, there are others undoubtedly that are less prominent that will deteriorate over the quarter and some of that will lead to some cancellations and with it whatever we’ve got on the balance sheet for them.

Joseph Greff – J. P. Morgan

You talk about new room openings on a gross basis. As you look out do you think the growth and the net numbers approximate each other a little bit better today than the relationship from the last couple of years? That you have a lot less attrition and stuff coming out whether its by design for quality assurance reasons or for other reasons?

Arne M. Sorenson

Yes, I think maybe a bit. I think the right assumption, we talked about 30,000 to 35,000 new rooms opening for next year. That’s up a bit obviously from 2008 and that’s really a function of that pipeline that’s under construction. I think the right assumption is about 5,000 rooms or so of deletions from our system. I would use that on sort of multiyear expectation. We could have a bit less than that in some years and some years we could have a bit more than that.

Our experience over the last number of years is that the overwhelming majority of our deletions are hotels that are not only towards the bottom end of our quality within their brands but probably at the very bottom of their contribution to our economics. Occasionally you’ll have a story which is an exception to that but I suspect that will continue. There will be hotels that need more capital than maybe can be justified based on their own performance and that causes us and/or the owner, hopefully working together, to say it probably ought to have some form of different branding.

Joseph Greff – J. P. Morgan

Then one final quick question, as you look to next year domestically or in North America, is your expectation that that full service continues to outperform on the service or do you see the comparisons as such that limited service outperforms full service?

Arne M. Sorenson

No, we would expect at least until we get to an inflection point that full service will outperform limited service.

Operator

Our next question comes from [Sue Lee Dapon] – Barclays Capital.

[Sue Lee Dapon] – Barclays Capital

I was just wondering at what point of RevPAR decline does that sensitivity to fees you provided no longer apply?

Arne M. Sorenson

Well, the only good news about these negative numbers is the farther negative you go the fewer dollars there are per point. That’s why we’ve gone from about $25 or so, probably even a little bit more than $25 in 2008 to something more like $20 and maybe it’s a hair under $20 based on the -3% RevPAR base scenario in 2009. We think $20 million is the right rule of thumb for sort of the foreseeable sensitivities you might want to run on that. But again, you can at least theoretically say that you went a lot south of that you would see that that number begins to approach about $10 million.

Operator

Our next question comes from Chris Woronka – Deutsche Banc North America.

Chris Woronka – Deutsche Banc North America

Could you guys maybe talk a little bit about how as an operating company you’re approaching the room rates because I guess the shorter question is how do you look at room rates for 09? And, why might it be different this time around? Do you have better control of your inventory? Just how you’re thinking about that and maybe what you’re seeing from some of your less rational competitors on the pricing front?

Arne M. Sorenson

I think there are some very important differences now versus heading in to the really first and second quarter of 2001 when we started to see weaker economic demand. One, we are probably a bit more oligopolistic of an industry and therefore the number of players in our industry that are longer term in focus probably control more rooms. And as a consequence they’re probably by temperament less inclined to chase occupancy by dramatically moving rate.

The second thing is I think our relationship vis-à-vis the various channels that sell rooms has changed meaningfully. In 2001 we had a number of new online intermediaries particularly who had good marketing teams out there and managed to go and convince many participants in the industry to give up effective control of the pricing of their rooms. And they did that by essentially taking rooms on consignment and reserving for themselves the ability to price it at whatever level they wanted to and to do so in a transparent way. So suddenly you had somebody out there who really just wanted to sell it and didn’t care about the long-term consequences on rates which had an impact on the pricing integrity for the balance of the hotel.

That’s changed too dramatically. If you look at the Marriott system, essentially we are philosophically committed to selling rooms however our customers would like to buy them including on third-party intermediary Internet channels. But with our best rate guarantee which applies to all rooms sold no matter what the channel, we’ve got integrity across those pricing areas and have the ability to in essence make sure that those channels are not dumping our rooms at prices which compromise the prices of the balance.

Having said that, we are still an industry that has thousands of players who are involved in pricing room product. There will always be some number of those players who have relatively shorter term focus or relatively more pressure on their financing, and as a consequence it will be more expensive for them to let rooms go down dark on a night. So they will cut prices, the simplest way to chase business.

And just as we’ve seen in the industry statistics that have come out this year, the longer demand works the more pressure there will be on rate. So you can plot it pretty steadily from basically December of 2007 until today with demand year-over-year either growing at lower rates than supply or declining in absolute terms. And as that has built and sort of maintained over time, you see rate performance year-over-year more and more modest and approaching flat as we speak.

Chris Woronka – Deutsche Banc North America

We were relatively impressed by the margin performance given the RevPAR decline. At what inning are we in the cost cuts and is it something that’s sustainable or is this quarter more kind of the low-hanging fruit quarter as we look forward to 2009?

Arne M. Sorenson

Maybe we should go away from the baseball metaphors. That’s what we talked about for RevPAR for the last number of years. Thank you for the comment on the third quarter margins. We think they were impressive too particularly when you think about 130 basis point negative impact on margins in the US, 50 basis points of that was energy alone. So if you back out energy, you end up with a pretty powerful story we think.

We’re not going to give up and we’ll keep pushing every idea we can to get further efficiencies around procurement, around staffing, around every idea we can come up with. But it’s going to get harder and harder. We have talked about this before but we think we managed through focus to drive margins back to nearly the levels they were at by the year 2007. We don’t think our competitors are anywhere close to that and we’ve done it through every tool that we can use but having used those tools, they get harder and harder to use going forward.

That’s baked into the guidance for the internal forecast planning purposes that we use for next year and for the fourth quarter with those margin sensitivities. We think that’s achievable but we think it’s going to be hard to do much better than that.

Operator

Our next question comes from William Truelove - UBS.

William Truelove - UBS

You talked about the slight increase in the fault rates on the timeshare side. Are you increasing your provision for losses which would be a contra revenue item for your revenues in timeshare?

Arne M. Sorenson

Every quarter we look at marking to market the residual value of the notes that we’ve sold and there’s some complexity to this because we’re looking not only at delinquency rates but we’re looking at forecasted average tenure of loans. Generally the longer a loan is outstanding, all other things being equal, the more valuable it is to us. So while we have maybe some increase in delinquency in this market, we also have some expectation that we would see the loans be outstanding a bit longer and therefore our residual interest more.

The short answer is those and many other factors go into our quarter-to-quarter mark-to-market of those residual interests and they are coming through our quarter results.

William Truelove - UBS

So are those mark-to-markets getting worse or better for you from a GAAP perspective?

Arne M. Sorenson

They’re not very dramatic. This year they’ve not been very significant.

William Truelove - UBS

You talked about the deferred revenues being $160 million at the end of the third quarter versus $100 million at the end of last year or $130 million this year. When you’re giving a top down kind of outlook for timeshare next year, are you moving around your deferred revenue amounts throughout the year or are you assuming a constant amount of about $130 million?

Arne M. Sorenson

I think we’re agnostic on that point. I don’t think any part of our 2009 forecast is focused yet on what kind of deferred revenue we’ll see over the course of that year. We give you that statistic only because while $130 million is a bit better than $100 million, it’s not dramatic. It’s not as if we’re sitting on hundreds of millions of dollars of deferred revenue as we head into 2009.

William Truelove - UBS

Yes. I just wanted to make sure when we were talking about the timeshare outlook, it’s not because of a major increase in deferred revenues, right?

Arne M. Sorenson

Correct.

William Truelove - UBS

You mentioned about how things were a little bit different this time around in lodging versus last time and you mentioned that you’re a leaner company without MDS and senior housing, but obviously now you’ve got the timeshare. So can you tell investors today about why timeshare fits your company much better than did Marriott Distribution Services or Marriott Senior Living? Why this works given the volatility we see on the income statement versus the volatility that those other divisions created on the income statement?

Arne M. Sorenson

That’s a great question. It’s like night and day I think in our view. The distribution business was essentially an unbranded business. It didn’t make any difference whether the Marriott brand was on trucks driving ketchup around or somebody else’s brand was on it and the expertise there was all about logistics and the expertise there was all about logistics and things which we had a team that could do but those expertise’s had very little to do with what we were doing in the core of our operating businesses. The senior living business was a business that we think branding made some difference but the customers were, maybe occasionally the customers would be the same as our customers in hotels.

But by and large, it was not a business that was focused on our hotel customers; it was a place that we got into because we thought the connotations of our brand name about reliability and good service and property management and those sorts of things would translate into what we viewed as a sort of seniors focused hospitality business. I think as we got into it, we discovered it was increasingly a health care business and as a health care business you end up with a very different risk profile. Exposing the same brand that’s involved in lodging and time share to that kind of business didn’t seem to make sense.

And so in short, there weren’t really any synergies at all between those two and so we could exit that business without it; it much better belonged with somebody who was focused on that. The time share business and the lodging business are in fact focused on the same customers and the brand has tremendous synergy because you’ve got resorts and time share facilities that are often located next to each other; they can be run together. We use Marriott Rewards heavily in the process of both marketing and serving our time share customer. We know that our time share customer becomes a better hotel customer once they’ve bought that time share and the brand translates wonderfully.

So that’s why we’re still in this business and that’s why we are so convinced that great value can be made. Having said that, we’re obviously disappointed in the way this economic market has walloped our time share business. That is it’s partly about financing; it’s partly about residential and fractional but it’s also weaker consumer demand and how that’s impacting timeshare.

And it’s been obviously a pretty significant decline in our expectations around that business. We will be focused mightily on driving the results better and we remain confident today that when the economy turns we will produce great returns from this business. If there ever comes a time where we don’t have that confidence, we’ll have to address that. It’ll be a huge factor.

Operator

Our next question comes from William Crow – Raymond James.

William Crow – Raymond James

Let me follow up on Will’s last question just a little bit. Earlier this year, you hosted the analyst meeting focused on time share and reaffirmed not only the commitment but the intent to grow that business. Has that wavered at all? I understand the benefits you see there but the valuation being attributed to it is awfully low these days and the capital it uses is pretty significant. So have you guys backed off at all?

Arne M. Sorenson

We talked about gross time share spending done 20% against budget so far.

William Crow – Raymond James

I guess I’m talking longer term, whether it’s maybe less of a part of the Marriott strategy going forward.

Arne M. Sorenson

Well, I think it’s too early to really have a different perspective on this business. I think the, obviously what we’ve experienced so far is disappointing and as a consequence, it doesn’t make it easier and it’s a whole lot harder to get out here and extol the virtues of the synergies across these two businesses. But having said that, we are wrestling with historically negative environments; environments that we haven’t seen for a long, long time. And I don’t think we’re going to in a matter of months react to those environments and say the sky is falling and we’ve got to move.

I think we’re going to have to watch it over a sustained period of time. I think if the capital markets don’t rebound and we end up with a building time share note sale portfolio that is not just about not doing the fourth quarter note sale but it’s about a number of quarters or maybe a number of years of not selling that, that is a big change to the capital intensity of the business. That by itself will be something we’ll have to wrestle with.

But I don’t want to, none of us I think want to overreact to today’s market. We are very much reacting to today’s market by scaling back dramatically the spending we’re putting into this business but we’re not going to throw the baby out with the bath water.

William Crow – Raymond James

You led me into my next question which is at point do you extract from your guidance where your framework I guess that you’ve presented for 09, the time share notes sales gains. If we’re at a similar point with the capital markets when you report in January or February, will you at that point, at that point we take it out of the earnings or you have a sense for that yet?

Arne M. Sorenson

If the capital markets are as bad in February or March as they are today, I suspect there’s no reason why we wouldn’t take at least the second quarter deal out of our guidance. That would be stunningly bad and I think that’s the wrong bet. We’ve got a well over a decade of experience in selling these time share notes. There is not part of our time share note transaction which depends on the kind of frothy markets we saw in 2006 and early 2007.

So our guidance doesn’t need us to get back to some bubble-like credit market. We need to get back to a more normalized environment like the one we saw five years ago. And if we get there I think the odds are there’s as much upside as there is downside in the time share portfolio. We could maybe sell a bit more notes than we’ve got modeled. We could maybe have a bit more gain.

William Crow – Raymond James

Two quick questions here, Arne, then I’ll cede the floor. Are you doing anything to hedge the dollar change as we look forward and how that could have a real negative impact I guess next year within reversing the positive impacts we’ve seen?

Arne M. Sorenson

Yes. We typically would hedge, oh maybe three quarters or so of our expected Euro, pound, Canadian dollar cash flow. They are highly liquid currencies and relatively easy to hedge. I think as we sit here today we’ve probably hedged about half, maybe 40% of next year’s cash flows in those three currencies. I can’t tell you precisely what exchange we’ve hedged at. I know we locked in a bunch very, very recently. On the Euro, when the exchange got back up to $1.47 or $1.48 in the last couple of weeks, I think we’re about $1.40 yesterday. I don’t know what the currency markets have done today.

William Crow – Raymond James

Finally, you talked about the pipeline ultimately shrinking, which seems like it has to happen in the financing environment. Is that going to shrink outside the U.S. as well or what are the trends there? Are they having as much financing difficulties as we’re experiencing here?

Arne M. Sorenson

Oh, it’s a big world out there. I think the U.K. and Europe are the most like the U.S.; the U.K. particularly. There’s not much of our pipeline which is in the U.K. where we’ve got broad distribution. I can think of a handful of hotels but not thousands and thousands and thousands of that 130,000 room portfolio.

You get to the Middle East, you get to Eastern Europe, you get to Asia, capital markets are stronger. Capital financing approach I think becomes increasingly different. A lot of equity going in and a lot of land value going in and as a consequence we would expect there to be less near term threat there. Having said that, the capital markets are global in nature. We are seeing banks under pressure all over the place, including some in India so this is spreading and that’s not going to be good news.

About 65% I think of our full service pipeline is outside the U.S. in that portfolio which is probably an historic high. That gives us a bit more confidence that those rooms will continue to open.

Operator

Our next question comes from Jeffrey Donnelly – Wachovia Securities.

Jeffrey Donnelly – Wachovia Securities

It seems fair obviously based on your comments to assume that 2008, 2009 period is probably certainly a peak for your new build unit growth as a result of the construction lending market but I’m curious. How aligned are conversions on financing? Do they often come in hand with hotel sales or the change of ownership not typically the norm in a rebranding, into Marriott?

Arne M. Sorenson

No. Change of ownership is the best time to accomplish a conversion. Part of that is that’s sort of when the, whatever financial pain has got to be taken gets crystallized. Part of that is a function of human nature. When you’ve got a buyer stepping in and taking a new hotel, they are often convincing themselves that the asset is worth more than the seller by definition because they’ve got a different plan for them. That different plan often includes brand conversion.

So the biggest conversion opportunities will occur when we start to see some trades occur again in the industry. I think if you look at the statistics, hotel sales from one, existing hotel sales this year are down 80% to 85% from levels of last year. And that’s the case whether you look at, even if you back out the big M&A style transactions. You just look at run-of-the-mill trades of existing assets and they’re down massively.

I suspect that as we get closer to maturity of existing debt on hotels we’ll see that transaction volumes start to step back up. That’s probably not until the second half of next year we would guess at the earliest.

Jeffrey Donnelly – Wachovia Securities

Does Marriott have an effort or do you guys have experience maybe even working with lenders out there? For example, banks and acceptor that might be taking possession of assets over the next few years, that you can step in and be asset manager or help them through issues?

Arne M. Sorenson

Oh, yes. And I guess that your question, I liked another area where there is some opportunity. I know we’ve got at least one conversation in discussion which is about a luxury hotel which was slated to have a different, one of our competitors’ brands on it and it is in trouble from a financing perspective. It’s not in such trouble that it will get killed; it will still happen but the folks who are stepping in with new financial participation in that project are very interested in seeing that convert to a Ritz-Carlton project. That’s not a hotel that’s opened yet but it’s an opportunity that presents itself even short of a sort of existing conversion, if you will that we talked about a moment ago.

We are obviously involved significantly through our partners but meaningfully involved with the participants in the capital markets as it relates to financing hotel assets. There’s a lot of fluidity. There’s a lot of search for pricing and understanding about value in the business today but there are lots of conversations about where the opportunity is. Are there opportunities to pick up debt on existing assets or projects under construction that give us some opportunities with our partners to explore that stuff? And we will look at all of those things.

Jeffrey Donnelly – Wachovia Securities

I know I’m asking you to look into your crystal ball but if you assume that your unit growth overall is going to be declining I guess into future years, would you expect then beyond say 2010 though that the competition in that pipeline is going to increasingly shift more towards conversions, rebuilds likely; you just aren’t going to have the construction financing in the near term.

Arne M. Sorenson

Yes, I think we will see healthy growth out of our development pipeline in 2009 and 2010 probably full year. I think particularly the full service hotels slated to open in 2010 are overwhelmingly under construction and financed today. You start to get to 2011 and we’re going to end up being more dependent on conversion activity and we’ll see. I think the last cycles have told us that the new builds will fall a few years after the operating peak if you will.

Conversions step in reasonably well during that period of time. Our net unit growth probably reaches its lowest point in the year or two after recovery has well begun by which point rev par and margin growth often provides as exciting feed growth for us as the new unit growth would. And then you get beyond that and you start to see the pipeline build again.

So while I think you could say that 2009 may be, it might even be a 12 month period that bridges 2009 and 2010, will be this cycle’s peak of new built hotel openings. It is by no means the all time peak and we’ll see that cyclicality will bring us back some strong growth, particularly global growth when we get beyond that.

[Unidentified Executive – Wachovia Securities]

Jeff, if I could add to that as well. In the 50 years that Marriott’s been in the hotel business, we’ve always had unit growth every year.

Jeffrey Donnelly – Wachovia Securities

If I just ask two quick last questions, can you give us any color on the default rates by Vintage or year of origination on those time share loans?

Arne M. Sorenson

No. At least not sitting here, we can’t. I wouldn’t expect that there will be a lot of difference. I think the, if you look at them for sort of comparability purposes. Obviously, the most likely time we’re going to see it default is relatively early because after the customer has been servicing that debt for a couple of years. The loss, if they would let that go, becomes correspondingly greater. But if you look at that performance, I don’t think you’ll see it’s dramatically different.

Jeffrey Donnelly – Wachovia Securities

And where are default rates overall on your paper? I’m sorry, did you say that earlier?

Arne M. Sorenson

Only the delinquency rates that we’re seeing, 6.4% going to about 6.7%.

Jeffrey Donnelly – Wachovia Securities

My last question was on international incentive fees. I think you said they accounted for 36% in 07 and I think upwards of 70% next year. Do you have a figure on where you see that for 2008?

[Unidentified Executive – Wachovia Securities]

It’s in the third –

Arne M. Sorenson

For full year 2008 –

[Unidentified Executive – Wachovia Securities]

In the third quarter we were at 70%?

Arne M. Sorenson

Incentive fee?

[Unidentified Executive – Wachovia Securities]

Incentive fee.

Arne M. Sorenson

I would think we’re going to be in the more like a 50% to 60% range but we ought to get an accurate number for you back on that. I think the first two quarters were well below 70%.

Operator

Our last question comes from William Marks – JMP Securities.

William Marks – JMP Securities

I had a question on, you gave some indication of next year in terms of rev par growth being better I guess from full service/unlimited service. Can you be more specific especially with regard to luxury?

Arne M. Sorenson

Yes, I think luxury will be interesting. Now, a reminder; we don’t have our budgets together yet and we really mean for our comments about 2009 to not be guidance so much as a way for you to look at how we think our business will perform under an assumption which we think is obviously within the realm. We think it’s a relevant assumption to make but it’s not the only way things could go.

And without having rolled our budgets together, the comments about full service doing better than unlimited service are basically based on trends, based on the group business in hotels which should help full service generally. When you get to luxury, there is an advantage because of group business but there is a disadvantage because more of that group business depends on the financial markets.

I suspect financial contribution to the luxury, Tempo Ritz-Carlton hotel compared to a typical Marriott hotel is probably twice as much. So maybe it’s group businesses 10% finance in a Marriot hotel; it might be 20% finance in a Ritz-Carlton hotel. That won’t surprise anybody; we would guess at the moment that that’s going to be the hardest hit segment of our customers that are out there. You can hardly keep current on the business cards, let alone booking that business.

So I could guess luxury will be weaker than the rest of full service. Whether it’s weaker than limited service or not I think we’ve got to wait until we go through our budget in the end and I think to some extent, that may depend dramatically on the individual market you’re talking about.

William Marks – JMP Securities

One other just very general question and I won’t ask anything else after this. Just on supply, every company seems to say there’s new supply but it’s not going to impact us as much and some say that it’s mostly limited service and some say it’s just not in our market. Any general thoughts on that?

Arne M. Sorenson

Well, supply in historic terms is not that remarkable. You’re talking about supply growth this year of 2.5%, maybe something like that. It’s a bit over the long term averages but it’s nothing like the 4%-ish supply growth we saw in the late 90s. As demand weakens obviously from a same store perspective, everybody would like for supply to be zero or lower no matter how low it was.

So I think one of the reasons you hear the kind of optimistic comments you do hear is that quite fairly, supply is not the threat today that it was before. Now having said that, any supply growth in an environment with weaker demand is relevant. The supply growth has been the strongest in the upscale without food and beverage sort of segment so that’s Courtyard and Hilton Garden Inn and Hyatt Place and those sorts of brands.

Courtyard is a fabulous brand; it’s a great return for our franchisees typically who are building these things. They love it; they’ve got expertise in running it. They’re relatively low risk; that’s why you’ve got that kind of supply growth there. But not surprisingly, you see because of that those are the segments which are posting probably the most modest rev par statistics. And they will suffer a bit more than some of the other segments will next year because of that but it’s a segment that has grown very well; much better than any other segment over the last decade because it offers a pretty interesting value proposition to the customer.

And as it grows, it’ll put more pressure on some of the other segments which have been shrinking over at least the last 10 years; particularly mid scale with food and beverage and we’ll see that decline. But I think supply is relevant obviously to rev par. It’s not a huge factor and it’s not, we’re quite sanguine that when demand starts to recover, we will quickly gobble up the kind of supply growth that the industry is seeing and post some pretty impressive rev par numbers when we come out of it.

Jake, we’re going to close the call. Thank you all very much for your time and interest this morning and as always we encourage you to keep traveling.

Operator

Once again, that does conclude your conference for today. Thank you for your participation. Everyone have a wonderful day.

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