希爾頓酒店 (HLT) 2004 Q2 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the Hilton Hotels second quarter earnings conference call.

My name is Steven and I'll be your coordinator for today.

At this time, all participants are in listen-only mode.

We will be facilitating a question-and-answer session for the end of this conference.

If at any time during the call you require assistance, please press star, then zero, and the coordinator will be happy to assist you.

As a reminder, this conference is being recorded for replay purposes.

I would now like to turn the presentation over to your host for today's call, Mr. Mark Grossman.

Please proceed, sir.

Thank you, Steven, and good morning, everyone.

Thank you for joining us for our second quarter earnings call.

We're here in Beverly Hills with members of our senior management team and we'll have a few prepared remarks to give you, but then as usual, we'll spend the bulk of our time answering your questions.

Before we begin, though, a little bit of housekeeping.

The press release that we put out this morning and today's earnings call contain forward-looking statements within the meaning of Federal Securities law, including statements concerning business strategies and their intended results and similar statements concerning anticipated future events and expectations that are not historical facts.

The forward-looking statements in the press release and in the earnings call are subject to numerous risks and uncertainties, which could cause actual results to differ materially from those expressed in or implied by the statements herein.

I will also tell you that today's call is being webcast and you can access that by going on www.HiltonWorldwide.com, going to the Investor Relations link and then clicking on Quarterly Conference Calls.

There will also be a replay of this call available until August 4 at 8:00 P.M.

Eastern time.

The phone number for that playback is 888-286-8010, passcode 90806139, and this call also will be archived on our Investor Relations website.

So again, appreciate your joining us.

To start off with the remarks, let me turn it over to our Co-Chairman and CEO, Steve Bollenbach.

Good morning.

There are a couple of basic things that I wanted to hit before Matt begins his review of the quarter and how our various businesses performed.

First, you know, whether you think this is the first, second or third inning of the recovery, the game is still in its early stages and the fact that our business is gathering momentum is illustrated by the increasing numbers of business travelers, more group bookings, continued strong leisure trends, and maybe most importantly, our gradual return to pricing power.

And helping to drive that pricing power is a continuing favorable supply story on the full service side.

I will leave it to the economists to determine the degree of recovery, but the numbers in our business are great.

After three tough years, it's evident that business travelers are coming out.

We're seeing more customers, that groups are convening more often and in greater numbers and that the leisure travelers are taking more vacations.

Because we have a wide range of properties and pricing points for every customer, it's great to see that these business segments are improving.

Our owned hotels, franchised and managed properties and time-share resorts are reaping the benefits, as Matt will discuss in a minute.

Secondly, I wanted to spend a minute reaffirming our commitment to technology and our belief that this commitment provides our Company with a sustainable competitive advantage.

We're doing more in this area than anyone in the industry, and as a result of this commitment, we are able to create and introduce a number of innovative technology-based programs.

Now, we've discussed our On-Cue [phonetic] system before.

We're the only hospitality company with a common electronic system linking all of our hotels and brands, and in our case, that's over 2,200 properties.

On-Cue is raising customer satisfaction and bringing operating efficiencies to our hotels.

We've taken the lead in providing check-in kiosks at our bigger hotels; 45 of our larger owned and managed hotels will have these units in place by the end of this year, and nearly all 2,200 of our hotels will be equipped with high-speed internet access by the end of the year.

And we have many more initiatives in the works.

The size and the scale of our company allows us to make significant investments in technology, earning us a clear leadership position in the industry.

It's our view that the creative and effective use of technology to serve our customers and run our properties will continue to be a major point of differentiation among the top lodging companies.

Now, we stake out the lead and we intend to extend that lead.

So with that, I'll turn it over to Matt.

Okay.

Thanks, Steve.

It's great to be able to talk about growth and momentum in each of our businesses.

When all three are performing well, it makes for a very satisfying quarter.

I'm going to talk about each, so let's start with the owned hotels.

The list of strong markets is getting longer.

New York City, Washington, D.C., Hawaii, New Orleans, Boston, Phoenix and San Diego all did really well in the quarter.

New York and Boston were particular standouts.

It was common for us to see occupancies of 90 percent-plus in those markets, along with significant rate increases.

I'll take a minute just to talk about Boston and New York relative to their two political conventions.

In Boston this week, we are requiring four night minimums and all of our hotels in the area are sold out, including those in the suburbs.

In New York, we're requiring a five-night stay.

The Hilton New York has the Texas and Florida delegations and the Waldorf Astoria is hosting the White House, and the bar bill is expected to be about even between the Democrats and the Republications.

Demand among business, transient and groups has been strong in most of our business-oriented cities; hence, the good results in New York, Washington, New Orleans and Boston.

We saw many of you at the NYU Conference in June, which was held at the Waldorf Astoria.

It's a really good piece of business at our hotel, owing to the Sunday night occupancy and the extensive catering business.

Summer leisure travel has been very strong, bringing us outstanding results in resort-oriented markets like Hawaii and San Diego.

Japanese travel to Hawaii is getting stronger and San Diego is one of this year's hot destinations.

Phoenix was strong in the peak April and May time period and all indications show continued high demand for the remainder of the summer, and that will benefit our resort destinations.

We've highlighted San Francisco and Chicago in past calls, so here's an update.

Thankfully, San Francisco continues to show improvement, off a low base to be sure, but still improvement.

And this is due to an increase in domestic conventions and the pickup in overseas travel to the city.

Chicago continues to be a challenge and we expect it to be so for the remainder of this year.

Chicago impacted our second quarter rev-par growth by 230 basis points.

So take away Chicago, and our comparable owned hotel rev-par was up 10.6 percent.

And as we've noted on previous calls, we expect improvement in Chicago in 2005 and significantly better results there in 2006.

Steve mentioned a return to pricing power.

As our business mix continues to shift in the right direction, that is, more business, transient and groups, we are seeing rates become a bigger component of rev-par growth.

It was roughly 40 percent of the rev-par growth in our comparable owned hotels in the second quarter.

That helps the margins, as Bob is going to discuss, and as demand strengthens among the more highly rated business segments, we can look forward to even greater pricing power in the periods ahead.

Group business is tracking about where we thought it would be.

In the second quarter, our group room nights were up over 6 percent from last year and our group booking pays to -- continues to be strong up just over 20 percent from the second quarter last year. (Audio gap) originally contracted for and so attrition is not the issue it had been in previous years.

Looking at the full year, we expect that at the end of 2004, our group business in terms of room nights will be up roughly 7 percent over 2003 and that includes the difficult environment in Chicago.

One more point on the group business: we talked on the last call about our property mix, that is, our preponderance of 1,000-room-plus hotels.

We have more of these properties than anyone else in the industry.

In fact, about half of our owned rooms are in these large hotels and their bread and butter is large groups and conventions.

As we take advantage of increased demand from higher rated groups in the latter part of this year and into next year, these big properties will benefit the most.

So while the current story on group business is good and improving, our Company, given our own property mix, will be in a particularly good position starting in 2005.

Now I'd like to take a minute to talk about a few trends we're seeing.

The first and most important is our ability to increase room rates.

As occupancy strengthens, we can be more aggressive in our mix of business and effectively raise our average rates.

That's the normal pattern for our business and as Steve has said, we believe we're in the early stages of this trend.

I would also point to heavy call and reservations volume.

We noted in our release this morning that call volume in the second quarter through our call centers was up 6 percent over last year.

Gross reservations through Hilton Reservations Worldwide, the GDS and all internet sources, were up about 12 percent and nearly 14 percent in June alone.

Certainly, comps were easier this year, but these are still encouraging increases.

For the month of July, total bookings so far are up 12 percent over July 2003.

We've been successful in growing the distribution channels that are the most profitable to us.

Online bookings on our branded websites continue to grow well ahead of bookings on the third-party sites, demonstrating that we are doing well on controlling the business that comes through the internet.

In the second quarter, consumed room nights from our branded websites increased about 30 percent over the second quarter last year, while consumed room nights from third parties actually declined 13 percent.

The benefit here is that taking reservations on our website is the most cost effective for us.

Overall, about 12 percent of our total bookings are made via our branded websites, versus about 2 to 3 percent via the third party.

So while the internet as a whole is important in growing, the third parties continue to make up a fairly small percentage of our business.

Now, onto the fee business which is the same consistently positive story we've reported in previous quarters.

The increase in demand that is benefiting our own hotels continues to spur rev-par growth at our franchise properties as well.

For the second quarter in a row, about half our fee income increase came from rev-par growth and the other half from the addition of new units.

All of our brands showed very strong system-wide rev-par growth in the quarter.

Homewood Suites was up 5.9 percent, and all the other brands were up roughly in the 6 to 9.5 range.

The rev-par index story continues to be a good one, with the majority of our brands maintaining significant rate and occupancy premiums over their competitors.

Our brands also continue to be recognized for quality, value and service in various consumer surveys.

The American Customer Satisfaction Index recently rated the Hilton family of brands number one among all hotel companies.

It's our third first-place ranking in five years and we also achieved the largest percentage increase from '03 to '04 among all lodging companies.

In addition, the leading consumer advocacy magazine -- which Mark says I can't mention their name -- ranked Embassy Suites and Homewood Suites among the top chains in their respective categories.

Our brands to continue to score well in the J.D.

Power customer satisfaction rankings.

Yesterday, it was announced that Hilton Garden Inn and Homewood Suites each earned first-place rankings in their categories.

That's three years in a row for Garden Inn.

And two of our other brands, Embassy Suites and Hampton, were ranked in the top three in their categories.

When you put all this together, it's not hard to see why our brands are in demand among hotel owners.

According to Lodging Econometrics, in the second quarter, we had the highest number of U.S. hotel openings of any company.

And just as important, we continue to have more rooms in development in the U.S. than any other company.

We're continuing to accept applications and improve projects at a rapid pace.

The relationship that we have with the ownership and the franchising community continues to be excellent.

Our pipeline currently has over 425 hotels and about 58,000 rooms.

And at the openings we're right on track to hit our projection of adding 15,000 to 17,000 rooms to our system this year.

Hanson Inn and Hilton Garden Inn get most of the ink when we talk about new developments due to the quality of the hotels and the fact that these two brands comprise about 60 percent of the rooms we'll add to our system this year.

But I also want to point out that there's lots of good activity on the Doubletree front.

USAA Real Estate has just acquired six Doubletree's around the country, has started significant renovation projects with these properties.

In the second quarter Doubletree opened its first hotel in Canada, Niagara Falls, and new built Doubletree opened outside Detroit.

Another six Doubletree's, all conversions from other brands, are scheduled to open before the end of this year in major markets like New York, Chicago, Atlanta, and Miami.

On top of that, we have about 15 deals in the works for Doubletree properties, again, predominantly conversions.

And with an eye towards brand enhancement about half of the 150 Doubletree's in our system are undergoing significant renovation programs.

I mentioned on the last call that we are focusing on enhancing the Hilton brand, and a lot of work is being done on that score.

The refurbishment projects we talked about last quarter, $275m being spent at about 80 Hilton franchise hotels, are underway and should be completed toward the end of next year.

As part of my new job I've been spending a lot of time touring our hotels and those of our competitors.

In addition to new bedding and new TVs we're looking at a number of product and service enhancements that will strengthen the Hilton brand.

I'm very excited about the direction we're taking, and as they get rolled out I'm confident that you'll like them as consumers and as investors.

On the Conrad front, the Conrad Miami opened just a few weeks ago.

This is a spectacular new hotel on [Brickel Avenue] [ph], a great location in Miami.

Plus we've announced management contracts for new built Conrad in Indianapolis and Las Vegas, which are scheduled to open in 2006.

Finally, on to our time share business, another great quarter here with revenue up 24 percent.

Overall unit sales up 34 percent.

And a 7 percent increase in the average unit sales price.

We've developed and executed against what we think is the right strategy for this business, and that is focusing on the development of really high quality property in a select number of strong year-round destinations.

And for us, those are Las Vegas, Orlando, and Hawaii.

We've taken this approach because it makes the most efficient and effective use of our people and capital, and we've been very happy with the results.

Our properties in all three of these markets have been very successful, and we're adding units on a regular basis as existing inventory approaches sellout.

As we mentioned on the last call, we'll begin the second phase of our Las Vegas strip property later this year.

In Orlando, we'll begin construction of phase five at our International Drive property in early 2005.

Sales of phases one and two have exceeded our expectations, and three and four will open for occupancy early next year.

So all in all, a very upbeat quarter on both the hotel side and the time share side.

And I'll close by saying we've got a great Management Team in place at Hilton that is experienced and working together well.

And with that, I'll turn it over to Bob.

Thanks, Matt.

For all of the reasons Matt discussed, the second quarter was really a [great] [ph] one.

Top line growth continued to be strong, but where we are having particularly good success is in bringing that growth to the bottom line.

Specifically, our margin story is excellent, and we believe separates us from our competitors.

In the second quarter margins at our comparable owned hotels were 30.5 percent, an improvement of 140 basis points over the prior year.

It's certainly great to deliver margins over the 30 percent mark.

And if you exclude the tough quarter in Chicago our margins actually improved 230 basis points over last year's second quarter.

Flow through on our RevPAR gains was good, 1.5 times.

The fact that about 40 percent of our RevPAR growth came from ADR gain, and food and beverage revenue was up due to more group room nights, certainly contributed to this strong flow through.

But our ability to bring in margins that lead the industry also relates to our focus on cost management.

In the second quarter total cost per occupied room at comparable owned hotels was essentially flat with the second quarter last year.

This is a result of a number of things.

First and foremost, both our wages per occupied room and our labor hours per occupied room were flat compared to the prior year.

And so we continue to be efficient and effective as to how we deploy our team members.

Healthcare costs were up about 6 percent in the quarter, but this was more than offset by a decline in workers comp costs.

Given the continued success of programs we implemented over the past few years we had a record low number of team member injuries in the first half of 2004 and the severity of injuries was also significantly lower.

We now expect workers comp cost to show a year-over-year decline of about 20 percent.

We also continued to make strides in the area of property taxes.

While this is an area that is very difficult to control we have been successful through the appeal process in reducing the [set] [ph] values of many of our large urban properties.

As room rate increases continue to comprise a greater proportion of our RevPAR growth, along with our continued focus on costs, we expect year-over-year margins to increase by well over 100 basis points in the second half of the year.

With revenues growing across the industry we think margin should be a point of differentiation for lodging investors.

Moving on to the balance sheet, we ended the second quarter with total debt of $3.6b, this is a reduction of 81m during the quarter.

It's also net of $325m allocated to Caesar's Entertainment, and that note was repaid by Caesar's on schedule earlier this month.

And it's also net of $100m of debt resulting from the consolidation of a [Maddes Hotel] [ph] which is non-recourse to Hilton.

Another point, we noted in our release this morning, we repaid all the outstanding amounts under our $1b revolving credit facility during the second quarter.

At this point we are on target for achieving by yearend our long sought after goal of trailing 12-month debt to EBITDA below 3.75 times.

We were pleased that Standard & Poor's recently revised its outlook on Hilton as stable and reaffirmed its investment grade credit rating of our company.

So that's the Reader's Digest version of the financial story.

To summarize, the business is strong, we're running our business well as evidenced by our margins, and the balance sheet is in good shape.

I'll turn it over to Mark next.

Okay, Bob, thank you.

Before we go on to the q and a session, let me quickly review the updated full year 2004 guidance that we've provided in this morning's press release.

And this new guidance reflects an increase from the estimates we gave on our last earnings call.

Total revenue is now expected to be approximately 4.170b, with total adjusted EBITDA of approximately $1b, and total operating income of approximately 650m.

RevPAR at our comparable owned hotels is now expected to be up in the range of 6 to 8 percent, and that by the way includes Chicago which we anticipate will impact our RevPAR growth by about 160 basis points for the full year.

And finally, diluted earnings per share for 2004 are expected to be in the mid to high 50 cent range.

So, that concludes our prepared remarks.

And Steven, we are ready for questions.

[Caller instructions.]

And our first question comes from Jeremy Cogan.

Please go ahead, sir.

Hey, good morning, everybody.

Hi, Jeremy.

Hey, listen, obviously talked about Chicago for the last few quarters, understandably so.

I was wondering if you could maybe expand a little bit on those remarks about Chicago for next year?

What we've been hearing is that things have been so tough this year that the market is now starting to scale back expectations for 2005, and things will be particularly good in '06.

I'm just wondering how much better it's going to be in '05, and maybe how much that impacts the results for next year?

And also, I was wondering if maybe you could just kind of go around some of the big group cities for you in the next year, like New Orleans, or Boston, even San Francisco, just give us an update on how things are shaping up on the group side of those group towns?

Thanks.

Jeremy, I'm going to have [Dieter] [ph] talk a little more detail about Chicago and some of the bigger group markets.

But, you know, some numbers that are coming out in Chicago Convention & Visitors Bureau, they're seeing overall convention business next year up 8 percent, and an 11 percent increase in citywide's next year, and that's coming out of the Convention Bureau there.

So, you know, that does give an indication that things will be better in Chicago in '05.

But Dieter, you want to ...

[A great model.] [ph] The signs are positive for Chicago [inaudible] the room nights, and over 150,000 room nights in '06.

But the booking pace is really, really strong, stronger than certainly '04.

And our charts, they see us all as very healthy pickup in major association and group business, and we should be in pretty good shape next year.

The other - yeah, I mean throughout we see particularly in our gateway cities that we have very good booking trends for major convention associations, from Hawaii to New York, San Francisco is shaping up better, as well.

But I think the main point is what we are seeing is already, and you know, in the last couple of months that corporate business is really up.

And that's important for us as short-term booking pace, and we believe that the combination of convention association and company meetings will give us a very good base for '05 and going forward.

Okay.

And let me, just a quick follow-up question.

It's on a different topic.

Bob had mentioned the long sought after 3.75 times or less, that's EBITDA metric which I think you're going to get to by next quarter, at least based on my numbers.

What should we think about, what's the latest thinking in regards to buying back stock, boosting the dividends, using free cash for growth, et cetera?

Nothing has really changed, you know, since we talked about this in the last call.

And you have to, your calculations are probably on a pure debt to EBITDA basis.

The rate agencies do look at it on a little different basis because they included 100 percent of our guarantees, and don't give us any credit for cash.

And so we're just kind of going off of a debt to EBITDA calculation that the rating agencies use.

You know, but as I noted on the last call, we're beginning to focus on obtaining an investment grade rating.

I know, noted on the call that S&P raised their outlook to stable and reaffirmed their investment grade rating to Hilton.

And so we're kind of 50 percent of the way there, if you will.

And then, you know, we are, you know, our current expectations still are that we're going to be strong generators of cash, in excess of a billion dollars over the next, at least over the next 3 years.

And as I noted on the call, our bias in terms of the use of the cash over the long-term is to reinvest in our core business.

And, you know, and I'd say a disciplined and measured basis, and focusing only on investments with attractive returns.

And, of course, you know, we're going to do that, and evaluate investment decisions vis-à-vis where our stock is trading.

And, you know, and as I mentioned, if we're not able to deploy that cash at attractive rates above our cost of capital we'll definitely look to opportunistically return it to our shareholders.

You know, we're going to be - we're entering our capital budgeting stage, kind of the end of the third quarter or the beginning of the fourth quarter, and we're going to be certainly talking about, you know, what our capital plans are and reviewing all of the investment opportunities that we have before us, again, primarily within our core business.

And we're going to be discussing that with our Board, as well..

So stay tuned.

Thank you.

That's helpful.

Thanks, Jeremy.

And our next question comes from Michael Rietbrock.

Please go ahead.

Hey, guys.

Those were really my questions.

Just one follow-up, though.

Did you guys say that the volume of rooms through third-party web sites was down 13 percent this quarter?

Yes.

Is that just a function of less distressed inventory or is there something beyond that?

Mike, let me - I think that was the quarter's results in Vegas, more like flat or up just a little bit.

But the real - the reality is what you're seeing happen is the distribution strategy that we announced about a year ago, with our best rates guaranteed, with no honors points and miles booked on third party sites, with better control of our inventory.

All that has allowed us as a company, to focus on selling rooms through the channels that make us the most money.

And that's what we're doing.

And so you see our own sites are up dramatically and growing faster than other channels.

In fact, three of our brands nearly produced as many room nights through our own internet sites as we do through HRW now.

So, we're aggressively pushing that and we're pushing it because we make - we leave more money at the hotels by doing it that way.

And that's our whole focus, how do we leave more money at the hotels.

The next question comes from Steve Kent.

Please go ahead.

Hi, good morning.

Could you just discuss a little bit more about maybe your guidance for the full year.

You know, Bob, I guess given how strong things are going, especially that flow through in the margins, which I think are the highest of the industry so far, I guess I'm surprised you're only raising your EBITDA forecast by 10b.

I mean, I just think the trend seems so strong.

By how much?

Ten billion?

Wow!

Sorry.

That would be quite the number.

Steve, if you look at the - you know how we reconcile our guidance in the attachment to our earnings release, you'll see that it's actually 15m of EBITDA, not 10m of EBITDA.

We said in the press release in the billion dollar range, but if you look in the back, it's really one billion five million.

So if that's the extra - maybe is that the extra 5m that you're looking for?

Yes, it's not 10b, but it's close, same period--.

Yes, we'll work on that.

Did that help you?

Yes, I guess, is it the volatility?

I mean are you getting that much bookings that are coming in early that you just don't want to go too aggressive out there?

Is that part of the conservatism?

Bookings are just coming in a week or two in advance, so it doesn't give you as much confidence as you'd like, given the current trends?

I think that's a fair statement.

This is still a difficult business to predict.

The bookings are coming in late.

We'll probably take a little more risk with that now, because we don't like to have turn-aways, particularly when that corporate small meetings segment calls.

They need the rooms.

They're not particularly price sensitive and you hate to be sold out at that time.

So we're probably entering a period where we will be taking a little more risk with that business mix.

The other thing too, Steve, just on the EBITDA part of it, and the impacts had a little bit - we had some property sales.

How many property sales would you say, more?

There were two in the quarter, this quarter.

It's not a huge number, but it does impact things a little bit.

And since we're just talking about that, just one, and I know it's an extra question.

But on selling assets, Matt, Steve, the whole team has been through this a number of times.

Some of the prices being paid are extraordinarily high on a multiple basis.

Does that change things a little bit?

Do you think you could accelerate your own maybe selling of some of your assets?

Well, we always look at that.

We have some other limits on it.

We've got a lot of really great assets that have low tax bases and so that makes it less attractive.

But we're not in love with any of the assets per se, if it's all just a financial question.

So we're very attuned to the fact that individual properties are selling at some really extraordinary multiples.

It's the other side of the coin in what's kept us out of the market for the last few years, is that the prices have been high relative to the current earnings value of the property.

So all I can say is that we certainly consider it as a financial transaction.

And that's all I know.

Yes, so the answer is we'd be more sellers than buyers in this environment for sure.

Our next question comes from Joe Greff.

Please go ahead.

Good morning, guys.

In the Q2, 40% of the RevPAR was rate related.

What do you sort of have baked into your full year or [2004] guidance with respect to the rate composition relative to the RevPAR growth rate?

Joe, it's about 50-50, 50 from [AK] and 50 from rates.

Great.

And then, is 20% revenue growth in the back half of this year on timeshares sustainable?

Well, timeshare is, first of all, the business is just going great and we expect unit sales to be really strong for the remainder of the year.

And contract sales have been strong.

Yes, unit sales-contract sales, same thing.

I think the comparisons though are going to get a little bit more difficult in the second half.

Because last year we were recognizing more of the income in the later quarters due to the percentage of completion accounting for our Las Vegas and Orlando projects.

And also we're expecting our sales mix could be different in the second half as well.

We're going to be selling more of our Orlando and our Las Vegas properties.

We've had a higher product cost and a lower unit price relative to - like the Lagoon Tower, for instance, in Hawaii.

We're also going to be selling more of our Waikoloa project, which also has a higher product cost and a lower sales price than the Lagoon Tower.

So, we've had spectacular growth in the first two quarters.

And our unit sales are going to be strong, if not stronger, but it's just that the EBITDA comparisons will be a little more difficult than what we've seen in the first half of the year, because of the difference in the mix that I just talked about.

Great.

And then with respect to your bigger owned hotels, if I remember correctly, I think most of them have had significant capital [put in them].

I think the only exception to that is the Palmer House in Chicago.

Have you guys made any CapEx decisions on that property?

No, that's a process that we're going to be going through in the next couple of months and looking at our CapEx plans for '05.

And that's typically when we do it.

And we get with our GMs, our operators and go through everything.

One thing though I should mention on that is we are quietly making sure that all of the properties that we own are 100% up to our own standards, in terms of our own new bedding product and TVs and high speed internet access.

We're not really making a big deal about that with the customers, but you as investors should know that that's where we're putting a lot of our - not a lot, but a significant amount of capital to make sure that the properties are what they need to be for brand standards.

Your next question comes from Harry Curtis.

Please go ahead.

Good morning.

A couple of quick questions.

Going back to the last comment, Matt, about the new renovated product, what percentage of your owned hotels have the new bedding and the new TVs?

They'll all have them by the end of the year.

Okay.

And secondly, in your press release you mentioned a 6% increase in comparable owned expenses and then also mentioned that at least your labor and wage per occupied room were flat.

And part of the increase in the 6% in the quarter was due to an increase in occupied rooms.

If you could explain what the other expenses are that are driving that 6% number, please?

They're primarily all occupancy related, Harry.

Because our cost per occupied room was flat quarter over quarter.

So what's driving that increase is pure occupancy.

Okay.

So the cost is - I'm being thick here, but what specifically are those costs?

It's the cost of operating the hotel that are directly related to how many rooms are in house.

He's talking about an absolute increase.

Okay.

So there's no year over year increase in any of these expected line items?

He means like on a comparable apples to apples.

Probably the only one would be healthcare costs continue to be higher year over year.

Our next question comes from Will Truelove.

Please go ahead.

Hi, good day, gentlemen.

Following up on Harry's comments or question there, there's been a lot of costs that have, obviously, entered the system as we've cut back other expenses during the downturn.

I'm just wondering, what can you do or what kind of initiatives can you do to get back to the prior peak in terms of margins?

You guys have always run probably the tightest ship in terms of margins.

Are there things that you're doing from initiatives to sort of offset the decline, in say, telephone margins or the increase in healthcare that will get you back to those previous peaks on the margin side, other than just raising rates?

I think - Dieter is going to make a comment here.

But I really think the way to get back there is through raising rate.

I mean, our cost per occupied room, in what we expect to be for 2004, is roughly about $182.

And we ran in 2000, our cost per occupied room, and we're talking about the 36 comparable Hilton-owned properties here, just to frame it.

In 2000, our cost per occupied room was 180.

And there's about a $20 rate differential between 2004 and 2000.

So in my mind we've done an awful lot at the cost side.

I'm not saying there isn't more to do.

And we're continuing to work on cost and I know a lot of that is related to what Steve just talked about in terms of our use of technology and driving operating efficiencies in our hotels.

So there's definitely some more opportunities at the cost line.

But I really think that the real opportunity is going to be rate.

Well, that's the key and that's yield management, looking at your business mix, taking advantage of the good demand, the compression, the pricing power we have now, looking at our strong trends in business group and internationally the business.

That's going to drive ADR.

And we are going to take some risks, particularly in looking at '05 and how we place that kind of business with the high ADR.

But as you know in the last few years we've done a lot in consolidations of our operation, not just downsizing it.

It was intelligently done so that the benefit goes for us as a running operation, but also for our customers.

And if you look at productivity gains, we're leveraging our technology on queue and many other, productivity staffing schedules throughout our operations have been very effective.

For years we have had, I think, a very focused worker's compensation program.

We have the lowest accident and incident rates in the industry.

That has saved us millions of dollars.

So there are a lot of initiatives we have done and we're still focusing on.

Okay.

Let me just check on one other area.

Hawaii, I believe that's your largest market from an EBITDA perspective.

Can you give us an outlook?

We're hearing some positive notes on Hawaii from other lodging companies.

Can you provide a little bit of color on that, especially from the Asian travelers coming back to Hawaii?

Last year we had a good year and this year it's really a strong year, because the Japanese market is coming back quite strongly.

And we have benefited already in the Hilton Hawaiian business tremendously and in Waikoloa as well.

So having that driver from Japan, and traditionally we have had a very strong domestic market, particularly for group and association business.

So, I know that our business is strong.

Will, just to put a little bit of detail to that, the year to date at the Hilton Hawaiian Village, Japanese travel is up by roughly 45% over last year.

And that's 11% of your EBITDA, right Mark?

Yes, it's actually, I think it's more around 12%.

All of Hawaii.

That's the Village and Waikoloa.

And our next question comes from [Azad Kazeem].

Please go ahead.

Hey guys, [indecipherable] already asked this, but if you could give me some clarity.

With the implied RevPAR growth in the second half being 8%, versus 5-6 in the first half, you're expecting roughly, just 507(PH)m in EBITDA in the second half.

Can you help breakout how much of the increase in the second half or how much of a decline timeshare will have in the second half, just to get a better sense of how much lodging profitability is increasing in the second half?

Well first of all, there's not going to be a decline in timeshare.

I had mentioned earlier, Azad, that it was just the increases aren't going to be as large.

But, I don't know if we want to get into specific numbers regarding our timeshare EBITDA.

But just suffice it to say that the growth in the business for the second half would probably be less than half what we experienced in the first half.

And it's not as a result of a slowdown in unit sales, because our sales are just going gangbusters.

It's more kind of around the accounting for the sales.

Got it.

But if that's the case, you know, unit franchise growth is the same in the second half, roughly maybe slightly higher in timeshare.

If it's--even if it's flat then the guidance just kind of doesn't gel if you have almost 8 percent implied rev par growth and more of that is coming from rate than it did in the first half, unless I'm missing something.

Well maybe the thing to do is just put together your model and then we could--well, we can't really get specific on it, but maybe we can just understand how you are calculating it and see if there is any problem in the way you are looking at it.

Great.

Thank you.

Our next question comes from Jennifer Parker.

Please go ahead.

Actually, I think this is Bill Crow at Raymond James.

Good morning, guys.

Hello, Jennifer.

New assistant here.

The question, I guess, following up on a couple of--trying to twist some prior questions a different way.

Your guidance in the second half, given that July reservations are up 12 percent, August looks strong with the convention in New York, are you just really being cautious on the fourth quarter?

We've heard that out of a couple of companies already that because the group business isn't quite there yet in the fourth quarter, that they are really taking a cautious approach to that.

Is that--if we were to look at your quarterly guidance, which I know you don't provide, but in your model.

Are you really looking at a sharp reduction in rev par growth assumption in the fourth quarter?

Yeah, it's really how, Bill, it's--you know, we really stopped giving kind of a quarterly guidance and commenting on a quarter-by-quarter.

The 68 percent represents our best estimate at this time.

You know, it's realistic and represents what we see in the business at this point.

Okay.

Thanks, Mark.

And our next question comes from John Vodachek.

Please go ahead.

I don't know if it was Peter or Matt mentioned that the rating agencies do not sort of net debt--use net debt or add the cash flow?

Neither, it was [inaudible].

And I guess my question is if the cash is just sitting there and they are not taking it into account anyway, why can't you guys start to the buyback currently?

The buyback?

Buy back stock.

Did you mean buy back stock?

Yeah.

Why couldn't you start repurchasing shares now if they are not using that cash?

You can't pay down any debt that [inaudible].

Now there's two things going on there.

One is we are dealing with rating agencies and trying to get an understanding of the way they estimate the creditworthiness of the Company.

The other thing is running the actual business.

And while the rating agencies may not count cash in the bank--and the reason they don't is that they don't know what you are going to spend it on.

So they may not count cash in the bank as a reduction in the net debt.

We do.

So in running our business, when we've got cash in the bank we offset that against our debt in deciding our own ability to make investments.

But it really doesn't change the kind of--the model where we want to look first within the business and see if we have high return opportunities that well exceed the cost of capital, in which case we would make those investments.

And then, if in--and only that after we've reduced the debt to a level that is agreeable with the credit agencies.

So after those two things are done, then we are looking to see if we don't feel we have a proper use or ability to invest above the cost of capital in the reasonably near future, then we would look at returning capital to our shareholders.

And then, we would make a decision about whether the better way--best--better way to return the capital would be through an increase in dividends or a stock buyback.

So I guess what I am saying is there is a lot of--there is a number of gates to be crossed before we get to a decision about buying back stock.

What is your--.

--We don't look in the short term and say, you know, we've got some excess cash in the bank, therefore buy back stock.

That's not the model.

I understand.

I guess, what is the free cash flow for the back half of the year?

And I guess, I am just trying to understand what sort of balance you will have at 12/31 if you can't pay down any debts until 2007 because the balance is in such good shape.

I guess I'm just sort of saying if the business keeps running as it is, the stock price is going to --it's not going to be [inaudible] in a couple of months.

I'm sorry, I missed what you said there.

If the business keeps running as well as it is right now, the stock--may not be an opportunity in a couple of months because it will be higher.

I guess that's my concern.

Well, we are not trying--this is a little--this is the way we think about it.

And we are not trying to pick a stock price that's low.

We are trying to manage our balance sheet and our Company for the long term.

So if we have excess capital that we think that we really can't invest to provide value for our shareholders, that's when we start thinking about sending it back to the shareholders.

And then the question is what's the best way to send it back.

And all we can--the only ways we can see is either increase in dividends or a buyback of stock.

And so, you know, it's not--we're not trying to outguess the market and buy stock cheaply.

We are trying to manage the balance sheet and the business of the Company.

Okay.

What was--what's the free cash flow over the back half of the year?

And that's all.

Well, what we've said is over a three-year period you can look at a billion dollars.

Great.

Thanks a lot.

We have a follow-up from Jeremy Cogan.

Please go ahead.

Yeah, kind of following up on that.

Hello, Jeremy.

I think it's an okay question.

You don't have to answer it if you don't want to.

I understand.

With respect--that's just acoustics.

With respect to that last question and my earlier question, I just--what do you need an investment grade rating for now anyway?

And on top of that, what type of return on investment projects are we really thinking about?

You said earlier you are thinking about being more of a net seller of properties than a net buyer, which would mean you would have even more cash flow.

I think I said you would have a buy [inaudible].

Okay.

So, a buy.

So, let's just call it a wash just for now or maybe you are looking at buying some stuff here in the near term that would help--resorts or whatever.

But I'm just kind of curious whether the numbers are going to be--the numbers are going to be what the numbers are going to be.

So why do you really need the investment grade rating from Moody's today?

Why not, as that last caller said, be a little bit opportunistic here and worry about the full investment grade rating at a later point in time?

The free cash flow should be pretty significant, as you mentioned.

Yeah.

Here's our theory on staying investment grade--is that it's obviously cheaper and there is quite a flex point if you look at the cost of borrowings as you move from investment grade to non-investment grade.

So there are some economics in it.

But even more importantly, in our view and our observation of history is that if you are not investment grade you can run into times when credit is simply not available to you.

And we would--and when we're talking about investment grade, I mean, we are talking about at the bottom end of the range.

So we are conscious of the fact that debt adds value to the stock price.

And so we're--we move out as, you know, quite aggressively in terms of taking on debt within the investment grade category.

So I'm not saying that that's a rule of nature, but that's just the way that we are running the business is that we want to remain investment grade.

We're prepared to borrow as much as we can because we understand the economics of debt and the tax deductibility of interest, but we do want to maintain an investment grade.

And we want to do it over the long term.

So I don't think it's a question of--and as I said, we are barely there now.

So it's not a question of us saying to the rating agencies, you know, month after month, quarter after quarter, year after year, we want it to stay investment grade, and then one morning wake up and say, you know what, we decided to not reduce our debt like we've been saying we're going to do.

We decided to go out and spend whatever, a relatively small amount in terms of the total, a relatively small amount in buying stock back.

I just don't think that that--it might please some investors, but it shouldn't please long-term investors because they should be looking at how we run the business.

And so, you know, that's the whole answer to that, Jeremy.

Okay.

So, I appreciate that.

In terms of the capital projects, so just in terms of scale from an ROI standpoint, because it did seem, and maybe you didn't intend to, but it did seem like Bob, or whoever answered the question before, kind of backed off a little bit on the buyback.

I know your thoughts on the dividend, but really on the buyback.

So are you thinking about some other return projects that are a little bit more sizeable in terms of the absent dollar amount?

How--well, I don't know what we mean by sizeable.

But for example, let's just look at kind of our history, recent history.

When--I think it was you, mentioned resort hotels.

We've followed the sales of resort hotels.

We've been in the process.

We didn't buy anything and it's because we don't think we can provide a return above our cost of capital when you need to pay the prices that the resorts go for.

On the other hand, and a much--so a KSL kind of multi over a billion dollar deal, we understood it and we were there, but not at those prices.

So that kind of thing you shouldn't--we don't think about, and therefore, I guess you shouldn't think about us doing.

But we do have opportunities within our business to do kind of bolt-on investments like we did at the Waldorf with the Starlight Roof.

We estimate the return on that investment was in the mid-20s.

So we also have an opportunity, in a controlled way, not a big way, but in a controlled way to increase our investment in timeshare.

We've been extraordinarily successful in timeshare.

We don't want to overdo it because we realize it's a very management-intensive business.

And so we don't want to have a lot of marginal projects.

We'd much rather have a smaller number of really good projects.

But we could probably invest some more money there.

I guess what I am saying is that it's just not--it is what I said before.

Our first goal is to be sure we are going to remain investment grade.

Second goal is to invest where we can have clear investments that add value for the shareholders.

I mean, investments that are--that return such a high return on investment that we are confident that it's going to be above our cost of capital.

Then we are going to say, now we don't--then we'll look at if we have capital that we can invest for the benefits of the shareholders, then we'll send it back.

So that's kind of the [unintelligible] order there.

Jeremy, we typically earmark $50 to $60m a year in ROI projects, our own hotels.

That's been the case going back the last three, four, five years.

You know, once we get to our desired debt to EBITDA ratio, yeah, we would certainly look at increasing that, looking at some good projects that would generate returns of 15 percent plus.

As Steve mentioned, the Starlight Roof at the Waldorf.

We added a lounge at the Waikoloa Village.

You know, good projects, again that get us returns above our cost of capital.

So that would be one use of some of our excess cash flow.

Thanks.

I think we probably have time, Stephen, for one more question.

There actually are no further questions at this time.

We timed it right.

Okay, well again, thank you everybody for joining us and we'll be talking to you soon.

Thanks again.