萬豪國際 (MAR) 2003 Q2 法說會逐字稿

At this time, for opening remarks and (inaudible), I would like to turn the call over to the Executive Vice President, Chief Financial Officer and President of Continental's European Lodging, Mr. Arne Sorenson.

Please go ahead, sir.

Thank you, Ruffus. Good morning, everyone. Welcome to our second quarter of 2003 earnings conference call.

Joining me today is Laura Paw, Senior Vice President Investor Relations, and Carl Berkowitz, Executive Vice President International Information and Enterprise Risk Management.

Before I get into the discussion of our results, let me first remind everyone that many of my 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 SCC 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 earlier this morning, along with -- along with my comments today - are effective only today, July 17, 2003, and will not be updated as actual events unfold. In keeping with new SCC regulations, you can find a reconciliation of non-gap financial measures referred to in our remarks at our website at www.Marriott.com/investors. In our remarks today, we will summarize the results of our second quarter, provide an update on our balance sheet and investment plans and provide guidance and sensitivity information for the remainder of the year.

The second quarter included the war in Iraq, SARS in Asia and Toronto, and continued economic weakness. Under the circumstances which were horrible, we were pleased with our results in the second quarter. Diluted earnings per share -- earnings per share from continuing operations totaled 52 cents, a 6% increase over the prior year, and our strong balance sheet has allowed us to purchase 6 million shares of Marriott stock here today.

Systemwide, North American REVPAR for all brands, including the franchise portfolio, which tends to be in less volatile markets, declined 5% on the quarter. As a manager and franchiser, we have much less sensitivity to changes in REVPAR than ownership companies.

We achieved significant efficiency improvements through the quarter, so, despite the REVPAR decline, house profit margins declined only 2.8 percentage points. Combined are base management and franchise fees were flat on a year-over-year basis as unit growth offset the impact of comparable hotel REVPAR decline. Our management fees declined by $24 million from a year ago.

The decline was driven by three separate factors. First, roughly 5 million of the decline came from international markets, where SARS and the war had a pronounced impact. Second, four big fee earners in the U.S. were in very hard-hit markets and by themselves generated 6 million in decline. And third, last year's second quarter, which was much stronger compared to the prior year than the first quarter, making for some difficult comps. Other than that, the decline was driven by the obvious, lower REVPAR and house profit margins.

Similar to the first quarter, only 22% of our managed hotels earned incentive fees, compared to 37% a year ago. You may recall the percentage was nearly 70% in 2000. As a result, downside risks going forward is limited, yet we retain considerable upside when operating fundamentals return. Weak U.S. markets included Boston, New York, Philadelphia, San Francisco, Atlanta, Orlando, and Los Angeles.

Many markets were impacted by fewer citywide conventions, lower business transient demand and new supply. On again/off again code orange alerts, as well as the musician strike in New York also took their toll. On the west coast, many high-tech firms continue to reduce travel. On the east coast, the spring rains reduced weekend demand from youths sports teams and tourists.

Results in Fort Lauderdale, Tampa, and D.C. were relatively stronger. Fort Lauderdale benefited from low-cost air travel, pre- and post-business and higher international arrivals. Tampa and D.C. benefited from strong government demand during the quarter.

Today, new group bookings tend to be either very long-term, two to five years out, or very short-term, two to five weeks out. Hotel event managers continue to juggle meeting space to enable us to capture as much large last-minute bookings as we can. Responsiveness to the customer is key to capturing short-term business.

The good news is that group meeting inquiries have picked up the last two to three weeks. Leisure business remains strong in most markets, and we are booking leisure guests without relying heavily on expensive third party internet sites. During the second quarter, internet reservations represented 9% of room nights sold with still approximately 80% of those room nights booked on www.Marriott.com. In the second quarter, www.Marriott.com room nights increased 23%, and room nights on that channel increased 2%.

Outside the U.S., hotel performance was challenged by the economy, the war, and SARS. REVPAR at company-operated comparable hotels declined 13.8% in constant U.S. dollar terms, and 9.7% using actual exchange rates.

In Latin America, most business remained regional rather than international as that region continued to deal with the difficult economic climate, but the Caribbean benefited from strong leisure business. Overall, REVPAR in Latin America increased 8% in constant dollar terms, but was flat using actual exchange rates.

In the Mid East and the United Kingdom, REVPAR suffered from the impact of the Iraq war with occupancy rates meaningfully lower. Germany, which typically contributes considerable regional travel to other markets, remains mirrored in recession, and fewer Americans are making the summer pilgrimage to the European capitals. In total, continental Europe constant dollar REVPAR declined 11% during the quarter, but increased 6% on an actual exchange rate basis benefitting from the strong euro.

During the first quarter, strong economic growth in Asia spurred across the region. As the second quarter began, the growing concern about the SARS virus produced profound declines in occupancies at properties in Hong Kong, China, Singapore, Thailand, and Vietnam. Travel warnings and restrictions significantly reduced international travel to Asia. REVPAR declined 36% in the region in the quarter. Occupancy at the JW Marriott in Hong Kong averaged only 29% for the quarter compared to 77% a year ago. But last week, occupancies in Hong Kong had increased to nearly 50%, substantially better than the roughly 30% occupancy we experienced in the month of June.

Despite our relatively soft REVPAR, we and our owners were largely pleased with our house profit performance. House profit margins at company-managed hotels declined only 2.8 percentage points at North American managed hotels, and declined only 4.2 percentage points in our hotels in international markets.

The U.S. casualty insurance and medical benefit costs continue to climb. U.S. energy costs rose 8% during the quarter, largely due to higher prices. And hourly wages at domestic properties increased 3.2% year-over-year. Despite the higher costs, we continue to see outstanding productivity improvements, and I don't mean arbitrary cost cutting. Rather, the cost savings are largely the outcome of a carefully designed process that significantly improves productivity.

We have dramatically simplified the scheduling process by reconciling associate availability, time off requests, and forecasted labor requirements, and we have focused management time and attention on productivity efforts, not just on cost-cutting. This process, which began with a handful of hotels in 2001 and has now been implemented in over 175 managed full-service hotels, has produced dramatic improvements in productivity and profitability.

Through the first two quarters of 2003, hours per occupied room declined by 2.4% or program hotels, compared to the prior year. And last year, we had already achieved dramatic improvement in hours work -- hours work per occupied room. Our full-service hotels not using the system have seen improvement of less than a half a point in hours per occupied room compared to last year.

Our scheduling system is part of a broader effort to improve back office productivity and customer satisfaction using Marriott business services. Located in Knoxville, Tennessee, Marriott business services opened for business in 2001 and has reduced on-property, back-office staff and produced a dramatic change in the process.

Marriott business services is currently handling centralized accounts payable and billings and accounts receivable. This system is not only delivering great improvements in productivity today, but should enable us to retain permanently a more profitable hotel operating model.

In the second quarter, we opened 7,400 new rooms under our flags, including 21 hotels that converted to the Ramada International brand. Deflaggings totaled approximately 1300 rooms. At quarter end, our worldwide pipeline of rooms awaiting opening totaled nearly 50,000 rooms. 28% of those rooms are outside the U.S. and 38% are full-service properties. The pipeline is likely to decline a bit as 2003 progresses as we continue to open hotels faster than new hotels are added to the pipeline.

Outside the U.S., project activity is strengthening. New management agreements in Asia, especially China, reflect more favorable terms than Marriott has ever seen. SARS and the war slowed the development process but did not result in the cancellation of any projects. We remain very optimistic about the long-term economic growth prospects in Asia.

In contrast to a difficult environment to new construction in the U.S., we continued an excellent pace of hotel conversions during the quarter. Over half of our global (inaudible) during the quarter were conversions from other brands, including 1800 rooms for the Ramada International. We expect continued strength and conversion activity in our brands, especially in light of the ongoing weakness in the industry as owners and investors seek to reposition hotels and improve returns. Largely as a result of our successful conversion activity, we now expect our 2003 openings to hit the high end of our previously-stated 25,000 to 30,000 room forecast. And we continue to expect to open 25 to 30,000 rooms in 2004.

Turning to our timeshare business, contract sales increased 7% during the quarter reported profits totaling $44 million, consistent with expectations. Contract sales were strong at resorts in Hawaii, Aruba, and St. Thomas, but remained weak in Orlando and Lake Tahoe.

You may recall that last year we disclosed our intention to sell our timeshare notes twice a year rather than every quarter as had been our previous practice. Consistent with this plan, we completed a $130 million timeshare note sale transaction in the second quarter and booked a $32 million gain.

In the year-ago quarter, we sold $85 million in notes for a gain of $15 million, but on a year-to-date basis, timeshare note sale gains were 32 million in the first two quarters of 2003, compared to 28 million in the first half of 2002. While timeshare profits were favorably impacted by the note sale gain, two other factors are also important to note during the quarter.

First, while contract sales were up 7% year-over-year, a greater proportion of them were from projects under construction like Aruba and Hawaii and have not yet reached the percentage completion threshold or financially reportable sales. As a result, financially reportable development sales declined 12% from last year's second quarter. Contract sales not recognized in the second quarter and their associated profits will be financially reported in the future as construction progresses.

Secondly, financing profits were reduced by financing incentives and lower notes receivable balances. In addition to our timeshare business, our lodging profits reflect results from our giant venture investments. Book profits from our lodging joint ventures totaled $2.1 million, including a $2.5 million loss from the Courtyard giant venture and a $5.7 million profit from the Ramada giant venture. Lodging giant venture profits in the 2002 quarter were $6.3 million. In 2003, we expect the Courtyard giant venture to continue to pay -- joint venture to pay all debt service, including principle amortization. The joint venture's total indebtedness declined every quarter since our investment in the partnerships three years ago.

Still, given the uncertain economic climate, as well as seasonal variations in cash flow, we expect the joint venture will continue to retain excess cash in 2003 and defer payment of our interest and perhaps a small portion of our ground REV. This is permitted under the joint ventures existing loan arrangements and won't change our recognition of interest income or ground rent from the venture. When business conditions improve, the joint venture is required to use cash to repay any unpaid interest in rent.

Our lodging results include the impact of gain and gain amortization from asset sales completed over the past several years. We recognized $6 million in gains and gain amortization during the second quarter, compared to $4 million in the prior year. Corporate expenses increased modestly from $23 million to $24 million, based on first quarter performance, second quarter expenses were low. We expect third quarter expenses to increase above second quarter levels due to the timing of certain legal expenses and office space vacancies.

For the full year, we continue to expect corporate expenses to run roughly $10 million for four-week accounting period or 130 to 135 million for the year as a whole. Interest expense increased by $4 million during the quarter as capitalized interest continues to decline along with our investment spending.

Total debt including debt from discontinued operations was $1.7 billion at the end of the second quarter, compared to $2.2 billion at the end of the first quarter; however, our cash balance was $144 million at the end of the second quarter, compared to $525 million at the end of the first quarter. Dispositions totaled $108 million in the second quarter, including the sale of the Seattle Waterfront Marriott and in Orange County, California. At the end of the second quarter, we sold another hotel for $39 million. In all cases, we retained long-term operating agreements.

Our synthetic fuel segment produced 2 million tons of treated fuel in the second quarter. The operating loss from this investment totaled $42 million during the quarter, the tax benefit was $15 million. Tax credits totaled $53 million and the impact on net income was a favorable 26 million for 11 cents per share compared to 6 cents in the prior year. Early in the third quarter, we completed the sale of a 50% interest in our synthetic fuel business to a major U.S. financial institution. We received approximately $25 million in cash and notes at closing and expect to receive substantial contingent payments over time. The size of which will depend on the volume of synthetic fuel produced.

The purchaser has a one-time right to earn its interest in the synthetic fuel venture only in the event the IRS doesn't issue a satisfactory private letter ruling -- ruling by December 15 of this year. In late June, the IRS publicly confirmed it had suspended the issuance of private letter rulings regarding tax credits generated under section 29 of the internal revenue code, specifically those requesting a ruling on whether or not COAL feet stock had undergone significant chemical change and thus been converted to synthetic fuel.

We have four existing private-letter rulings covering our investment in synthetic fuel and have rigorous procedures in place to ensure compliance with all of the requirements of the law. We remain confident that the tax credits claimed by Marriott are valid. Unfortunately, we can give you no assurance as to the outcome of the IRS review or it will have no adverse income generated by the fuel investment. Marriott, together with the (inaudible) tax advisers and independent scientific experts, intends to work closely with the IRS to obtain our pending private letter ruling in a timely matter. By closing the transaction in June, we expect our synthetic fuel operation to generate 2003 earnings per share of 34 to 37 cents.

In 2004, we expect earnings from the business to total roughly the same, 33 to 36 cents. In the event that the purchaser returns its interest to Marriott, our 2003 earnings would not be effectd and our 2004 earnings per share from synthetic fuels, we would expect a total of 25 to 28 cents for share. Because our joint venture partner in the synthetic fuel business has a one-time right to return its interest, we will continue to consolidate the operations on our financial statements until the earlier of the receipt of the private letter ruling or December 15, 2003. Given the presence of the one-time rights, we expect to consolidate the joint venture for accounting purposes until the right expires. We remind you that in any event, these tax credits will expire at the end of the year 2007. For 2003, excluding synthetic fuel, we expect our tax rate to be 35.1%.

Typically we spend a few minutes on our call updating on you our balance sheet and contingent liabilities. Let's start with our guarantees.

At quarter end, not including 457 million in guarantees remaining from the sale of our senior living business and 257 million of guarantees that are not yet effective, we had 617 million of effective guarantees. The effective guarantees include 330 million of debt service guarantees and roughly 180 million of operating profit guarantees. For these two categories of exposure, we have roughly 50 million in deferred gains and reserves. Project completion and other gains make up the remaining balance, the majority of which relate to construction projects which have been essentially completed.

Other than some guarantees required as part of our insurance program and modest new exposure from our latest timeshare note sell deal, our guarantee exposure was essentially flat quarter-over-quarter. Our loan portfolio at the end of the second quarter was approximately 1.1 billion. At the same time, our loan commitments stand at 192 million, and we expect to fund only 146 million of those commitments. Our loan portfolio should continue to decline as the loans are repaid from operational cash flow or from refinancing proceeds.

Consistent with our philosophy on real estate, we do not intend to be long-term investors in our license and expect to sell or refinance those loans at appropriate economic terms. During the second quarter, interest expense and provision for loan losses netted to a favorable $1 million. Performance was better-than-expected because interest rates remained low. Low losses were minimal and investment spending was less-than-expected. Approximately half of our interest income was noncash, including primarily the cash deferral of our interest income from the Courtyard joint venture.

Second quarter investment spending totaled $140 million, including $42 million for (inaudible), $31 million for loans and equity investments, and $67 million for timeshare spending. We repurchased 1.1 million shares during the quarter and 6.1 million shares year-to-date through the second quarter of 2003. We continue to expect that we will invest at least $400 million in share repurchases in 2003.

Now, let's turn to our outlook. In formulating our guidance, we are mindful of the significant uncertainties which still face us. While the impact of a war in Iraq and SARS seem to be abating, we still face considerable economic risk in the U.S. and across the globe. Perhaps the most positive thing we can say is that we now have at least mixed signals. Not just negative ones. Most significantly, there are increasing sign that is the U.S. economy is improving and corporate profit growth is returning.

We know from experience that corporate profit growth should show up as improved lodging demand, roughly two quarters later. We are hopeful these signs of relative economic strength will reveal themselves in our business as we hit closer to year end. We have seen some indications of improvement in our business.

For example, our net global reservation activity in the last two to three weeks has been significantly stronger than we have seen in the earlier months this year. And as I mentioned before, inquiries for possible group meetings in our hotels also have picked up recently. Notwithstanding these signs, however, the summer season is primarily a time of leisure travel and we have not seen enough data to give us real confidence about the future direction of business trends and travel or of the group, of the corporate group business. We don't expect to have meaningful data points for these segments, but most important for Marriott's results until we get into December.

Without any real clarity that strength is returning to our business, and in light of the recent REVPAR results, we believe it's prudent for us to modestly adjust our REVPAR guidance for the third and fourth quarters. Our best guess today is that REVPAR in the third quarter should fall between minus 3% and 0%, and in the fourth quarter, minus 2% to plus 2%.

These forecasts still imply a significant sequential improvement from the second quarter. Why? Because primarily we believe the comparisons get easier as the year progresses. This is best (inaudible) by looking at the REVPAR run rates in comparison to the baseline years of 1999 and 2000 rather than the much more volatile results of 2001 and 2002.

To achieve these new REVPAR forecasts, we're also likely to see the impact of a modestly strengthening economy as we get toward the end of the year. Based on the economic data, we think this is a fair, but by no means, certain expectation.

So how does this translate into profits and earning -- averagings for Marriott for the balance of the year in overall? We estimate lodging, including timeshare, should earn between 135 and 140 million in the third quarter of 2003, compared to 160 million earned in the third quarter 2002. As previously indicated, we don't plan to complete a timeshare mortgage note sale in the third quarter, but rather expect to sell a larger portfolio loops in the fourth quarter. In total in the fourth quarter, we expect to earn 23 to 27 million from our timeshare business, down from 40 million in 2002.

Excluding the impact of the $18 million timeshare note sale gain in the 2002, third quarter, lodging profits are likely to be down roughly 5% in the third quarter. This is a relatively better performance versus last year than we achieved in the second quarter because of the somewhat stronger REVPAR expectations.

In addition, our forecast includes $10 million of gains on the sale of two international equity stakes, which we expect to close in the third quarter. There are some risks these gains will shift into the fourth quarter, but as the buyer is already bound to complete the transactions, we are confident the profit will be realized this year. Incidentally, we expect gain and gain amortization, including these forecasted gains, to be roughly flat versus 2002 for the full year.

In the fourth quarter, we anticipate a somewhat stronger year-over-year REVPAR comparison, as we expect lodging operating profits to come in between 230 and 240 million dollars. Timeshare profits benefitting from 25 to $30 million in forecasted note sale gains are expected to be 57 to 62 million dollars in the fourth quarter. The full-year 2003 our REVPAR supplied a roughly minus 1 to minus 3% decline in REVPAR. A minus 1.5 to minus 2.5 percentage point decline in average hotel house profit margins and full-year operating profits from lodging for Marriott. Of $690 million to $705 million. To complete our EPS outlook, we estimate corporate expenses should total $35 to $40 million in the third quarter as we pick up some spending delays from second quarter. And $130 to $135 million for the full year.

With declining capitalized interest from slower investment spending, and with additional spending on share repurchases, we expect interest expense, net interest income to again approximate mate 0 in the third and fourth quarters and net to a $5 to $10 million expense for the full-year.

Well, we have sold half of our synthetic fuel business, the purchaser retains the right to return our investment to us (inaudible) a private letter ruling has not been received by December 15. As a result, we expect to consolidate the results of the joint venture for all of 2003. Pretax losses from the business are expected to dramatically improve for the balance of the year due to the earn-out payment made by our partner as tax credits are produced.

In the third quarter, pretax losses should total 0 to $3 million and in the fourth quarter, 10 to $15 million. Full-year pretax losses are expected to total $115 to $120 million. In the third quarter, we anticipate tax credits of $50 to $60 million and in the fourth quarter, tax credits of $55 to $70 million. This minority interest amount is expected to be a reduction of income of 25 to $28 million in the third quarter, and 30 to $40 million in the fourth quarter.

Bottom line in total, we expect third quarter earnings per share from continuing operations will total 35 to 39 cents. Fourth quarter EPS from continuing operations will total 57 to 61 cents, and full-year 2003 EPS should total $1.8 to $1.88. Included in that forecast are synthetic fuel business is expected to generate 9 to 10 cents per share in the third quarter and 6 to 8 cents per share in the fourth quarter for a total of 34 to 37 cents per share for full-year 2003. For full-year 2003 investment spending is likely to total approximately 550 to $600 million.

We expect to spend a bit over $100 million for new unit capital expenditures, roughly $75 million for maintenance capital expenditures, $200 million for loans and equity investments, and 175 to $200 million for timeshare development. The philosopher Charlie Brown once said when you have to get q-and-a

Thank you, Mr. Sorenson. For our first question, we go to Joyce Minor with Lehman Brothers.

Hey, guys.

Hi, Joyce.

I'm still chuckling over Charlie Brown.

I know you said you're not going to get a lot of data points on travel trends until later in the year, but if you could give us maybe whatever you've got so far. You mentioned your reservation combines, can you give us a number around that or maybe group bookings up, down, you know, pricing up, down, and if you could also speak to a timeshare, it looks like sales there may be not as robust as they had been. Are we seeing any degree of buyer fatigue on that front, or what is your take on that? Last question is, that (inaudible) lot of corporations you have seen move from share repurchases toward larger dividends? Is there a reason why that may not make sense for you as well. Thanks.

Sounds like three questions. Let's take them one at a time.

Future bookings. We have, obviously been watching all the same data that you all have in terms of the travel reports by week, and we look at our own system, and are struggling real hard to see if there is any sign yet in our business, including future booking trends that strength is demonstrated clearly, and we really have not seen that yet. Now, having said that, I think it's important to recognize that we would not expect our business, which tends to lag the economy by two quarters, to be a very good barometer of leading indicators of check strength. In a sense, it doesn't surprise us the data points don't show it yet.

When we look at our future bookings, we see still year-over-year mid-single digit declines in terms of revenues on the books between now and the end of 2003. That is roughly similar to the declines we have seen in earlier parts of this year as we look forward. It's important, though to keep in mind those go with the shortest booking window we have ever seen and to some extent as the consequences are not surprising.

When we look into 2004, we're seeing, however, very low single-digit increase in revenues for group bookings on the books. We take some comfort in that. Again, we caution everybody not to put too much stock in those future bookings as being a guarantee for what is going to happen with REVPAR in those quarters. We look also at daily reservation volume. We see probably a bit more volatility now than we have seen at many times.

I mentioned in my prepared remarks over the last two, three weeks, we have seen a good healthy increase in net reservation activity globally. Up around 10% or so. But actually in the last number of days, that has tended to moderate again and come down a bit. And, you know, all of those fans pull together, that's why we said we were seeing mixed signals on the positive, you know, good booking trends, good inquiries on the negative, group business on the books looking forward is still down versus last year. Net debt, that causes us to believe until we start to see what happens in December with the business traveler and the corporate group, um, it's a bit of a folly to try and say that our data is going to show anything that is crystal clear (inaudible).

Second point on timeshare, we're not seeing buyer fatigue there. We're seeing continued good, strong interest, the finance has come up even as rates remain relatively steady, delicate in terms of the rates we're putting on the notes, but we get good, strong interest, it varies a lot by market. Markets like Orlando tend to be weaker. We have a fractional product in London, which has been impacted by the travel to London in the second quarter. As I mentioned, markets in Hawaii and California by contrast are really quite strong. We continue to be very optimistic about that business.

Your last question was dividends. We are, I think, listening to the investment community and trying to understand, I think where corporate America is going with (inaudible) dividends. Obviously we'll keep our ears open on that. Our bias, I'll confess (inaudible) share repurchases rather than towards a dramatic increase in dividends. There is obvious flexibility there for us that doesn't exist on the dividend side and that flexibility is particularly appreciated, given the last couple of years which have been quite volatile, and if we think about having backed in a much more significant dividend stream in the kind of world we have lived through the last couple of years, that's not a very attractive proposition for us.

We have mentioned before that over a sustained period of time we're talking about 20 years. Marriott has used a good 40% of its free cash flow either to distribute dividends to shareholders or buy back stock in the open market. I suspect that trend will continue to be a significant one for us going forward.

That's helpful. Thank you.

You bet.

For our next question, we go to Steven Kent with Goldman Sachs.

Hi, good morning, Arne.

Hi, Steve.

I'm trying to understand something. You're seeing mixed signals, comps are getting easier, stronger economic data, reservation activities up, and you're lowering REVPAR guidance for the balance of the year?

I guess I just don't get it. I don't understand why go so conservative. Your expectations are pretty low already. Is there something specific to Marriott? Is there something that you're incredibly concerned about? It just doesn't add up given your other comments.

I would -- a good question, Steve. I think I would say that your reaction to our third and forth quarter guidance probably would suggest it more fundamental in a sense than we view it. We view it as fine-tuning as the year is progressed and giving you our best estimate where things are going to fall. We're not out here deliberately trying to provide conservative guidance or aggressive guidance at all, but simply trying to provide the best work that we've got.

The thing that has changed since a quarter ago is we had REVPAR results in the second quarter and until some very recent reservation volume, by and large, the second quarter was a pretty significant disappointment. You know, minus 5% for system-wide comp hotels in the U.S., minus 6 and change for the full-service brand. Those aren't statistics to write home about.

We were hopeful as we entered the second quarter that they would be better than that, and I suspect that's the thing that has changed most significantly from a quarter ago. But still, the REVPAR guidance we're giving you today, we view simply as our best guess and the fine tuning as the years progress are what we expect to see in Q3 and Q4.

Okay, thanks.

You bet.

We go next to Brian Egger with -- [ Indiscernible ]

Good morning.

Good morning.

A couple of questions about your cost outlook.

We looked into that and you touched on that and energy, as well as insurance in your earlier prepared comments. Kind of trying to get the sense of when you think perhaps some of the more significant of those year-over-year cost increases begin to maybe taper off or when the comparisons get easier.

Do you have any sense in the second half, or as you start to think about next year, what the nature of the cost increases look like on a year-over-year basis?

When we look at our margins in addition to the things that you mentioned, one of the things that I think you would add there, two other things.

One is a big pressure on margin, is that when REVPAR declines are driven by rate declines more than occupancy declines, it's tough to calibrate the expenses the same way you would if you had occupancy declines.

Secondly, I think we have sewn as the industry has and as the telecommunications industry has, that the use of cell phones and other portable communications devices is having an impact on our telephone profits in the hotels. That has been pretty dramatic over the last three, four years. I suspect we're reaching the bottom on telephone profits and that will get easier. As if and when we get to a point where we can move rates, and there is really no pricing power today, we'll then start to see some of the pressure on margins getting released.

I think as we look forward on the other categories of expenses, you will have to reach your own judgment about energy expenses. I don't have a forecast to give you there. Medical benefits and the like, associated with employee cost, looks like they're going to be up significantly again next year. I think the industry data I have seen shows, not just industry but corporate America, shows healthcare benefits up, you know, at least 10%. Maybe more like 10 -- 15% forecasted for next year. We don't know what the numbers are going to look like for us next year, but our expectations will be that they'll be up meaningfully.

Insurance premiums will hopefully start to see relief, even in the second half of this year. Property insurance, some of the pressure has come off of that. (inaudible) That for us is a mid-year renewal program and should start to give some relief there and casualty insurance we'll have to see how things go there as those policies are renewed at year-end. Hopefully there will be less pressure on those forms of insurance as we get into 2004.

Okay, thanks, Arne. That's helpful.

Okay.

We go next to J.D. Cogan with Bank of America Securities.

Morning, everybody.

Hi, Jay.

I have a handful of questions for you as well.

Why don't you try two or three, a handful I'll probably forget.

Okay. Let's do three.

First, I think if I'm looking at the calendar right, your third quarter includes 9/11 specifically whereas last year it didn't. I knew you knew that before. If you could touch on what the first couple of weeks of September are looking like for you. They were obviously pretty weak for the industry last year.

Second, I was wondering if you could comment more specifically. You mentioned to Joyce that group revenues are up a little bit next year for '04 so far. I was wondering if you could talk about group rates and what you expect in corporate rates and finally, I was wondering if you could comment as to why you only bought a million shares in the second quarter back relative to about 5 million or so in the first.

All right. Let's see.

All right. First couple of weeks in September, we don't really have any specific guidance to give you there. We have looked at the September 11th weeks in 2,000, 2001, and 2002, and we have looked at the weeks before and the weeks after. I think -- obviously a week in September 11th, 2001, and the week that followed were horrible. Last year the week of September 11 and the week after September 11 would suggest that there probably were some folks that stayed home on the first anniversary of September 11, but it's hard to tell exactly. Our MHRS brand, for example had roughly 8% better REVPAR in the week after September 11 than the week of September 11.

So, if that levels out this year and you assume that while people might be well prepared to travel on the first anniversary of September 11 that they'll be able to travel on the second anniversary, maybe could have a few incremental points of REVPAR in the week of September 11 itself. I wouldn't expect it to be more dramatic than that and probably not have a big impact on quarterly REVPAR numbers. 2004 rates, group rates, are probably up a point or two for the business that's on our books, but more or less flat. So there's no -- there's no real bad news there.

We don't have any -- anything material to give on you corporate rates for 2004 yet. We have not started to negotiate those yet. That's really going to be a function of the discussion in the fall, and I suspect our ability to drive rates on that category of business for 2004 is going to depend very significantly on what demand looks like in the fall of 2003. Without some strengthening in logic demand, it's going to be very tough to do anything better than hold those rates flat, and I suspect that will be a challenge.

On shares, we had purchased 1.1m in the second quarter. Obviously if you look at our stock price performance in the second quarter, it was a pretty steady positive line, which we love to see. We tend not to be aggressive in buying our stock on up days for a number of obvious reasons, and as a consequence, we were a little less aggressive in the second quarter. But we continue to like our stock as the investments for us and expect, as we said in our prepared remarks, we will proceed toward our $400 million of purchases at least over the balance of the year.

Great. Thanks a lot.

You bet.

We go next to Bill Crow with Raymond James & Associates Inc..

Good morning, Arne. A couple of questions here.

First of all, Arne, you mentioned that four hotels in particular weighed heavily on management fees. I don't know whether you care to tell us which four hotels those are, but would that have any impact from the renegotiation of the host Marriott agreement?

No, not in any material way at all. There -- it might be there was a few hundred-thousand dollars in the second quarter related to that. I'm not going to calculate that. This is very much driven by the more fundamental results of those hotels, which, as you might have anticipated, I won't tell you which ones they are.

Okay. And are you sensing as you deal with the franchisees and other folks at your hotels, you're having anymore impact on steering them toward using one internet distribution method versus another?

I -- I think that is a continually evolving area, and an area that gets an awful lot of focus. I think the number of the third-party internet sites have become more friendly to lodging suppliers as alternatives have become available to customers on the internet. And as a consequence, some of the most extreme markups are now tending to moderate a little bit. The more they moderate, the more all of these various channels will become attractive channels for everybody to use.

I think the second thing, in addition to the markup, that we look at is our ability to control pricing. We want very much to have integrity of pricing across our system, both to make sure we're fairly priced and to make sure that all of the various channels get a fair shake. And I think there are some developments there, too, that are going to help us control pricing, and so I suspect we're going to see some convergence of all of these channels towards a more narrow band. But that's a bit more of a prediction for the future.

I think at the moment, we continue to be much more reliant on our own propriety -- proprietary website as a industry as a whole. We tend to be less reliant there on some of the third party sites, which have the most exorbitant expenses associated with it, and, therefore, some of the most dramatic impact, negative impact on profit margins.

If I could do one final question here, Arne.

You talked about your guarantees. Could you maybe give us a percentage of the properties where you have a profit guarantee there (inaudible) today and maybe compare that to where they were a year ago.

Say that again, Bill, I'm sorry.

The performance guarantees on a number of hotels - and I'm just wondering how many of those fail to produce rules so that your guarantees are, you know, you have to use your guarantees.

What we do when we look at the guarantees every quarter, as well as our loan portfolios, we do a full-year forecast. And -- not a full-year forecast, like a 10-year forecast, and basically the forecast to guarantee fundings and make an estimate of whether or not the forecasted fundings should cause us to take reserves on the guarantees themselves.

We had the forecast for this year, which was not very aggressive as we did those calculations. I think today we're probably on average - a tiny little bit worse but not significantly different from the forecast we would have used a quarter ago or the -- or two quarters ago for that matter. Um I think in terms of incremental guarantee reserves, we might have had in our second quarter, a million dollars, for example, which would be indicative of that. The numbers are running more or less at the level we would expect for that portfolio.

Thank you.

Yup.

We go next to Michael Rietbrock with Solomon Smith Barney.

Hey, guys

Hey, Mike.

Arne, pretty much one quick question on the infield situation.

I don't want to predict the future, but is there any indication, at least up to this point, that the IRS is either looking at, you know, retroactively eliminating some of the tax credits or just kind of cutting them off before 2007 at this point?

We have really had no indication of that. At the same time, we're in no position to speak for the IRS.

Yeah.

All we know, and we know it with (inaudible), is that with four private letter rulings that we hold for our plans, every one of which has attached to it, detailed technical descriptions of the chemicals we're going to use, and based on the way we run these businesses, and we have dotted every I and crossed T. There won't be a meaningful impact. Maybe any impact to this aspect as it relates to Marriott, but we're just going to have to see how that develops over time.

Okay, and just -- just a couple of quick timing questions, did -- would the second quarter REVPAR on a calendar basis have been materially different than what you reported?

No.

Okay and, Laura, when does the fiscal third quarter end specifically?

September 12.

12. Okay.

So, the week of September 11 shifts this year from Q4 last year to Q3 this year.

Okay.

On the one hand, that gives you, you know, there may in fact (inaudible) . [ Indiscernible ] On September 11, on the other hand, the week is a strong business week.

Okay. And Arne, last timing question on the timeshare business, when do -- when are the properties which are currently deferring the revenue, when do you begin to reverse some of that?

I don't have the schedule. It's done on an individual property basis. On average, it's probably a couple of quarters. You won't see a, probably a huge bump. I think we'll see some improvement, but you have always got some not hidden there -- hitting their construction schedule, some are a few quarters away. Average is probably a couple of quarters.

Okay.

You can look back and see the disconnect between contract sales growth and reported sales growth by looking at press releases going back. It usually evens out over time.

Yeah. And just one last one, the guidance for the core tax rate at 35%. The previous guidance had been 36, right?

I think that's right. And I don't -- I think probably the biggest reason for that is that international income becomes a relatively larger portion of our total income.

We're probably going to see that tax rate drift down a little bit, and even though SARS in the world are very tough on the international business, generally in the second quarter with strength in the Caribbean and Latin America, and with the strong (inaudible), which actually cause -- euro, which caused our REVPAR to be up in dollar terms, I suspect this year's 35.1% is driven by long-term international. I think long-term, we're probably in the 35 to 36 range.

Okay. Wouldn't see a dramatic change.

Yup.

We go next to Will Marks with JMP Securities.

Pretty much everything's been asked. One quick question on the pipeline.

I think it's been awhile since you have actually mentioned your pipeline might be decreasing. Can you comment on that?

Um, I'm not sure, I guess we have been 50,000 rooms for a couple of quarters, but you will recall two years ago, we were at 70. And what we have seen as supply growth has come down in the United States is that our pipeline has declined a bit as well. And I think that's a trend we're going to continue to see as the year goes along.

I don't think it will be dramatic down from 50,000, but there are clearly fewer new construction starts today, and, therefore, there will be fewer new room openings in the United States for newly-built hotels. A lot of that, hopefully, will get made up with conversion activity, but as we have talked about before, the conversion activity often never lands in that pipeline.

Okay. Thank you, Arne.

You bet.

We go next to Keith Mills with UBS.

Good morning.

Hi, Keith.

Three questions for you. I guess three is the lucky number today.

First, Arne, could you tell us what Marriott's management strategy is now as it pertains to the second half this year - in 2004, improving -- improves relative to corporate -- [Indiscernible ]

Let's see. You used words that mean a little different sense to me. The part of your question, sort of a mixed strategy.

Yeah, trying to get a sense from a corporate perspective of, asking hotels to focus on (inaudible) groups.

We're going for every bit of business that we think kind of has a shot at being -- [Indiscernible ] So there is no group business we will not compete for unless it's also rated so low we think it's not fair to go after.

Okay.

And until I think as we get into next year, you know, we probably -- we probably spend a lot of time debating to what extent do we group up and to what extent do we leave individual assets enough room to deal with what will hopefully be a strengthening transient demand.

(inaudible) second question is and you brought up in your prepared remarks, that city-wide business was weak in the second quarter. One of the concerns has been given the explosive growth over the last few years and what we expect to take place over the next few years on convention space supply growth, the fact that Las Vegas seems to be taking some market share from convention.

How is Marriott at the property level working to try to, particularly in the largest market, have big assets that are supporting the convention center, working to try to keep those conventions in those markets?

That's a different challenge in every market. You know, we have got, for example, convention center, hotel in Philadelphia is working with Philadelphia Convention Authority and the city government, as well as the state governments to do everything they can to make that a more attractive convention destination than the market appears to think it has become in the last few years. And it's if dealing with the kind of challenge that Orlando by contrast, which has good city-wide and good convention business in the '04, '05 time frame, so it's got a good challenge.

We do what we can with the local authorities. I think beyond that, we believe that we can, with our biggest customers, work with them to try and make sure we're providing the outlet for wherever they want to have their group meeting. To some extent, provide our own Marriott rotations.

So, if the group customer said I want to be in the desert one year and the beach one year, and an urban environment one year, we'll go tow up a desert beach and urban hotel for them and try and get their bookings for the next three years. So we're doing something even independent from the convention authorities to try and capture as much of that business as we can, and our statistics suggest we're performing very well.

Thank you.

And then the final question is if you look at the, I guess, the loss ratio on the synthetic fuel business, it's variable from quarter to quarter. Looks like 67% this quarter. It's arranged from, you know, 60 to 90%.

Is there any way you can kind of give us some sense as to how that may play out the rest of the year in 2004 and why it's volatile?

Yeah, you're going to spend if you're interested in this, time with Laura. I won't go through all the details. What is happening is the first part of the year, which which in 2003 was the first quarter, and 2002 was the second quarter as related to the business, we're paying relatively more per credit produced because of the terms under which we bought the synthetic fuel plans.

Until we get through the first level of volume, therefore our losses per credit produced are going to be higher early and that will be the case basically every year between notice and when it ends in the end of 2007. (inaudible) will always be a greater loss in the first part of the year.

The other thing that is happening, which I think won't be repeated after 2003, is in the the balance of 2003, given the transaction we did at midyear, our partner in this business will be taking relatively more of the tax credits than we will, because we already took, you know, essentially all the tax credits the first part of this year for the balance of the year, and they'll be taking them, we'll be making a profit on the sale of the credits to our partner, which will meaningfully reduce our losses in Q3 and Q4. Again, that trend should not continue next year. But I would have you get with Laura and (inaudible) for more detailed questions on that.

Okay. One final question.

I just thought of this while I have you on the line. Could you give us an update on the legal front, in terms of the lawsuits filed in the last 18 months against Marriott.

There is not much new. We have got, I guess, four lawsuits left. We have had, I think, three or four that have resolved themselves. Those four include the most recently filed case in New Orleans, which we won on two preliminary hearings.

The lawsuit remains pending but is essentially -- [ Indiscernible ] We have a lawsuit in West Virginia involving an individual hotel. That lawsuit actually has been stayed in the expectation in hopes that the parties can reach some sort of understanding which will cause it to go away and hopefully that will turn out to be a reality. Um, but the two more significant cases, which are the case against Henry Chang and the case against strategic hotel remain in discovery and other than lawyers making a lot of money on that process, there has been no change.

And there haven't been any new cases.

And no new cases.

Appreciate your comments. Thank you.

Okay.

We go next to David Anders with Merrill Lynch.

You win the prize, David. This will be the last question. And we'll wrap up. Go ahead.

If you could comment on the increase as far as the conversions go, it's been a big part of your business. The momentum continuing there or how do we think about conversions?

Conversions, you know, we look at our REVPAR premium numbers and every one of our brands has substantial REVPAR premiums. In some brands, it's dramatic. You look at the REVPAR premiums of Courtyard and Residence Inns and you're talking about (inaudible) and Residence Inns.

Marriott brand running it in the midteens as a premium over their competitive sets, and what all that is an indication to many people who own hotels or who are thinking about buying hotels, they believe if they can take a hotel that doesn't carry our flag and put one of our flags on it and therefore get some of that premium, they're going to create more value than they would if they leave a weaker brand on it. And that's driving a lot of these investors to approach us about converting brand.

We continue to take a pretty small fraction of the conversion opportunities that are (inaudible). For a big mix of reasons. Sometimes the product quality, sometimes it has to do with the fact that we have got adequate distribution from the markets, particularly low demand environment and have no need to take additional hotels. But we are continuing to take them where we think it makes sense. For us and for our partners. And that's what is driving that volume. I think we'll continue to see strong interest on the conversion side for a good number of quarters going forward.

Um, you know, all of us should remember even when we start to report positive REVPAR numbers, those REVPAR numbers are not going to immediately turn to plus 20%. They're going to be less than a few points, and it's going to be a good number of years, I think, before we get back to the level of profitability we have seen before, meaning there is going to remain pressure on a good number of the systems for a sustained period of time, and that's what is going to drive the conversion opportunities towards us.

Great, thank you.

You bet.

All right, thank you all very much for your time. We obviously are here to answer any questions that we couldn't get to in the time allotted and to take any follow-up as you think of any questions that develop later.

As always, we appreciate your interest very much in Marriott's results and forecasts. And as we have done in the last number of quarters, we beg of you to get out and travel. Travel with your families, your jobs and fill hotels.

Thank you all very much. Talk with you soon. Bye.

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